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An open look at the future   <<<
 >>>  Una vista abierta del futuro

The next 20 years are not

 going to be anything like

 the past 20 years.

Los próximos 20 años no

 van a ser nada similar a

 los pasados 20 años.

ENGLISH (Español mas abajo)
The Crash Course seeks to provide you with a baseline understanding of the economy so that you can better appreciate the risks that we all face. Dr. Martenson states his three beliefs: massive change is upon us, that change may overwhelm our ability to respond, and that we do not lack the technology or understanding necessary to build a better future. 


El usamericano Chris Martenson se doctoró en ciencias en la Duke University (Durham, North Carolina). Es autor del Crash Course (que rápidamente recibió grandes elogios y alcanzó una enorme popularidad en su versión inglesa original. El Crash Course pretende ayudarles a comprender la naturaleza de algunos retos de extraordinaria gravedad para nuestra economía y su futura prosperidad. Lo que están ustedes a punto de ver es una versión muy resumida de un seminario de entre 6 y 8 horas que Chris Martenson ha estado impartiendo desde hace cuatro años en su país, Usamérica.
1. El cambio masivo y está en marcha.
2. Es posible que el cambio sea sobrecogedor.
3. Podemos programar el futuro.


Okay, so you’ve seen the entire Crash Course, showing how the Economy, Energy, and the Environment are interlinked. Specifically, you’ve seen that there is a substantial mismatch between an economic model that must grow and a physical world of peaking oil and depleting resources. We cannot possibly solve any one of these main issues in isolation, because doing so will simply create new problems in one of the other “E”s. Truly non-status-quo solutions are called for.

Which means there is a very real chance that our collective path will not be a linear extrapolation of the present. Our individual challenge is to accept the possibility that the future may be quite a departure from the present.

I believe that the future is not some purely random roll of the dice, and that we can minimize future disruptions in our lives by taking actions today.

In one way I am glad to have waited to produce this final chapter, because we have had the great financial panic of the Fall of 2008, and we can more precisely map where this is all headed.

The multi-trillion-dollar bailout packages offered to banks by various governments across the globe are nearly 100% dedicated towards preserving the status quo.

But at the same time, none of these challenges or trends are going to be helped in the slightest by bailing out the banking system, and some will be made worse. The fact that our national leaders have chosen to go several trillion dollars further into debt in a desperate bid to preserve "what was" simply indicates that it is now even more probable that the burden of meeting these challenges has shifted a bit further towards private citizens and small communities.

Part of the complication with developing a “what should we do” chapter is that I have no idea where your beliefs lie. Everybody exists somewhere along this spectrum of belief, ranging from expecting a rather ordinary, if not slight, interruption in economic growth, all the way on up to a big breakdown. Everybody exists along here somewhere.

And depending on where you happen to sit, both the number of things you could do, and their urgency, increase dramatically.

Given this, where do we start? How do we get started, when there are so many variables and things that need doing?

This is why we need a framework for action.

There are four sequential steps to this framework. First, you have to decide that you are going to take action. Without this commitment, there’s not much point in continuing. Second, you need to take stock of where you are, and here I propose a self-assessment that will unearth your strengths, weakness, opportunities, and threats. Third, you’ve got to sort among the infinite list of things you could do, and then fourth, you’ve got to prioritize this list, because you can’t do everything. Together, these create the framework for action.

So let’s begin with Step 1 - the case for action.

First, let’s add some detail to the spectrum I laid out before. Here we might assess the potential for disruption as beginning with “status quo,” meaning that all the key risks dissipate relatively rapidly. Next on the spectrum would be a prolonged recession and all that that entails. Next we might place a collapse of the financial system on here, and finally we might envisage a collapse of government services at all levels

I am pretty certain that our future lies somewhere along this spectrum; the problem is, I don’t know where. The key here is that I cannot entirely rule out any particular outcome. I can’t place a probability of zero next to any of these, so I need to weigh them all.

So let’s play a little thought game with one of them and see how it might lead to making a case for action. Let’s use #3 – Financial System Collapse.

