Recession 'shape' points down

May 22, 2009

Recession 'shape' points down
By W Joseph Stroupe

We've heard a lot of talk about the shape of this "recession", especially for the United States. The optimists think it will be V-shaped and that we are even now seeing the bounce upward toward growth again. Those somewhat more in tune with the deeply worrying fundamentals think it will be U-shaped, and they think we've probably hit the bottom, or nearly so, but we have some months to go before growth begins again. Then there are the pessimists, who insist on being called realists, who think it will be L-shaped, with America's economy stagnating perhaps for an entire decade, or even more after it reaches the bottom of this recession.

Finally, there are those relative handful of so-called "prophets of gloom and doom", who continue to advise that this isn't merely a severe recession, but is rather the opening phase of a full-blown crisis, a financial/economic collapse centered in the US in which the severe recession is merely one of many repercussions to come.

They predict the crisis will be shaped like a series of steps going downward - in effect, a series of collapses with deceptive plateaus in between, with economic growth returning very slowly and painfully in the US and the UK several years off from today. They insist that we haven't even remotely seen the bottom yet, but have only experienced the first few steps downward so far, and that there are several more to come. They also warn that the worst for the US and the UK, by far, is yet to come.

Obviously, those in this last category of prognosticators aren't very popular, in spite of the fact that, by and large, they were primarily the ones who called this present dire crisis correctly, some of them doing so years in advance. Yours truly is proud to be in this last category.

At present, the optimists generally have the floor, as the media report multiple developments that are said to signal a turnaround, and the Wall Street rally that began on March 9, after US Treasury Secretary Timothy Geithner's US$1 trillion toxic asset removal plan was announced, continues. In the crucial housing sector, pending sales of previously owned homes jumped 3.2% after a 2% jump the previous month, for the first back-to-back jump in more than a year.

Foreclosure-driven housing price collapses and Federal Reserve-driven mortgage rate decreases are putting homes in reach for more first-time buyers, who accounted for at least 50% of the pending home sales contracts.

However, the continued losses in the weakening job market and soaring foreclosure rates, with foreclosures reaching a record 803,489 in the first quarter alone, are likely to overwhelm such "green shoots" of "recovery". Builders of new homes are struggling as buyers flock to foreclosed properties at bargain prices. Thus, a genuine recovery of the vital housing sector is not genuinely being signaled yet.

Bigger trouble looms, regardless of this Wall Street rally and other "green shoots". Geithner's toxic asset removal plan hasn't worked yet, and it and other government plans face huge obstacles. Fears over the size of US debt are swiftly mounting, while China has "cancelled our credit card", according to US Senator Mark Kirk, referring to the fact that China's investors have radically slowed their purchase of US Treasury bonds in the past three months.

While Kirk's statement may reflect a significant measure of jumping to conclusions before all the facts are in, we nonetheless are witnessing a meaningful deterioration in the quality of foreign financing of the US Treasury. This extremely important development must not be lost in the fog of the present crisis. We should not be distracted by fleeting "green shoots" that appear and then disappear as suddenly, but analyze the condition of the roots, from whence all else of consequence emerges.

So before we can intelligently choose what the most likely shape of this crisis will turn out to be for the US, we must first look at its root causes to determine if these are actually being remedied, and if not, what the impact will be of a crisis like the present one whose root causes are not adequately and accurately addressed soon enough.

If we find from our investigation that the present severe recession is indeed only a symptom of something much more serious, that efforts to deal with the crisis are not reaching the root causes, that many of these efforts are actually exacerbating the situation in very dangerous ways, and that the present global environment in which the US operates as an economic power has changed so radically that a resumption of US growth anytime soon can no longer be taken for granted, then our choice of the most likely shape for this crisis is made far easier, is it not?

Economists often speak about the boom-bust "cycle" and implicitly insinuate or explicitly state that this bust, though severe, is merely part of the perpetual boom-bust cycle, and that growth will inevitably (and almost automatically) return soon, once the bust portion of the cycle runs its course and resets the financial and economic parameters for a resumption of growth. Thus, a resumption of growth before long is taken for granted.

