Lately, I have been struck by how bleak and black the newspapers have been in their coverage of the economy. Not that I've been surprised, but one can never know when events in the economy will coalesce into the news that causes the masses to realize how difficult the environment is.
In reading the papers, it was obvious to me that it's becoming clear to everyone that "the next time down" is well under way, though the average person wouldn't call it that.
1980-82 versus nowI was trying to remember the last time I had seen the economic news quite as ugly. For me, the 1980-82 period is the closest example I have lived through. Of course, it was quite a bit different. Many of the problems were a function of sky-high interest rates induced by then-Federal Reserve Chairman Paul Volcker (a consequence of money-supply targets, not interest-rate targets) to break the back of inflation. Also, the world looked a lot different, as the Soviet Union was still in existence and capitalism was not yet a gleam in the eye of the communists in China.
What we are now dealing with is roughly 20 years' worth of massive speculation and excess leverage, championed by the United States and mimicked by other countries around the globe. It appears the potential for the newest round of financial weakness is being precipitated by economic problems in Eastern Europe, which are impacting the European banks, especially German ones.
We are at the stage now where economic weakness is feeding back into everything, making the situation more difficult for banks everywhere. And, it's becoming clear to nearly everyone that many banks are not just illiquid but insolvent.
The globe took up our gauntletThe "next time down" scenario that I outlined in 2004 is hitting now with full force. However, at the time, I hadn't really thought through the implications of the speculative nature of what had transpired in the entire world, because when I first started thinking about and discussing this outcome, the rest of the world had not gotten quite so drunk. But by the time the madness of the crowds finally breathed its last on the upside, the insanity we saw at home had been pursued in many other countries. Iceland is bankrupt, Ireland may be following suit, and who knows what others may join that sorry parade?
The one surprising outcome thus far is that the dollar has been able to stay as strong as it has (which I believe is a temporary phenomenon). It is becoming clearer to everyone that currencies -- the dollar included -- have no intrinsic value, as they are just pieces of paper. That's one big reason gold has been so strong recently.
How we got hereOf course, one of the underlying reasons for the strength in gold has been the action of the governments and central banks around the world. Along that line, The Wall Street Journal on Feb. 18 carried an article titled "Synchronized boom, synchronized bust," in which my friend Marc Faber detailed just what the headline implies. None of this will be news to any reader of this column. But Faber's article is a well-written, concise explanation of how the world arrived at its current predicament, which makes it a worthwhile read.
A couple of important points that he makes regarding the government's meddling in the markets:
- "It is not that the free market failed. The mistake was constant interventions in the free market by the Fed and the U.S. Treasury that addressed symptoms and postponed problems instead of solving them."
- "Further interventions through ill-conceived bailouts and bulging fiscal deficits are bound to prolong the agony and lead to another slump -- possibly an inflationary depression with dire social consequences."
Not exactly a feel-good piece, but understanding where you are is an essential component of figuring out where you're headed.