Happy days are here again1
The skies above are clear again
So let's sing a song of cheer again
Happy days are here again
—Jack Yellen

I ask you: How do you have two major hurricanes costing enough to pay for another war plus an increase in energy prices to an all-time high (along with the budget deficit and the trade deficit) while consumer confidence goes down the tubes and expect to go on living as you've been living? You listen to the Republicans.

Soft-pedaling the economic news is to be expected. After all, if the public realized the situation we're in, it would only get worse—and besides, they wouldn't be so likely to vote Republican at their next opportunity.

The situation is actually so bad that even the AP reporters are beginning to wonder out loud. Yesterday Tom Raum wrote,

Things are going so badly for President Bush and his fellow Republicans that it is hard to imagine what could come along and make it worse. Think recession.
....

The "R" word is being heard more often among economists, especially after recent reports showed tumbles in consumer spending and confidence.

New home sales are down. Auto sales have slowed. Higher energy prices - due partly to the hurricanes that damaged drilling and refining installations along the Gulf Coast - have eroded consumers' buying power. Inflation is trending higher. Interest rates, too.

"Recession risks are rapidly rising," said Mark Zandi, chief economist of http://Economy.com, an economic analysis service in West Chester, Pa. The last recession was in 2001.

Zandi is not forecasting a recession. But he said a cold winter, a further pullback in consumer spending, a terrorist attack and other variables could tip the scales. "And if we are going into a recession, by time we get around to figuring that out, it will be too late," he said.

As I read it, Zandi is saying there will be no recession so long as we live in a perfect world, so don't be alarmed.

I've been trying to alert readers to the coming economic disaster over the past year, but like everyone else in the gloom-and-doom business, I could not say what would be the precipitating event. And while our problems cannot be laid at the feet of Katrina, I believe Katrina may be identified as the event that marked the beginning of a steeper economic decline.

I haven't been alone in my pessimism. In April economist Paul Krugman was reminding people of a condition that arose during the Jimmy Carter presidency of the 70s, another time of high oil prices. It was a condition that economists didn't even believe could occur until it did occur, so they had to invent a new name for it—stagflation, a high rate of inflation paired with high unemployment.

Krugman thought we were in a mild stagflation in April, then added—

We shouldn't overstate the case: we're not back to the economic misery of the 1970's. But the fact that we're already experiencing mild stagflation means that there will be no good options if something else goes wrong.

Suppose, for example, that the consumer pullback visible in recent data turns out to be bigger than we now think, and growth stalls. (Not that long ago many economists thought that an oil price in the 50's would cause a recession.) Can the Fed stop raising interest rates and go back to rate cuts without causing the dollar to plunge and inflation to soar?

Or suppose that there's some kind of oil supply disruption - or that warnings about declining production from Saudi oil fields turn out to be right. Suppose that Asian central banks decide that they already have too many dollars. Suppose that the housing bubble bursts. Any of these events could easily turn our mild case of stagflation into something much more serious.

All of Krugman's suppositions are coming true, though the housing bubble has still to be popped. Further bad news is that Krugman doesn't see a way out of this jam—

How do we get out of this bind? As the old joke goes, I wouldn't start from here. We should have spent the years of cheap oil encouraging conservation; we should have spent the years of modest growth in medical costs reforming our health care system. Oh, and we'd have a wider range of policy options if the budget weren't so deeply in deficit.

So if any of these things does come to pass, we'll just have to see how well an administration in which political operatives make all economic policy decisions, and the Treasury secretary is only a salesman, handles crises.

In other words, we're screwed.

Related economic news ...

Last week President Chavez pulled all of Venezuela's substantial foreign currency reserves out of U.S. treasury bonds and moved them to European banks—a smart move as the dollar sinks but also a wise move given the U.S. propensity for freezing assets held by foreigners it doesn't like. At the same time the transaction further weakens the dollar but was hardly noted in the MSM.

The American auto industry, which insists that the only reason they sell gas guzzlers is that the American public wants them, has suddenly found that SUVs and trucks have fallen from favor. GM reports SUV/truck sales down 30% and Ford took a similar hit of 28%.

And a word from a currency and precious metals trader

You would expect Jim Sinclair to be bullish on gold, but he has his reasons—

1. The US Federal Budget deficit as a result of really bad weather and worse contingency planning is not going to be as advertised - under $360 billion - but rather over $550 billion. The idea that you can fight multiple wars, rebuild decimated cities and lower taxes is madness of world-class proportions. Lets' also not forget that cities and states as good little children are following the example of their Federal Daddy and deficit spending their tiny rear ends off as well.

2. The Trade balance thanks to ever escalating energy prices is also going off the scales on the deficit side.

3. The mad, mad, mad, world of US conspicuous consumption has landed US saving rates at below zero.

So how can all this be financed? Don't look at China as China bashing has finally bashed the dickens out of the theory that because Asia has so much US paper it has to buy as much as the US can print. Not so! Asia may not be functionally able to sell what they have but their continued consumption in order to allow the US to offend them is simply not going to happen. Asia will off-load their US paper by massive international corporate acquisitions outside of the US.

It happened again as the US put pressure on China for a more vigorous revaluation of their currency at the recent Washington get together. This is like a person (the financial management of the US) slitting their own throat and demanding a sharper knife so they can cut a few other necessities off as well.

So as currently presented, US financial managers intend to peddle US federal paper to people who are fed up financing the US, producing a backlash that no one really expects. More federal paper means more dollars. More dollars mean more supply on the market as interest rates rise as a direct result of smaller and smaller purchases by non-US interests of the much bigger supply of US Treasuries for sale.

The classical result that will happen by mid 2006 is:

1. A sharply lower US dollar.

2. Sharply higher interest rates.

3. Former Chairman Volcker's prediction that we would have a financial crisis within the next five years (one more year to go) could actually unfold tomorrow.

I just thought you should know while you can still convert to euros and buy that foreign real estate.

Previous posts
Something you should know about your dollars (9/24/04)
More comment on the dollar (10/11/04)
Buying a used Mercedes (2/8/05)