The Great Correction will continue for a long time

Feb 15, 2011

Baltimore, Maryland

First, let's step back and look at the big picture.

In 2007, after 60 years of stretching credit, the US economy snapped.

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Savings rates went up...from near zero up to 7%. Houses went into foreclosure. People tossed away their credit cards. Wall Street wobbled...and almost fell.

The feds rushed in, trying to stop the correction.

They threw everything they had into the fight against the big D - deflation, de-leveraging, default, and depression.

Fiscal stimulus, monetary stimulus, unorthodox stimulus - trillions of dollars' worth. The biggest stimulus program of all time - with budget deficits of 10% of GDP...special stimulus spending on shovel ready' programs for $800 interest rates...and a total of $1.7 trillion in Fed purchases of mortgage backed securities and US Treasury debt.

What happened?

Well...not much. Unemployment rose to nearly 10% (after President Obama promised that his stimulus program would hold it at 8%). About 30 million people are still jobless.

House prices are still falling. Foreclosures are still rising.

GDP is positive...meaning, technically, the recession is over. But after such overwhelming stimulus (negative interest rates for more than 2 years)'d expect more than a tepid increase.

Besides, who knows what is really going on? The figures are all in terms of dollars. And now, who knows what the dollar is worth?

The feds' hot money has swamped the world. Food prices are soaring. Oil is approaching $100 a barrel. And a prominent analyst predicts that it will hit $300 by 2020.

The feds say the US core inflation rate is still less than 2%...but the core rate doesn't include the things that are going up - food and energy. Properly adjusted for real cost of living increases...

...and shorn of the curly growth caused by government's deficit spending (which it can't continue forever)...

...real GDP growth might actually be negative!

The Great Correction continues, in other words. Confusing and frustrating...with mixed signals and false starts. And it will continue for a long time. For the harder the feds fight against it, the tighter the ropes become.

The feds' hot money boosts stock prices. But prices for the raw materials go up too. And food and energy prices paid by consumers. The consumer has less real purchasing power. Business profit margins are squeezed.

Meanwhile, the Fed continues printing dollars -- $600 billion of them scheduled for January to June of this year. Alert dollar holders wonder how long it can continue. Shrewd investors wonder how it could stop.

If it takes a $1.5 trillion budget deficit and negative interest rates to produce 3% growth...what would a balanced budget and a 3% lending rate do?

We don't know. But we know one thing: no one in Washington or in a position of authority wants to find out.

The Financial Times yesterday reported that Mr. Obama will propose cutting $1.1 trillion from US deficits over the next 10 years.

Hey...wait a minute...that's $110 billion per year...out of a $3.7 trillion annual budget - a cut (please sit down, dear reader) of 3%...or only 7/10ths of 1% of GDP!

Woo hoo! Hallelujah...

Our problems are solved.

*** We promised more thoughts on refuges, hideaways, and family strongholds...

...that will have to wait until we have more time to think about it.

Stay tuned.

*** Uh oh...people are wising up... The IMF has called for a close look at the alternatives to a dollar-centered world financial system. CNN MONEY has the story:

" The International Monetary Fund issued a report Thursday on a possible replacement for the dollar as the world's reserve currency. The IMF said Special Drawing Rights, or SDRs, could help stabilize the global financial system.

"SDRs represent potential claims on the currencies of IMF members. They were created by the IMF in 1969 and can be converted into whatever currency a borrower requires at exchange rates based on a weighted basket of international currencies. The IMF typically lends countries funds denominated in SDRs."

"While they are not a tangible currency, some economists argue that SDRs could be used as a less volatile alternative to the U.S. dollar."

"Dominique Strauss-Kahn, managing director of the IMF, acknowledged there are some "technical hurdles" involved with SDRs, but he believes they could help correct global imbalances and shore up the global financial system."

"Over time, there may also be a role for the SDR to contribute to a more stable international monetary system," he said.

The goal is to have a reserve asset for central banks that better reflects the global economy since the dollar is vulnerable to swings in the domestic economy and changes in U.S. policy.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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