Themes And Analogies: Kondratieff Winter; Supercycle; Interconnected Financial Defaults; Bubble Bursting; Financial Dominos Falling; Financial House Of Cards Collapsing; Financial Nuclear Reaction; Financial Meltdown; Contagion; One Hemorrhaging Patient Giving Blood to Support Another Patient Who Is Hemorrhaging Even More; Financial Hurricane – Leaving The Eye And Entering The Second Part Of The Storm.
For the past 80 years, governments around the world made a series of financial mistakes. They detached their money from gold and silver, enabling more and more “money” not backed by anything of value to be issued.
For the past 30 years, many governments in the developed world lived beyond their means. They ignored the warning that debt can cause very serious problems (the rich rule over the poor, and the borrower is servant to the lender – Proverbs 22:7). They ignored the principle that every 50 years, during the Year of Jubilee, the debts of the people of Israel were forgiven and the financial system was reset. To finance their over-spending, they issued debt. National levels of debts have steadily accumulated until they are at critical levels. Now there is danger of default.
Adding to the financial instability, highly leveraged banks bought the debt of these nations. If enough smaller nations default on their debt, or if a larger nation defaults on its debt, the banks may collapse into bankruptcy.
Adding to the financial instability, in response to the first part of the financial hurricane, the FASB, the Financial Accounting Standards Board, along with most governments, allowed banks to over-value their assets. That means that those banks are weaker than they might appear.
Adding to the financial instability, governments promised trillions of dollars worth of pension and health care benefits which can never be paid.
Adding to the financial instability, hundreds of trillions of dollars worth of derivatives, which function as a kind of insurance, have been bought and sold. If interest rates make a sudden move up, or if government debt or banks collapse, derivatives claims will be activated. And, if an issuer of derivatives is under-capitalized and can’t meet its obligations, that might cause the parties it promised to insure to fail to meet their obligations, and a chain reaction of derivative failures can ensue.
Adding to the financial instability, the gold and silver markets are very small compared to the amount of money and credit that have been created. As this less-quality money seeks safety, there can be an explosive move upward in the price of the best money – gold and silver. That can cause a crisis of confidence in governments and their non-gold-and-silver-backed currencies.
Adding to the financial instability, some governments created moral hazards by responding to previous crises by lowering interest rates, loosening credit and bailing out companies. That encouraged people and institutions to take on additional risks and make more bad investments.
The US government responded to the bursting of the stock market bubble in 2000 and then the bursting of the housing bubble by creating money, lowering interest rates, loosening credit, deficit spending, issuing more and more bonds, bailing out companies, guaranteeing money markets, and buying bad debts at too high a price. That created another and bigger financial bubble – a government debt and currency bubble. That gave a little temporary relief (the eye of the hurricane) but made the situation worse. Now the US government is in a weaker and more precarious financial position.
All of these errors and instabilities have created a situation in which the government debt and currency bubble has started bursting. It started in the most indebted of the European nations. Since the US made the same mistakes and went to the same excesses, expect the US government debt and currency bubble to burst. Expect everything that is “too big to fail” to be bailed out with more “money” and credit. Expect real things to get more expensive when measured in most fiat (non-gold and silver backed) currencies. Expect a much lower standard of living.
How Governments Respond To Severe Financial Crisis
When governments have been spending too much, giving too many perks to too many people, and are unable to sell more bonds and pay off their debts, they have the following options (or combination of options):
Raise taxes significantly. This may be hard to do.
Cut spending significantly. This may be hard to do.
Declare bankruptcy. This causes immediate, serious financial and political consequences and is hard to do.
Create more money and pay off the debts with increasingly worthless money. This is easier to do than declare bankruptcy, since it buys time, but it is worse to do because it destroy the currency and much of the economy and the confidence of the people in the government. Since it is easier to do, and most people can’t easily see it happening or understand the implications, and since it delays the day of reckoning, most governments tend to choose this option. That is what the European governments choose to do the weekend of May 8-9, 2010. That means the most likely outcome to the current financial crisis is a hyper-inflationary depression.
80 years ago Ludwig von Mises understood the choices and outcomes to a credit bubble: “There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved”.
Who Is Responsible For Allowing This To Happen?
Flawed economic theories (Keynesian); stupid or corrupt (or both) political leaders from both parties over many years; negligent regulators; an uninformed and uninvolved citizenry; financial predators that took advantage of the growing disaster.
How To Respond
The way to respond to a government debt and currency crisis is to buy real tangible goods that will maintain value – especially gold and silver (and especially silver, which is undervalued compared to its traditional relationship to gold). The precious metals have a long history of being able to store wealth in inflationary and deflationary depressions.