The unstoppable bull market of optimism & prosperity was only yesterday, but has been all but forgotten in this climate of uncertainty and war. To provide a framework to where we are, and where we are headed, a short piece on where we've been.
Introduction - Twilight of the Millenium, Dawn of Fear
SEATTLE - 27 December 2001
The late 1990's was the twilight of the illusion of endless economic growth, prosperity and peace for the world. It was a fanciful time, for the idea that the End was near was a foregone conclusion to no one, yet it seemed to simmer softly on the background of people's minds. Under the surface of rationality, rabid emotions were afoot and bubbled to the surface in the form of economic crises in the Far East, and disaster movies in the west: Independence Day, Armageddon, and the grand daddy of them all, Titanic. Aliens, asteroids, and icebergs threatened the wholesale destruction of the status quo on movie screens across America, while the Asian Contagion ravaged formerly high growth economies across East Asia.

The movies suggested the gravity of disaster which lay before us, and economists fretted aloud about the horrible impacts of the "contagion" should it spread to this country. In the end, the disasters took place only in the movies, and in lands far, far away from our own. The twentieth century had a happy ending, or so it seemed.

But if reality were a movie, the NASDAQ wouldn't have ended in that horrible, slow-motion crash, but with heroes Greenspan and Bush Jr. dashing to an heroic rescue, holding the market up with the sheer strength and force of will, saving the American Public from financial ruin. And those planes…they never would have hit the Trade Center.

Titanic offered an eerily perfect metaphor: well dressed, well fed, affluent individuals, ignorantly putting their blind faith in the newest technology, the New Era, oblivious to the unseen forces which would ultimately spell their demise. The same description could easily have applied to the U.S. economy in late 1999, when the economic party still looked like it was going strong. America was a singular beacon, floating, seemingly effortlessly, high above the financial catastrophe that the rest of the world had become. Russia had defaulted on its international debts. The "Asian Contagion" - a series of market crashes, competitive currency devaluations, and economic malaise that began in 1997, loomed like a specter over the apparent good fortune of the U.S. economy. It hung dark and menacing on the horizon, like a storm that could either blow in and wreak havoc or disperse harmlessly to sea. The "Contagion's" threat to the U.S. economy was deemed vague and too distant, and after 2 years with no discernible effect, were all but dismissed. As always, what you don't know can't hurt you. Until it does.

As the economy picked up steam from 1997, domestic economic sights shifted from the carnage abroad to the miracle at home: Levitating stock markets. The New Era. Dot-com Mania. Endless prosperity for all. In 1999, if you hadn't heard of Technology, the internet, and the NASDAQ, you were simply out of touch with the times. Which may not have been such a bad thing, considering. While many now say that the New Era has ended, few realize that the ending has only just begun. For few recognize the mania for what it was: A temporary leave from our economic good senses, the return to which will be quite painful.

Even in the waning days of the Internet bubble, the mania was given only kid glove treatment. There were plenty of half-hearted allusions to the Dutch tulipomania, but they seemed almost tongue in cheek, delivered with the cheeky confidence that this was something different. After all, in 1999 we were much more enlightened than in the Middle Ages. Computers and the internet were to rule the world. New Media was the big idea. We weren't as silly as to ascribe astronomical value to something as worthless as a tulip bulb. Were we?

The end of boom times always heralds the beginning of the bust. This particular bust, of the largest boom ever, will have repercussions further than most analysts currently anticipate. This is where the Asian Contagion comes home to roost. In 1997, the worry du jour was that the Asian economic shipwrecks, after devaluing their currencies, would export "deflation" to the United States, causing a deflationary spiral and economic stagnation at home. There was debate, but no conclusion. America continued to prosper, Asian nations sank further, and the debate was forgotten.

At this point, it may help us to define a "deflationary spiral." As opposed to an inflationary spiral, wherein prices climb higher and higher, spinning out of control and out of reach of consumers, a deflationary spiral features falling prices. Businesses, due to excessive competition, lose pricing power: They can't raise prices because too many competitors are willing to lower them. Consumers, sensing this, postpone purchases knowing that if they wait long enough, prices will come down.

This past Christmas, we all witnessed a mini deflationary spiral. Shoppers knew that prices would be cheaper the closer they got to Christmas. And after Christmas, it was simply a bonanza of lower prices!