Without worrying about how likely or probable a financial crisis might be, let’s simply say it is either true or it is false. That is, it either happens or it doesn’t. Hopefully we can all agree that “true or false” pretty much covers the total range of possible outcomes.

And down on this axis, we’ll say that you either prepared for this crisis in advance or you did not. Again, it is either true or false that you chose to take steps to mitigate the impact of a financial crisis.

So what happens if it’s both true that the crisis happened and that you did prepare as best you could? Congratulations - give yourself a smiley face; you did the best you could.

And what about the case where the crisis did not happen and you did not prepare? Again, congratulations - you did the best you could. It turns out that these are essentially equivalent outcomes, and we can therefore remove them from our decision framework. In each case, we got the best outcome we could, so there’s not much to be gained from weighing and comparing them.

But what about this case, where the crisis did not happen but you did prepare? How bad could that be? What’s the worst that you could put in this box? Well, you probably wasted some money (maybe the opportunity to participate in capital gains in the stock market) and some wasted time, but perhaps worst of all, you ended up feeling foolish. That’s awful.

Now let’s compare this box to this other box, where the financial crisis happened but you did not prepare. What can we put in this box? Here it’s possible that you suffered a massive loss of wealth, had to make sudden, massive adjustments under the pressure of little time and scarce resources, and live with a sense of recrimination for having been “right” in your concerns but unprepared nonetheless. You can probably put a bunch more things in each of these boxes, and you should. But for our purposes, we’re done.

Now all we have to do is compare these two boxes. That’s it. In the scheme of things, which is worse? Where would you rather be? We are all built differently, but I am the sort that could never forgive myself for being right but unprepared. I can more easily forgive myself for being wrong and prepared. But that’s just me. Only you know which of these two boxes carries more weight for you. But if you picked the upper right box, then I need to ask, “What’s preventing you from taking action?”

Here’s a slight refinement of this thinking that allows for more subtlety than “true or false.” Suppose that we revisit our spectrum for a financial crisis that spans from “it’s not too bad” all the way to “everything breaks down and stops working for awhile.” Let’s assume that everyone has a different assessment of how likely any particular outcome is.

We might find that one person assesses the chance as very low that anything too bad will happen, while another person holds a nearly opposite view. In one important respect, they hold the same view; they both hold the possibility of a bad outcome as being greater than zero. When an outcome has a potentially huge impact, a prudent adult may decide to react to that risk, even though it is not very probable.

As long as some risk exists in your mind, and as long as the potential costs of not taking action are outweighed by the costs of taking action, then it makes sense to take action. That’s the case for action.

Okay, assuming you’ve decided that taking action makes sense, the hard part is where? We’ve been talking about some very big changes in the Crash Course, so where does one begin in this enormous universe of potential actions?

Here’s where I would recommend that you spend an hour and perform a self-assessment. There is an outline for this that you can download in the ACT section of ChrisMartenson.com.

It consists of three main areas. Your financial self-assessment should include your current & future needs, your current & future income, taking stock of all forms of wealth, and any issues concerning accessing your wealth that apply.

There are similar sorts of areas to cover that I am calling foundational that are equally as important, if not more, than the financial areas. Lastly, there are all of your physical needs to consider. A typical result of conducting a self-assessment is discovering that our lives are very much dependent on a lot of things we take for granted.

Once you’ve got your self-assessment complete, you have a pretty good idea of where you are strong and where you are not. The self-assessment, then, is your starting point – it represents your position in relation to the outside world.

Now we need to go to the outside world and rank all of the possible risks and challenges that exist, that we will then match against our self-assessment.

The three dimensions that we will use to begin bucketing the various events and risks are time (that is, how near or urgent is the risk or event), impact (is this a big deal or a little deal?), and likelihood (which is the same as the probability of the event).

To get a handle on time, consider grouping events on a timeline. In the first Horizon, which I see as running from zero to two years out, I place the housing bust, a credit bubble burst, and the possibility of a systemic banking failure. A bit further out, I foresee petroleum demand and supply crossing, issues with boomer retirement, and the possible emergence of very high inflation. Even further out, I see really big, hairy challenges like national insolvency, perhaps the end of fiat money, and the emergence of a new economic model.

