Mood:  not sure

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THE GREATER DEPRESSION
by Doug Casey

It's been said that if you spend 15 minutes a year thinking about the
economy, you're wasting 13 minutes. That's generally true. But as an
amateur historian, I can't help myself. And I'm forced to believe that
this is a time when the subject is worth some real thought.

My view is that the longest, and certainly most important, trend in
history is the ascent of man. I have little doubt that it will not only
continue but accelerate. But that doesn't mean there won't be nasty
setbacks along the way. As I have said before, possibly the best
definition of a depression is a period when most people's standard of
living drops significantly. You can also define it as a period when
distortions in the economy and misallocations of capital are liquidated.
The distortions are almost always the result of government intervention in
the economy, through things like taxes, regulation and currency inflation.


Those are the factors that caused the unpleasantness that began in 1929.
Since the government is exponentially more powerful and invasive today
than it was in either the 1920s or the 1970s, I expect the consequences
will be much worse this time around. Things could have come unglued, and
almost did, back in the 1970s. I don't see how we'll dodge the bullet this
time. Although that's not really a good analogy, in that, for reasons we
don't have time to explore in depth, a depression is probably inevitable
this time.

The only serious question in my mind is whether it will be essentially
deflationary in nature, as it was the case in the U.S. in the 1930s, or
inflationary like in Germany in the 1920s. My guess is the latter because
the government is so much more powerful today. Or it could actually be
both at once, in different sectors of the economy.

How?

Inflation could drive interest rates to 20%. This would collapse the bond
and real estate markets, wiping out trillions of dollars of purchasing
power - which is deflationary. Meanwhile, that same inflation doubles the
cost of food and fuel. In other words, the opposite of what we've mostly
had for the last generation, when we had "good" inflation in stocks, bonds
and property, but stable or dropping prices in "cost of living" items.
This time the pattern could reverse, which would be a nightmare for most
people.

And as people become more focused on speculation in a generally futile
attempt to stay ahead of financial chaos, they inevitably divert effort
from economic production. Which will decrease the general standard of
living even more.

The situation isn't made easier by the possibility that we're facing Peak
Oil - the start of a secular decline in world oil production. Or the fact
that Americans, both individually and collectively, are deeply in debt and
living on the kindness of strangers. The problem with debt is that it
artificially increases our standard of living. But when we pay it off,
especially with interest, it reduces our standard of living in a very real
way.

Wrap this economic environment around the so-called War on Terror, which
is rapidly morphing into the War on Islam, which could easily turn into
World War III, and you're looking at the perfect storm. The odds of a
major conflagration are very high, and it's not being adequately
discounted. If Bush starts a war against Iran, or if another incident like
that of 9/11 occurs, or even if the trend of the last five years
accelerates, the U.S. is going to be locked down like one of its numerous
new federal penitentiaries. And that will be accompanied, and compounded,
by mass hysteria among Boobus americanus.

At that point, your investment portfolio will be among your lesser
concerns. People forget that, in every country and time, there's a
standard distribution of sociopaths and misdirected losers. In normal
times, they seem like normal people. But when the time is right, they show
their colors, and they love to get jobs with the government, where they
can lord it over their betters.

You may be asking yourself: Is the Greater Depression really inevitable?
How bad will it be? Is there another side to the argument? Can it be
avoided?

I suppose it's not absolutely inevitable. Perhaps friendly aliens will
land on the roof of the White House and present the government with a
magic technology that can undo all the damage it's done. But we live in a
world of cause and effect where actions have consequences. That being the
case, I expect truly serious financial and economic trouble. And the
government will make it vastly worse by trying to "do something" instead
of recognizing itself as the cause and backing off. I don't see any way
out.

How bad will it be? In historical terms, the last depression was
relatively short and mild. The longest depression on record was the Dark
Ages. Residents of the old USSR and Mao's China suffered through a
depression that lasted decades. I'm not predicting it will be that bad, if
only because the U.S. has basically much sounder traditions and
institutions and vastly more accumulated capital. But it's hard to
overestimate how serious this could be. I sometimes joke that it will
likely be worse than even I think it will be.