Is the present crisis merely part of such a perpetual cycle of growth followed by downturn followed by growth again? Or has this crisis arisen out of extraordinary root causes which have actually derailed economic growth for the foreseeable future, destroyed financial and economic viability and stability, and severely discredited America's models of capitalism and finance on fundamental levels? Are you open-minded enough to give fair hearing to the facts that point unmistakably in the direction of extraordinary root causes that are producing the present crisis?

Income-based model versus asset-based model
At fundamental issue here is the new asset-based economic/financial model (as contrasted with a traditional income-based model) which the US and Britain in particular have progressively adopted over the past couple of decades, and whether that new model is really workable and revivable in the light of its massive collapse that began with the emergence of the subprime crisis in late July of 2007.

The US economy has rapidly converted from a traditional, income-generating machine to a so-called "new economy", an asset-inflating one. An income-generating machine derives wealth from the production and sale of goods and services, while an asset-inflating one derives wealth from accelerated asset appreciation, or targeted inflation of assets - in other words, by the creation of serial asset bubbles. In this new model, traditional wealth generation takes a back seat to "paper" wealth generation via serial asset bubble creation.

In the traditional income-based economic model, the financial sector serves to support the real economy, where the vast bulk of real income is generated, by providing credit and other traditional financing services aimed at sustaining existing and fostering new income-generating business ventures, and supporting consumer spending via traditional credit services. The income generated in the financial sector is not of major proportions, but is a distant second to that generated in the real economy.

The asset-based model is radically different. In this new model, innovative and grandiose opportunities arise for the generation of gigantic sums of "paper" wealth from within the financial sector itself, thanks to what can only be called the fostering of an incestuous relationship between government and Big Finance.

It is a relationship in which the state nurtures the negative real interest rate monetary environment and the "free" (inordinately unrestrained) market conditions wherein colossal asset bubbles can be grown, nurtured and capitalized upon by Big Finance, employing what has come to be known as "securitization" - the "innovative" process of the creation and marketing to global investors of cleverly packaged, deceptively credit-rated financial assets based upon, and secured by, the asset bubbles that have been fostered under the asset-based model.

That being the case, a huge financial services-based industry that is very tightly coupled to the wealth-generating core of the financial sector, Wall Street in America's case, proliferates its tentacles far and wide.

In this new model the entire economy takes on a decidedly finance/investment/asset-oriented complexion, with such ventures and operations coming to the foreground, while traditional income-based business tends to be eclipsed. When America's adoption of this new model is considered in conjunction with the decades-long trend of the withering of America's once-mighty traditional manufacturing sector, one can appreciate how America's "new economy" model has radically changed how it generates much of its $14 trillion of gross domestic product each year. A very large portion of that wealth is generated by, or is directly and considerably dependent upon, the new asset-based ventures and operations in the Wall Street core of the financial sector.

Catastrophic flaws in the asset-based model
Because the new asset-based model relies upon serial asset bubble creation (inflation) in order to thrive, the model simply chokes and suffocates when the environment of the massive credit excess needed to grow such bubbles is removed.

Hence, Washington's policies in attempting to deal with this crisis are all centered upon recreating the massive credit excess that it hopes will "reboot" the model and bring it back to life by re-inflating the assets whose values have collapsed in this crisis.

Therefore, Washington and Wall Street aren't interested in, nor are they attempting to revert to the traditional income-based model. Rather, they are committed to sinking all their efforts and all America's wealth into rebooting the new asset-based model. The salient question here is whether the model can be rebooted without triggering a cascade of much greater damage than it has already wrought.

One can easily see that the new asset-based model is an extremely dangerous trade-off between rapid and easy wealth creation on the one hand and acutely increased vulnerability and instability on the other hand, for the asset bubbles grown under the model inevitably rupture, leaving mountains of toxic rubble in their wake.

And when an economy subscribes to and adopts this new model to an excessive degree, as both America and Britain have done, thereby investing their future too fully in that model, then that economy invites catastrophe when all viable assets have been "bubbled and ruptured" and there's nothing left to feed the model to keep it breathing. That is precisely where America and Britain have now arrived.