Since I can’t respond to all of these at once, I mainly focus on those that are within the immediate Horizon. Again, you could place very different things in each of these Horizons, and those would be the ones you would use. These happen to be mine. For illustrative purposes, we’ll run through an example based on the possibility of a systemic banking failure.

Next, I segment things by Impact and Likelihood. If you understand insurance, you already understand this next process. Think of fire insurance on a house. We don’t carry it because such an event is especially likely (it is not), but because the impact is so catastrophic. That is, a prudent person will combine impact and likelihood to come to the decision that purchasing fire insurance makes sense.

So here’s a way to do that for the other areas in your life. Suppose we construct a simple 2x2 chart, and on this axis we break thelikelihood of the event into “High” and “Low” buckets, while on the other axis we split the impact into “High” and “Low” buckets.

So something that is both low impact and low likelihood is something that we should not ever spend any of our precious time or resources on. Things that fall here are just not worth worrying about.

Anything that is high impact and high likelihood is a slam-dunk. We always attend to these, and we do them first.

Things that are of high impact but low likelihood require more thought, but generally we would usually attend to most of the things in this box next. After that, we’d sometimes attend to things that are low impact but high likelihood, especially if they happen to have easy or quick remedies.

So this becomes the area where events fall that I attend to. How you happen to fill this in will depend on your age, financial means, family situation, and a host of other factors

Because I consider there to be a 50% chance of a systemic financial collapse over the next 2 years, I place this as a high impact/high probability event, meaning that this is a risk that deserved and got a lot of my attention.

So let’s continue with the example. With this two-by-two grid in our minds, we might flesh out the risks associated with financial system collapse using a table that looks like this.

First, we might assess the likelihood of widespread bank closures to be “high,” the impact to be “high,” and therefore the rank of this event as “high.”

Then we might come to the same conclusions about our own personal banks. But we might assess the overall rank of a disruption in the food distribution network as “medium,” and dollar destruction as “medium” because it has both a high and a low which average out to medium. We might assess cuts to government spending as “low.” These are a few examples. Other things can and should be added to the list.

The point here is to assess the likelihood and impact of each event that we think applies to the scenario we are studying. When you’ve completed this, we’ll have a ranked list of events.

My recommendation is that when you do these exercises, that you do them with like-minded friends…they will think of things you will miss, it’s more fun, and will go faster.

Now you’ve got to generate a list. You do this by filtering those events that are imminent, likely, and of high impact, through your self-assessment. I guarantee when you do this, you will end up with an entirely too long list of things that you could possibly do.

It’s time to prioritize.

First, the list can quickly be broken into things that you can or will do, and things that you can’t or won’t do. One person might feel completely empowered to move their wealth around; another might have their wealth locked in an irrevocable trust.

Of the things that you can or will do, we will break those into three tiers of action, such that Tier 1 is always started and completed before beginning Tier 2, which will always precede Tier 3. This makes it much easier to get started, because the lists are much more manageable.

Of the things that you can’t or won’t do, your options include finding someone else who can do them (and this is where community comes in), or letting them go and not worrying about them anymore.

Back to our example, let’s suppose that after filtering your ranked events through your self-assessment you came up with a nice long list of actions that you’d like to undertake. Almost certainly, there are too many to do all at once, and it is time to use the three-tier system to identify and tackle the easiest, lowest cost, highest bang-for-the-buck stuff first.

So what is Tier 1? It consists of the easiest, quickest, and cheapest items that require minimal outside assistance and no substantive changes to lifestyle. In this example, then, we might decide that taking a bit of hard cash out of the bank would provide a reasonable buffer against the risk of being without purchasing power, should the banks and ATMs go “on holiday” for a while. This is easy and very do-able. Our major risk would be feeling a bit foolish later, after nothing happens and we go to redeposit that money in a bank. We might also decide to spread our bets around, just in case the bank holiday was not universal and only applied to some banks. Lastly, we might decide to hedge against the vast loss of purchasing power that the people of Argentina experienced while their banks were shuttered. Gold represents one of the few ways to hold a money-like asset entirely outside of the banking system. And we’d do all of these things before even thinking about starting the Tier 2 list.