This is where the deflation debate reopens. Was the mini-deflationary spiral witnessed at Christmas time a one time event, or a precursor of things to come? After all, every Christmas season sees such a deflation spiral, though this year seems to have been stronger than most. Signs point to further deflation. Zero percent financing for cars is simply another way of lowering prices, enticing consumption. But with the recent spate of zero down, zero percent financing, everyone and his brother who was going to buy a car in the next 6 months ponied up for the deal. How will auto manufacturers entice people to buy new cars in the 6 months forward, after they've cannibalized their own customers from the future? The only answer can be lower prices. The downward spiral will continue. For a while.

The country is awash in stuff - merchandise, products - and people are not buying, at least not at these prices. National Reorganization of Priorities Day (9/11) has changed all that. What does anyone need in this country, that they can't wait to get a tad cheaper next month? The problem with this - a true deflationary spiral - is that the current economy has been fine tuned for high octane growth. One look at the debt levels being carried by individuals, businesses - the government itself - betrays as much. The gross magnitude and structure of debt is such that growth is a requisite for simply meeting interest payments. Stagnation means death. Look at what happened to the Airlines after 9/11 - one week without business and they nearly all went bankrupt. Their ballooning debt levels threatened to topple them instantly. Now they're living on borrowed time and borrowed money. Yours.

This is where it gets tricky in the deflationary spiral. Deflation can turn to inflation instantly, in the blink of an eye, because deflation or inflation is merely a matter of perspective. When the afore mentioned Asian nations devalued their currencies in 1997, their exports immediately became cheaper in terms of our dollars. They began "exporting deflation," as predicted. Imported goods that were already cheap suddenly became even cheaper. But in the countries that devalued - Thailand, South Korea and Indonesia - imported goods immediately became more expensive. These countries suffered massive inflation. In the case of Indonesia, the economic turmoil caused by inflation led to social unrest and violence in the streets. American consumers benefited by lower prices, while Asian workers and consumers suffered from shortages of money.

Inflation and deflation are two sides to the same coin, which makes fighting them quite tricky, especially in the same economy. Currently, the Fed is trying to arrest the deflationary spiral with an inflationary spiral of its own. They are inflating the U.S. dollar - making more available for use by lowering interest rates. They are loaning it out cheap to anyone who wants it. But it's not working. The economy is not growing, and the only thing being inflated by their policies is the supply of U.S. Dollars.

Inflation of the U.S. dollar is nothing new, and it happened with abandon through the 1990s. While we generally think of the 90's as a period of low inflation, nothing could be further from the truth! Inflation was rampant in the stock market, the bond market, in mortgage securities and in the U.S. dollar. All of these paper assets appreciated far in excess of the corresponding value of the real assets they represented. When that difference became so unbalanced, and so obvious, the paper assets began to lose value, and will continue to lose value until they again represent the true value of the underlying assets they represent. This holds true for stocks, bonds, mortgaged backed securities, as well as the dollar itself.

The dollar is merely a paper asset like the rest, backed only by the promise of the U.S. Government to pay anyone bearing a dollar…a dollar. The dollar has maintained its strength partly due to the strength of the American economy, but mainly due to the dollar's status as international reserve currency. Nearly all international financial transactions are settled in dollars, thus creating an artificially high demand for the currency. Were this not the case, America's financial position, with its perennial budget deficits and $6,000,000,000,000 debt, would look no better than say, Argentina's.

By continuing to inflate the money supply in the hopes of re-igniting economic growth, the government is playing for broke. There are no limits on the amount of dollars the treasury can print, as America's erstwhile budget surplus turned deficit demonstrates. Should world markets lose faith in the dollar and in America's commitment to "fiscal responsibility," our deflationary spiral could snap instantly and be replaced by massive inflation along the lines of Thailand or Indonesia.

It is no wonder that we are being told that our patriotic duty is to shop. Stagnation will mean death for many companies, and could start a financial domino effect that will ripple through every sector of the economy.

Change happens slowly, but our recognition of it occurs instantly. Prior to 9/11, the world was becoming increasingly unstable and unsafe, though we chose to ignore the signs. It took a violent shock for us to recognize the truth. Likewise, the U.S. economy will see massive shocks in the coming months and years. We are currently only feeling the tremors of what is to come.

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