Getting back to whether it's truly inevitable, it's a question of degree.
The recession of the late 1970s and early 1980s involved a terrible stock
market, 15% inflation with interest rates to match, 10% unemployment and a
near war with the USSR. But the country not only hung together, it went on
to a tremendous rebound. My guess is, however, that the last 20 years of
good times will later be viewed as an economic Indian Summer before a
harsh winter.

The good news, of course, is that no matter what the economic conditions,
technology - which is the mainspring of human progress - will keep
advancing. And many individuals will continue innovating, saving and
improving conditions for themselves and their associates. Also, it's
entirely possible to go through even the worst of times and not get hurt.
Indeed to profit from them. If the price of a house you want now but can't
afford falls 75% (as outrageous as that may sound at the moment) while
your own investments in the high-quality gold stocks we follow in our
International Speculator quadruple, you're much better off. That house now
really only costs you one-sixteenth of what it did before. Of course it's
a problem for the guy who has to sell his house... but I always prefer to
look at the bright side of the equation. There's time now to structure
your affairs so that you're on the right side of the trade.

Keep your eyes peeled for signs that indicate it's about to get ugly. One
obvious indicator to watch is how the price of gold is running. Gold is
the only financial asset left in the world that's either safe or cheap.
It's also under owned and largely unrecognized, which is why the smart
money has been moving into it.

Then there's the CPI itself - although I don't think it's very accurate,
in that all the adjustments, exclusions, weightings and what-nots the
government has insinuated into it over the years makes the CPI as much of
a floating abstraction as the dollar itself. It's funny how the government
plays with figures for fear of hurting confidence. They believe the
economy rests mainly on confidence, which, ironically, in today's world,
is true. Unfortunately, confidence can blow away like a pile of feathers
in a windstorm - and we have a class-5 hurricane coming. If the economy
were sound and people for some reason lost confidence, the currency and
the banks would be unhurt, and the next day things would go back to
normal. But that's not the world we live in. So, higher CPI numbers are
another thing that could destroy confidence and supercharge the gold
price. They're coming.

Higher interest rates, which we're already seeing, will inevitably burst
the real estate bubble, which is floating on a sea of mostly
adjustable-rate debt, a lot of it interest-only or even with negative
amortization. Higher rates will also crush bonds and probably stocks. And
they'll devastate the economy since everybody is deeply in debt. However,
I feel the Fed will keep short-term rates - which are really the only ones
they control - as low as possible for as long as possible. For one thing,
they don't want a recession, which this time could snowball into the
Greater Depression. For another, my guess is that they want to gradually
depreciate the dollar against other currencies, in part to decrease the
chronic, massive trade deficit. And because increasing the number of
dollars makes people think they're richer than they really are, it can
stimulate some additional spending...but these days that spending is
mostly done on credit, so it is only illusionary.

The biggest single problem, however, is that there are trillions of U.S.
dollars outside of the U.S. Unlike Americans, foreigners have no reason to
hold them. And at some point very soon, perhaps when the Fed finally hits
the wall on its ability to raise rates, these overseas dollars are going
to start flooding back home, while the products and titles to real wealth
flow out of America.

Therefore, when the trade deficit starts turning around - which most
people will think is a good thing - that will be the real tip-off the game
is over. Trillions coming back to the U.S. will skyrocket long-term
interest rates and inflation. The dollar will go into freefall.

But although I think these are the things to watch, to my way of thinking
it makes no sense to wait until the stampede starts to try to get out the
door. If you haven't done so already, take advantage of the current
correction in gold to begin repositioning your portfolio for what's next.

Regards,
Doug Casey
for The Daily Reckoning

Editor's Note: Doug Casey is the author of Crisis Investing, which was #1
on the New York Times Best-Seller list for 26 weeks. He is also editor and
publisher of the International Speculator, one of the nation's most
established and highly respected publications on gold, silver and other
natural resource investments.

For information on the International Speculator, click here:

Posted by Joe Anybody at 1:53 PM PDT

Updated: Tuesday, 6 June 2006 2:40 PM PDT

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