Our Scary Economy – Spoiled Brat or Dope Junkie?

Chicken Smith View:

Spoiled Brat“I want more candy!” says the 4 year old. “No, you’ve had enough!” replies the mother. Then the wailing and crying commences with interspersed pleas for leniency, promises of “I won’t ask for more if you give me some” and “please… just a little bit more?” maybe throw in a little temper-tantrum and some more whining as many 4 year olds can and will be prone to do. I’m sure many can relate.

JunkieNow, take the not too dissimilar scenario of a dope junkie trying to get another fix from her “sugar-daddy”. I don’t even need to change the quotes from the 4 year old above. The dialog is practically the same and the problem is practically the same — an absurd insistence for something that may satiate an immediate desire, but will, in the long-run, cause more harm than good (ie, bad teeth, bad personality, and bad health for both the child and the junkie).

Let us take a look at what is and what has been going on and let’s try to determine if we are witnessing the same type of problem in our economy: the rationale of a 4-year-old and the addiction of a junkie.

Business CycleFor starters, everyone is always referencing the “Business Cycle” as proof that markets, and therefore our economy, will naturally go up and down as part of the “cycles” although eventually it all goes up in the long run. What they generally don’t take into account is one little wrench that can skew many an upward trending chart: inflation.

Business and economics is much more complicated than what relegating it to a simple up and down line graph tends to portray. Living in our U.S. of “A” glass-bubble has caused us to ignore the fact that economies around the world have historically tumbled and shown long periods of downward trending line charts that seem all but a mystery to us on American soil. But make no mistake, charts do not discriminate and can and will make use of positive and negative trends on any continent.

InflationWe are currently witnessing inflation in our country at levels not felt since 1973. While that may sound reassuring in a round-a-bout sort of way (ie, “well at least it’s something we’ve already been through”), the fact is that we are at the start of a recessionary cycle, not the end of one, so this is only the beginning. If inflation continues the way it has been recently, we’ll easily exceed those 1973 levels and start entering into uncharted territory.

Think there’s no inflation, because the Fed says so? Think again. When the Fed says inflation is under control, they are only referencing core-inflation (as in long-term, according to their magic ball). Unfortunately, core-inflation does not include food and energy prices, which, if you’ve gone shopping for food or have been paying your energy bills within the past few years, you may have noticed how much they have shot up.

Energy is increasingly becoming more expensive due to emerging economies and their increasing demand for it. The same goes for food, as our American population has increased dramatically in the past century, while our farmlands have remained about the same. So now we purchase a lot of our goods from abroad — at world-market prices.

Dollar IndexInflation, of course, has caused our dollar to weaken, as you now need more of it to buy what you could last year with less of it. That, in turn, causes other currencies to have more value in relation to our dollar. Take the Canadian Dollar for instance. Just three years ago, one American Dollar would get you $1.30 Canadian, today, that same American dollar gets you about 95 Cents Canadian. That’s more than a 25% depreciation in under 3 years! It’s no wonder Canadians are flocking across the border on weekends to purchase goods here. It’s all at 25% off!

We are clearly experiencing increased levels of inflation that will have significant repercussions the longer it continues. And, unfortunately, it looks like inflation is here to stay for a while.

So, going back to our original premise, we have an economy that is beginning to slide downward with heightened inflation. So why do the markets look like they’re doing so well? Again, inflation. The reason the charts look so good is the same reason that’s causing prices to go up. Inflation. Because you now need more dollars to buy something today than you did yesterday, everything goes up in relation. Hence the Dow Jones Index has gone up close to 2,000 points since last year. Naturally, it’s not all due to inflation, but a lot of it is based on the illusion of a sound and strong economy with controlled inflation, when that’s clearly not the case.

Obviously, there needs to be a “correction” as many like to call it. However, what the economy needs is not a mild correction, it needs a major shake-up. Not by my desires, mind you, but rather by what is naturally supposed to occur in a market driven society. That means, once prices become over-inflated, as is currently the case (yes, they are, as everyone has become too accustomed to credit, whether it be credit cards, home equities, or other forms), people need to recognize the situation and cut back on spending to let prices adjust to pre-inflationary levels.

BernankeInstead, we do everything possible to avert “disaster” (the mild correction), but what is really happening is we are simply delaying the disaster for a later day and making it bigger in the process. How have we been averting it? The Federal Reserve. At the smallest sign of trouble or the smallest clamor of the people, it succumbs to their pleas and simply lowers interest rates to “stimulate” spending. In effect to squelch the cries of the people, but ignoring the larger implications.

In 2001, our economy was in a sad state of affairs. We were still going through the dot com bust when all of a sudden we get 9/11. Jobs were being sent overseas, prices were going up, and we were headed for a recession. The Fed, in an effort to “avert” further disaster, decided to lower the interest rates to “stimulate” spending in the economy. In light of the circumstances, one can give them a pass on this. However, two years later, the Fed was still lowering the rates, month after month. All to satiate the whines and moans of the addicts (all of us) begging for just one more rate cut. This, can be said, stimulated the economy a bit too much.

The over availability of cheap money (ie, credit at low interest rates) brought about the biggest boom in real estate and our overall economy since World War II. This certainly brought us out of the slump we were in, however it also took us past the correction point and into an inflationary period. This was due to the huge demands of homes and all the other goods and services that were being purchased as a result of a booming economy. Unfortunately, all on credit.

When things are looking good and money is changing hands so fast and small fortunes are being created left and right, people are willing to spend more money, thereby exacerbating the problem (inflation). We are now done with this period of irrational exuberance (to quote ex-Fed Chief Alan Greenspan, one of the architects of this mess), and the problems to come are many and long-lasting.

EconomySo now come the problems. Employment weakens (don’t just look at today’s numbers, see the big picture), foreclosures go up, the dollar goes down, inflation goes up, and again, the people (everyone, not just you and me, government and especially businesses) cry out for rate cuts. The same rate cuts that got us into this mess in the first place.

The Fed, unfortunately, has delivered. Is their hope to satiate the desires of a drugged society or to improve the economy? If the latter, rate cuts, no matter how much the 4 year old cries, is not the solution.

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