And so we proceed to Tier 2, which consists of those Items that plug the biggest gaps in your self-assessment and require a significant investment of time, money, and energy.

For instance, implementing a saving program so that you can afford needed items, or thinking about ways to create a food buffer for your community, or getting involved with your neighbors and local scene to a greater extent.

After these items have been gone through, it is time to consider the Tier 3 items - the hard stuff. These are the biggest changes or life decisions on your list, such as changing where you live, or acquiring new skills, or maybe changing your job. The point is that you should resist the urge to spend any time or energy mulling these over until you’ve made serious progress on the Tier 1 and Tier 2 actions.

If all of this seems like too much work, and you were hoping Chapter 20 would be a more directive and simplified “here’s what you do” shopping list, I can only say that there are no easy answers for the magnitude of the challenges we face. This chapter could easily be an entire course itself, and future videos on my site will explore these questions in greater detail.

What I have been consistently trying to prepare people for, the whole way along, is that the next twenty years are going to be unlike the last twenty years.

Specifically, I think we each need to be prepared for a financial catastrophe – not because we are 100% sure it will happen, but because we can’t be 100% sure it won’t happen. Prudent adults identify and manage risks.

And I think we each need to be prepared for the possibility, the possibility, that a disruption in our basic support systems could happen. The things that surface in this line of thinking are considered very “out there” in today’s society, but barely 100 years ago our complete dependence on the just-in-time delivery of the basics of life would have been considered mad.

Lastly, I think the future is going to be about moving from an “I” to a “we” culture…back to a bygone era, where neighbors weren’t just nice to each other, but relied on each other. As an informed person, it is now your responsibility to help others as best you can. Perhaps this will be with their knowledge and consent; perhaps you will have to be more indirect if they are not yet ready to confront the changes.

And so I close with a personal call to action. Now that you’ve completed the Crash Course, I hope you’ll agree that the challenges we face are not being adequately addressed at the national or international levels. I created the Crash Course specifically to reach people, one at a time, because I hold the belief that some of the risks we face are moving much, much faster than the political process. I created the Crash Course so that you would understand what is going on and to do my very best to help you appreciate that the future could be quite different than the past.

I need your help spreading the word. The Crash Course has been seen by hundreds of thousands of people all across the globe, without any advertising on my part. This is because people like you have taken the time to pass it along to their friends, relatives, and coworkers. But I want it to be seen by millions. We need to create a tipping point of awareness around these issues.



The Five Horsemen

 Martenson Report from May of 2009
Executive Summary
  • What can we expect next, and how will we recognize it?
  • A series of sharp, interrupted shocks is more likely than a major sudden collapse.
  • Five game-changing events, what I call The Five Horsemen, will indicate that the rules have changed and a new reality is about to take over:
    • The First Horseman: New credit growth falls below interest payments
    • The Second Horseman: The Fed monetizes debt
    • The Third Horseman: Government deficit spending exceeds 10% of GDP
    • The Fourth Horseman: The dollar goes down, while interest rates go up
    • The Fifth (and final) Horseman: US debt becomes denominated in foreign currencies

Severe structural damage has already been inflicted on our economy. As I wrote two weeks ago (May 16, 2009) inIt Has Hit the Fan:

If you have been waiting for further confirmation about the direction of the economy, or waiting for a sign that it's now time to get serious about preparing for a future filled with less, this report is written for you.

You are living in the midst of the collapse of western economies, which are moving from a more complicated state to a less complicated one. This is it.  Keep a journal, because it's happening right now.

After the Great Depression, many people remarked that it was only obvious in retrospect. While it was unfolding, things steadily eroded. But 75% of the workforce remained employed, while hopeful signs of progress were constantly trotted out by various politicians, private economists, and official-sounding government agencies. It is often quite difficult to appreciate the true magnitude of sweeping change while it is occurring.

