Why do I have such pessimism these days?

There are a couple of reasons.  None of them stem from much of anything that I get from the mainstream media.  One of them is the state of the American financial system and with that government and consumer debt.  When you add up all the obligations of the American government from foreign debt to medicare and social security the number is staggering.  It comes to $375 000 for each full time employee in the United States.  My source?  The United States Government Accountability Office

The latest expansion of the US economy was largely driven by credit and to keep things afloat the federal reserve is taking unprecedented measures.  The Fed’s monetary policy is causing inflation.  One of the Fed’s roles is the expand or contract the money supply.  They can generate money "out of thin air" to loan it against assets like houses.  Right now they backing worthless investment banks and financial institutions to keep them alive so the economy doesn’t seize up.  This is putting pressure on the US dollar

Currently America enjoys an advantage in the world marketplace as the US dollar is the world reserve currency.  It is the most commonly held currency and it is the currency commodities like oil and wheat are priced in.  If the US devalues its currency too much then other countries, particularly oil producing nations will be more and more tempted to start selling oil in a basket of currencies.  Iran and Venezuela have already begun pushing OPEC in that direction.  Asian nations have significant holdings of US currency, especially China. 

China and the US have something of an unspoken arrangement.  China makes lots of stuff for the United States.  China intentionally keeps the value of their currency low.  America buys lots of cheap stuff from China and borrows money to do it.  China buys up all that debt and the cycle keeps going.  Most countries couldn’t do this the way the US does because the trade deficit would obliterate the value of their currency.  Because the US dollar is the world reserve currency it can get away with this arrangement. 

So far it is in everyone’s best interests to keep this arrangement going.  If the US dollar is significantly devalued America won’t be able to buy the stuff most the world sells it.  This is why countries like Saudi Arabia have been very firm on trading oil in US dollars.  If the US borrows too much money and becomes so financially sick that countries start to think the value of its currency is a heavily inflated bubble they will begin selling their commodities in other currencies and start dumping their reserves of US currency.  Then the race to the bottom will begin.  When the carnage is over the dollar will have lost so much its value that it will be incredibly expensive to buy imported stuff.  Having exported much its manufacturing base off shore this will make things much more expensive.

There are couple of major trends that will continue to be a weight on the US economy.  As oil production begins to decline from its peak the price will continue to increase putting more and more pressure on the economy.  Measures to reduce demand will offer brief relief but as the relentless decline in oil production continues the room created by demand destruction will shrink and the price will remain high.  The only way out of the cycle is to completely change the transportation system and that is an expensive capital project.  If there is an oil shock, say Mr. Chavez decides he doesn’t want to sell oil to the US anymore, or conflict with Iran cuts results in a dramatic drop in supply it could cause such a disruption it will begin cause the US economy to unravel.  For a great explanation of what could happen read "Countdown to Meltdown" published at The Atlantic Monthly in 2005.

Another major trend is the health care costs of the baby boomer generation.  In America the government does pay for health care for those over 65 in the most expensive health care system in the world.  For a government already mired in debt because of wars and bailouts it will prove to be too much.  Something will have to give on the tax side or the spending side.  Whether that means more taxes or more people paying for health care it will put even more pressure on discretionary spending. 

The biggest deficit is in American leadership.  McCain 2008 isn’t an upgrade from McCain 2000.  Aside from Obama’s rhetorical abilities I’m not impressed with him either.  In her history America has overcome some serious challenges in the past.  I believe that America could overcome these challenges, with a lot of pain and hardship, but it could happen. 

Unfortunately the problems are more complex than "we need to defeat Japan."  Instead of putting manpower and ingenuity towards solving the problem of Peak Oil they are going on a witchhunt looking for someone to blame or someone to tax for high oil prices.  The Democrats and the Republicans are equally vacuous on this issue.  Without a common understanding of what needs happen very little does happen.  That is was depresses me the most. 

  1. #1 by Rev. Mike on July 24, 2008 - 12:55 pm

    I suppose the best part in all of this for you has got to be the knowledge that whatever the case, we will drag you along without your consent. Sadly, I share your pessimism. One suspects that a military coup or some other form of dictatorship may not be out of the question in the US over the next fifty years.

  2. #2 by Leighton Tebay on July 25, 2008 - 8:44 am

    Very true. Canada has a couple of advantages. We don’t have worthless subprime mortgages, our government runs surpluses and we have surplus energy.

    The downside is that most of what we sell goes to the US. If the US dollar turned in to the Peso we’d have to find other markets. Most of those markets make money selling to the US as well so……..

    It isn’t pretty.

  3. #3 by randall on July 25, 2008 - 12:30 pm

    Good post LT.
    Or should I say, sad, tough post?

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