The Stormwatch

We'll wait in stone circles
'til the force comes through ---
lines joint in faint discord
and the stormwatch brews

- Jethro Tull (Dun Ringill)

Occasionally I get caught up in thinking about the ongoing Depression 2.0. Given the magnitude of how this may well play out, all else can seem trivial. Today I have the luxury of philosophizing about ethical strategies for eating meat; in a few years obtaining any food at any price might be my overwhelming concern.

I believe the primary root cause of this crisis is the Federal Reserve System of money and banking that was created in order to serve government spending and banking profits. The nature of centralized fractional reserve banking is that boom and bust cycles are an inevitability as well as massive inflation (see here for full size):

This graph shows a roughly exponential increase in the supply of money. The funny thing about exponential functions is that they all look alike as long as you adjust the scale on the horizontal axis. Also, you can zoom in on the graph a bit and things look relatively stable: just a year-over-year increase of a few percent. But zoom out a bit, and it looks like a near-vertical spike. With that in mind and given the exponential nature of this graph, you could argue that we have been in hyperinflation since the last vestiges of the metal standard were removed in 1971!

I believe we are entering the end-game of this system. The system has seen a series of crises over the years. With each crisis, the government can respond by letting the system (or part of the system) fail and letting market forces realign resources, or by bailing out the system. With each bailout, the economy becomes more centralized and the potential for a larger crisis down the road becomes increased. Murray Rothbard presciently saw one scenario for how the system could fail:

At some point in the possibly near future, perhaps in the next recession and the next spate of bad bank loans, it might dawn upon the public that 1.5 percent is not very safe either, and that no such level can guard against the irresistible holocaust of the bank run. At that point, ignoring the usual mendacious assurances and soothing-syrup of the Establishment, the commercial banks might be plunged into their ultimate crisis. The United States authorities would then be faced with two stark choices. One would be to allow the entire banking system to collapse, along with virtually all the deposits and depositors in that system. Since, given the mind-set of American politicians, and their evident philosophy of "too big to fail," it is certain that they would be forced to embrace the second alternative: massive, hyper-inflationary printing of enough cash to pay off all the bank liabilities. The redeposit of such cash in the banking system would bring about an immediate runaway inflation and a massive flight from the dollar.

Such a future scenario, once seemingly unthinkable, is now definitely on the horizon. Perhaps realization of this plight will lead to increased interest, not only in gold, but also in a 100 percent banking system grounded upon a revalued gold stock.

Here's the kicker: the scenario above occurred last year! The great housing bubble of the last decade fueled the spate of bad loans, and last Fall the entire financial system was on the brink of default and utter collapse. The bailout is the spike on the right of the graph above. That plot just shows currency in circulation. Here is the plot when you include money stock held in banks (see here for full size):

So given the above, why haven't we seen runaway hyper-inflation and the complete destruction of the dollar? What Rothbard didn't foresee was the new "tools" the Fed is using, and in particular the fact that the Federal Reserve is paying interest on this money and as a result it is not being lent out as Rothbard expected it would be.

Nevertheless, the solution to one crisis sows the seeds for the next crisis. Will the next one be "the big one" that results in the final death spiral of the dollar? Maybe, but probably not. While history will judge the fall of America as happening practically overnight, in real-time it takes years, not days. However, I do expect that the time between crises will continue to decrease while their potential for total systemic failure increases until we see the complete destruction of the dollar. I used to think this would occur "some time in my lifetime" but not until 2030 or so. I now expect this will play out within the next five to ten years.

Here's what to expect:

• Total collapse of Social Security and government entitlement programs
• Destruction of the dollar, including all savings held in dollars
• The end of cheap imports, especially from China
• Governments worldwide to either default or engage in currency destruction
• Massive unemployment
• Civil unrest

The America of yesterday is gone forever. What will be in its place? The optimistic scenario is the collapse of the federal government, re-emergence of commodity money, and decentralized political systems. The pessimistic scenario is a totalitarian state with a new fiat currency, diversionary wars, and bread lines.

For now, I'll store a few acorns for the coming winter and continue the stormwatch.