The most pressing question now is this:  What can we expect next, and when? 

In this report, I give you the precise combination of macro-events that will cause me to issue an alert and kick my thinking and actions into new orbits.

The Path

I do not expect a major sudden collapse to be the most likely path, although it is a possibility. Instead, I anticipate a series of sharp shocks, followed by periods of relative tranquility. 

Here's how I described the various paths in May of 2008, in a report entitled Charting a Course Through the Recession:

While it is possible, I do not anticipate a one-way slide to the bottom, wherever and whenever that may be. I lean towards the ‘stair-step’ model, where a series of sequential shocks and relatively placid periods mark the path to the future. The three scenarios around which I tend to form my thinking (and actions) are:

  • No change. The future looks just like today, only bigger, and no major upheavals, shocks, or recessions happen. The Fed and Congress are successful in fighting off the deleterious effects of the bursting of the housing bubble, and everybody carries on without any major changes or adjustments. This is not a very likely outcome.  Probability: 1%.
  • A series of short, sharp shocks. Moments of relative calm and seeming recovery are punctuated by rapid and unsettling market plunges and marked changes in social perspective. Think of the food scarcity and riots, and you know what this looks like. One day there was low awareness about food scarcity and the next day shortages and prices spikes were making the news. Soon enough, relative calm returns, prices fall, and order is restored, but prices somehow do not recover to their previous levels, leaving people primed and alert for the next leg of the process. I see this as the most likely path forward.  Probability: 80%.
  • A sudden major collapse. Under this scenario, some sort of a tipping point causes a light-speed reaction in the global economic system that requires shutting down cross-border capital flows. Banks would no longer be able to clear transfers and accounts, which would wreak all sorts of havoc upon our just-in-time society. Food and fuel distribution would be the most immediate concerns. There's enough of a chance of this scenario occurring, and the impacts are potentially so severe, that you should take actions to minimize the impacts to yourselves and your loved ones.  Probability: ~20%.

Based on the odds, the most likely outcome that I see is a series of short, sharp shocks (#2, above) as being the most likely to define the path forward. So far this has been our exact pattern with the first shock occurring in 2007, the second between October 2008 to March 2009 and now a period of stability between March and June of 2009. I invite you to re-read the piece linked above as a means of assessing my information,gathering abilities, and my ability to connect the dots, and shine a light on the future.

In the grand sweep of the trajectory that will deliver the United States, and many other western countries, to a lower standard of living (although not necessarily a lower quality of life, but that's another story), there are several discrete elements that I think of as The Five Horsemen.

The Five Horsemen

I believe that a diminished standard of living is in the future for each of the major economies across the world especially those where the inhabitants have been living beyond their means.

Another belief I hold is that any period of living beyond one's means must certainly be followed by an equivalent trough of living below one's means. For example, if you produce 100 but consume 110, then at some point you will need to produce 100 but only consume 90. 

There are two ways that we might expect this period of adjustment to unfold economically. I laid out the basic elements in Crash Course: Chapter 12 - Debt. When too many claims (debts) are laid upon the future the only question is whether those debts will be defaulted upon or paid back (with "inflated away" being a form of default). If all those claims are destroyed by default, then the reduction in future living standard falls to the holder of the debt(s). If the debts are paid back, then the debtor must accept that they will have less money to spend on consumption.  Either way, somebody has less coming to them in the future than they either expect or currently enjoy.

Stretched across an entire nation, too much debt becomes an unsolvable problem, a predicament, due to the fact that no benefit accrues from shifting the burden of bearing the impact of default from one sector to another.  Shifting a promissory note from one pocket to the other does not change the net worth of the individual and this tactic is equally ineffective for an entire country.

Thus the fact that the US government is assuming massive piles of bad debt from stricken financial corporations does nothing to solve the underlying problem, which sprouts from a nation that has overconsumed for decades. But this is exactly what the government is doing, and the goal seems to be to preserve the status quo at all costs. 

Assuming this view is correct, there are signs we can read along the way to confirm if our fiscal and monetary authorities have selected the right path or the wrong path.  This report details the signposts that will tell us when certain thresholds have been crossed that will mark that the current strategy is failing and that a new leg of the journey has begun.