Asset bubbles are not new. They have existed and they have ruptured before, as in the Great Depression. What is new about the asset-based model is that, under the tutelage of such slipshod architects as former Federal Reserve chairman Alan Greenspan, the perilous prospects for massive "paper" wealth generation afforded by asset bubbles (which would be calculatedly produced) were then consciously incorporated into a new economic/financial model actually intended to supersede the traditional income-based model, a new model that was deceptively and successfully hawked to the dim political leadership in Washington and London.
Additionally, what is also new about the asset-based model is the raft of revolutionary new financial instruments and assets it fosters that ingeniously leverage the foundational asset bubbles in order to magnify "paper" wealth generation many times over.

Finally, what is new is the swiftness with which new asset bubbles have been created, their unprecedented proportions, and the sheer number of bubbles that have been produced in such a compressed period of time - primarily in the past 10-15 years - and the severe damage that has been caused by their rupture.

Well, the architects and adoptees of the new asset-based model have gotten what they aimed for. Their brainchild has, indeed superseded the traditional income-based model. America and Britain are inordinately dependent upon that new model for economic growth. Look at the severe repercussions they are suffering as a result of the crash of the model. Neither can hope to return to economic growth any time in the foreseeable future without the successful rebooting of their asset-based model - a prospect whose chances are slim to none.

Full-blown collapse of the new model
This severe recession is much less about the business cycle and much more about the collapse of the new asset-based model, and the fact that the US and UK cannot simply revert to the traditional income-based model to resolve their self-made crisis. They've both become far too committed to the new model.

A reversion would take a decade or more to accomplish, even if it could be accomplished, and in the meantime the rest of the world (where the traditional income-based model survives and thrives) would not wait for the US and UK, but would unquestionably overwhelm the two. (If the new model cannot soon be rebooted to thrive again, then that is going to happen anyway).

Attempting to reboot the new model carries gargantuan risks, whether it sputters back to life or stays dead. The colossal sums of new debt being racked up, the hyper-inflationary forces, the inevitable era of high taxation, the eventual severe damage to the US dollar and the British pound that is being set firmly in place, the undermining of the creditworthiness of sovereign debt, are just some of the risks.

As severely as America's "new economy" has been discredited in this crisis, which has infected the entire globe, who's going to buy its collection of severely tainted dollar-denominated financial assets even if the model does sputter back to life? And how much would anyone be willing to pay for them? America and Britain are in colossal trouble.

The present crisis, which is not merely a recession fueled by the boom-bust cycle, actually signifies the asphyxiation of the asset-based model. Oh, it may for a time keep flailing its arms about while it suffers its death throes, and it might even sit up on the gurney once or twice to protest its own demise, but it cannot get up and promenade again. It is on total life support and must eventually be declared brain-dead.

There have been warning signs of this impending death, but these were largely ignored or misinterpreted as merely part of the perpetual boom-bust cycle. One such warning sign was the destructive rupture of the equities and dot-com bubbles in 1999/2001, which wiped out many trillions of dollars of wealth, cast American's pensions into an irresolvable crisis and savaged America's lead role in the IT technology sector. Catastrophe, like what we're now witnessing, was only avoided (temporarily) back then because the Fed and Wall Street quickly collaborated on the swift creation of new bubbles in real estate and stocks. Now that these are rupturing, there are no remaining virgin assets to feed to the asset-based model. That's why efforts are underway to attempt to reflate the old, previously ruptured asset bubbles and all the innovative financial assets coupled to them.

The shape of this crisis, then, is a series of steps proceeding downward into the gloom for the US and Britain. The two powers are guilty of massive over-reach, and now they are suffering the terrible consequences. Sooner or later, these ongoing events that were inevitable, and that should have been foreseen before the new asset-based model was so enthusiastically and wholly adopted, will force the two powers to make the gut-wrenching, long reversion back to a more traditional economic model.

The longer their leaders resist this, the more profoundly painful and destructive the adjustment will become. Obviously, this situation provides a tremendous opportunity for the rest of the world, but especially for the increasingly wealthy and powerful states in the East, to capitalize in various ways. The ongoing crash of the US and UK liberal capitalistic incarnations of the asset-based economic/financial model also, therefore, signifies the collective rise of the Eastern managed-capitalistic (authoritarian) incarnations of the traditional income-based model.

W Joseph Stroupe is a strategic forecasting expert and editor of Global Events Magazine online at www.globaleventsmagazine.com

http://forums.delphiforums.com/sunkopitiam/messages?msg=29543.1