The problem and the mindset of the economic elites are neatly revealed in this quote:

May 30 (Bloomberg) -- World Bank President Robert Zoellick warned policy makers that fiscal-stimulus plans are insufficient to turn around the “real economy” and rising joblessness threatens to set off political unrest across the globe.

“While the stimulus has given an impulse, it’s like a sugar high unless you eventually get the credit system working,” Zoellick said in an interview yesterday

I like this quote because it distinguishes between the "real economy" and the economy resulting from excessive government borrowing and spending. Stimulus money is almost by definition wasted money because the probability of it resulting in proper investment is so low. The gains from stimulus money run out the very second the juice is turned off. 

But it is the second part of the quote that is revealing - "...unless you eventually get the credit system working..." - apparently those in charge find it unthinkable that an economy could be built on anything other than credit.

An alternative quote expressing a more fundamental view would read, "While the stimulus has given an impulse, it’s like a sugar high, unless it is followed by growth in wage-based income".

The difference between the real quote and the one I provided is like night and day. The Zoellick quote assumes that our past period of living beyond our means is recoverable and extensible, and mine does not. Mine assumes a long-term relationship exists between what people earn and what they can spend. In order for us to service our past debts, we need to grow our incomes, not our access to easy credit.

There is a mathematical limit to this "game," at which point it cannot be carried on any longer. I think we have reached the outer limits of our debt-fueled fantasy, although I recognize that the extreme efforts to carry it on a bit longer may well produce short-term results.

The most obvious and mathematically-defendable end of a credit economy comes when interest payments exceed all income. However, things rarely progress that far, as the trouble becomes painfully obvious far earlier and creditors withdraw their continued support.

How will I know that the participants in this game have finally caught on to the fact that it's over? Here are the five game-changing events that will indicate that the rules have changed and a new reality is about to take over.  As I mentioned, I have been tracking these for years and, unfortunately, been watching them unfold one by one.

The First Horseman: New credit growth falls below interest payments

Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.

~Kenneth Boulding, economist

In our debt-based monetary and economic system, it is imperative that new credit growth at least equal the interest payments on past debt. If this does not happen, then the entire financial edifice, levered up as it is, immediately begins to wobble and crumble. Of course this imposes an exponential growth "requirement" on our entire debt/money system rendering it a long-term impossibility.

Total credit market debt (chart below) stood at over $52 trillion at the end of 2008 and has fit an exponential curve nearly perfectly over the past 5 decades.

The "getting the credit system working again" quote by Mr. Zoellick refers to keeping the curve of this chart sweeping upwards in an uninterrupted fashion, as nothing less will get us back to "how things were."

Where this chart required ~$1 trillion of new yearly credit growth in 1995, the remorseless math of the exponential function turned that into $2 trillion per year by 2000, $3 trillion by 2005, and more than $4 trillion by 2008.

While the government's $1.8 trillion of deficit spending for 2009 is certainly heroic, it needs to be complemented by more than twice that amount from the private sectors in order to keep this chart on a smooth path. That, I am confident to say, will not be happening this year.

Status of the first horseman: Arrived.


The Second Horseman: The Fed monetizes debt

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

~Ludwig Von Mises

My second sign occurs when the Federal Reserve directly "monetizes debt," which is a fancy way of saying "prints money out of thin air and exchanges it for private and/or government debt."  This started in 2007 with the first set of rescues, although at the time the Fed took great pains to stress that it wasn't really monetization because they planned to reverse their actions soon.  Of course, that has not happened yet.  Some of their activity was cleverly concealed with complexity, such as when the Federal Home Loan Board (FHLB) bought up $160 billion in mortgages from failing originators such as Countrywide and then quietly passed them to the Federal Reserve for cash.  Minus the FHLB complexity, this represented nothing less than the Fed printing up some fresh electronic cash and handing it over to Countrywide for some failing mortgage products.

The beginning of the end for nearly every debt-ridden country has always been the attempt to pay for past expenditures with newly-minted money. It always starts innocently enough and seems like the right thing to do, but soon the programs grow and grow, and eventually the currency of the country is destroyed.

Now the Fed is openly and actively buying dodgy debt from the government as well as from the private sector. I covered this in a recent "In Session" posting, where I charted the amount of US Treasury debt that was being purchased by the Federal Reserve on a daily basis. 

Fed POMO activity daily rate v2.jpg

This chart reflects only the Treasury purchases. When we add in agency debt, mortgage-backed securities, and various other corporate debt programs, we find that the Federal Reserve is printing up roughly $15 to $30 billion dollars a day just to keep things limping along.

As for the opening quote by Mises, which I think most accurately reflects how things will turn out, I think it is safe to say this: Any country that is printing up to $30 billion a day just to keep things moving along is not voluntarily abandoning credit expansion.  

This means that we are risking a final catastrophe of the currency system involved. Unfortunately, the currency in question also happens to be the world's reserve currency, so this has enormous, far-reaching implications. 

Status of the second horseman: Arrived.


The Third Horseman: Government deficit spending exceeds 10% of GDP

I did not expect to see this one arrive for the US this early in the game and I am quite stumped by the apparent acquiescence by the rest of the world's financial authorities to the US running a fiscal deficit of over more than 13% of GDP.  I would have expected some resistance on their part, such as a refusal to continue buying US Treasury debt, more than a third of which (this year) has been bought by foreign central banks.

I am convinced that this stimulus money, as historical and enormous as it is, will fail to provide any lasting benefit, in part because so little of it is being spent on investments in the future. Promising to cover the losses for bad debts only protects those who financed past malinvestments.  At most, a few measly percent of the total cost of this bailout and stimulus is going towards investments such as beefing up our energy independence or modernizing our transportation infrastructure.  If, instead, 95% was going towards investments, and Wall Street had to fight over the remaining scraps, I would be singing a different tune. 

The inertia of government spending programs assures that these record deficits will recede slowly only under the best of circumstances and will actually grow larger under normal or worsening conditions.  I also want you to recall here that government deficit spending has the strongest correlation with future inflation handily beating out the impact of bank monetary reserves, a common red herring argument trotted out most recently by Paul Krugmanwho wrote in the NYT:

Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.

Again, inflation correlates most highly with government deficit spending and I remain at a loss as to why this clean, clear fact eludes so many who should, truth be told, know better. 

Status of the third horseman: Arrived.


The Fourth Horseman: The dollar goes down, while interest rates go up

As long-time readers know, it is this fourth horseman that I watch on a daily basis. The combination of a failing dollar and a rapidly rising interest rate on US Treasury obligations will signal to me that the "limitless borrowing spree" of the US government is over.

Currently, more than $7 trillion in US Treasury debt is "held by the public." (The other $4 trillion is owed by the government to the government, so it is not on the open market.)  Treasury debt is bought and sold in vast quantities on a daily basis. More than half of it is held by foreigners.  If foreigners sold this debt, rates would rise. If they then took the dollar proceeds from these sales and exchanged them in preference for some other currency, the dollar would fall.

The combination of rising interest rates and a falling dollar will signal (to me) that a final loss of confidence in the US dollar as an international store of value has occurred.  When (not if) this happens, all manner of financial ills will stalk the globe.  Everything priced in dollars will go up in price - in dollars.  That includes basically all commodities.  All holders of US dollars and US debts will be desperate to get out of their holdings, and you can expect wild plunges and gyrations in most markets.  Interest-rate derivatives, which are mainly denominated in dollars and linked to US interest rates, will become toxic destroyers. 

So much hinges on the US dollar retaining its role as the reserve currency of the world that thinking through this scenario would require a report all its own. Suffice it to say, that you cannot overestimate the impact of a rapid decline in the value of the dollar coupled to rising US Treasury interest rates.

Because of this, I am quite perplexed that the other central banks continue to play along and buy US debt, while the Fed monetizes like crazy and the US government sports a 13% of GDP fiscal deficit. 

Here's the latest data. We certainly are seeing a bit of a decline in the dollar and a bit of a rise in interest rates especially since mid-March when the Fed announced its intention to buy massive quantities of US Treasury debt. 

USD down.jpg

TNX up.jpg

However, these moves are not not yet strong enough to cause me to issue an alert or take personal actions.  They definitely have a big portion of my attention, but are not yet at the top of my list of immediate concerns.

What would make me sit up and take notice?  Right now that would involve the dollar slipping into the low 70's, while the $TNX (ten year bond yield) vaulted up by some massive amount which, for me, would be 50 basis points in a day (which is one half of a percent).

At that point, I would be putting out an alert that it's time for any fence-sitters to hurry up and grab some dollar-decline protection. 

Status of the fourth horseman: Maybe it's here. Maybe. But not yet in full swing.


The Fifth (and Final) Horseman: US debt becomes denominated in foreign currencies

For whatever reason, some people still trust the debt-rating agencies, and one of the more farcical practices is that these agencies routinely "rate" the US for credit-worthiness. The good news is that Moody's recently reaffirmed that the US still has a "AAA" rating, which is the highest possible rating. Or is this good news?

The reason this is a farce is captured in a post that I wrote in an "In Session" forum thread on this matter:

This is a bit of a non-issue.  For a country that has 100% of its debt denominated in its own currency there can be no other rating besides AAA.

The idea behind the rating is to answer the question, "What is the probability that this entity can pay off this debt?"

Well, that probability is 100%, when the entity has a printing press.

The only thing that would change this would be if/when that entity has debt denominated in something other than its own currency.

So while we can all be relieved that Moody's has such a high opinion of the US, this is useless information for the purpose of deciding if one wants to hold the debt of that country.  An alternative measure would be, "What's the chance that this country will resort to printing to relieve itself of its debt burden, thereby eroding the claims of the current bondholders?"

Let's call this new rating the "M system."  One M means, "Sort of likely," two Ms means, "Probably will do it," and three Ms means, "No doubt, they will print."  By this system, I rate US government debt as quadruple M, or MMMM.

Off the charts, in other words.

However, the absolute game-changer would be if the US had to pay off borrowed money in a currency other than its own.  Yen, for example. In order to pay off that loan, we'd have to get Yen from somewhere, with the usual source being a positive trade balance. 

If the US could not get the Yen through legitimate trade, then it could always print up dollars and buy Yen off the open market.  But this would serve to drive up the value of Yen and drive down the value of the dollar, so this scheme would rapidly unravel in a currency crisis.  If this sounds familiar, it should.  This is how most developing nations get in trouble and experience severe currency and debt crises.

Having your debt denominated in your own currency is an enormous privilege.  Should that luxury go away, it would become immediately apparent how much the US depends on the kindness of strangers to continue living beyond its means.

So far, only Japan has made some low-level noises about denominating their loans to the US in Yen instead of dollars, but you can be sure other countries are quietly considering it as well.

Status of the fifth horseman: Not here yet.



Three out of the five "horsemen," which indicate where we are in the trajectory of our downfall, have already arrived.   A fourth is possibly here; perhaps not quite yet. And the final one will mark an inevitable date with a vastly lower standard of living for US citizens and all countries that are the accidental holders of too many US dollars and debts.

I urge you to begin keeping a close eye on these five horsemen:

  1. New credit growth falls below interest payments
  2. The Fed monetizes debt
  3. Government deficit spending exceeds 10% of GDP
  4. The dollar goes down while interest rates go up
  5. US debt becomes denominated in foreign currencies

The current presence of three, or possibly four, of these signs has me thinking very carefully about my assets, my family's needs, and how we will manage the changes ahead.  When the fifth horseman arrives, it will bring a new reality for all of us, and I intend to be as ready as possible.


Whenever you find you are on the side of the majority, it is time to pause and reflect

                     --- Mark Twain

We have never observed a great civilization with a population as old as the United States will have in the twenty-first century; we have never observed a great civilization that is as secular as we are apparently going to become; and we have had only half a century of experience with advanced welfare states...Charles Murray

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