Nystrom - Unsustainable Illusions - 2004 Predictions

January 19, 2004

Economists and the press are overwhelmingly bullish on prospects for 2004. All sixty (60!) economists poled by Business Week magazine have called for stellar growth this year. Alan Greenspan has claimed victory in his battle against the bubble, and has managed to get both the economy and the stock market moving higher. Global markets are at 2-1/2 year highs, and last year’s 3Q GDP weighed in at over 8%. The Conference Board projects growth to hit 5.7% this year, making 2004 the best year yet in the last 20. To top it off, Saddam Hussein is safely behind bars, and happy days are here again. Apparently.

But recent growth is artificial and unsustainable. It is like a shivering camper, taking his remaining supply of kindling, newspaper, and even the gasoline from his car, and dumping it onto the glowing coals of his dying campfire. Of course the fire burns hot, but it is merely an illusion. Mesmerized by the fire, the camper might even say, “This is the brightest campfire I have seen in 20 years!” It will keep him warm for a few moments, but of course it is unsustainable. And when such a fire goes out and all his resources have been consumed, there is nothing left to start a new one. Not even the gas in the car remains to get him home in the morning.

This is the story of the current economy of illusion. Low interest rates have encouraged consumers to borrow against their homes and on their credit cards in order to continue on their unsustainable consumption binge. Now that the euphoria of the holiday season is over, bankruptcies and delinquencies are at all time highs. Like a societal fractal, undisciplined and overburdened consumers are simply mirror images of their government, which today is over $7 trillion in debt. Massive tax cuts have helped juice the economy in the short run, but have wreaked havoc on the national balance sheet. In three years, the government made a $700 billion swing from a record surplus in 2000 to a record deficit today, and like a common pauper, needs to borrow over $2 billion per day just to keep operations going.

Worse news is that America is hemorrhaging both jobs and investment. Jobs form the foundation of current economic strength, and investment is what ensures growth in the future. China has widened its lead over the U.S. and the rest of the world as the most preferred location for foreign direct investment. China now ranks first in the world in FDI, having surpassed the U.S. in 2002. Between 2001 and 2002, FDI in the U.S. fell from $124 Billion to a mere $44 billion, while FDI in China climbed to $53 billion. The number of manufacturing jobs in the US has fallen for 41 straight months. When you see headlines that say American manufacturing is recovering, it simply means that jobs are being lost at a slower pace, not that jobs are returning.

As we are mesmerized by the misleading headlines of the booming economy, remember this: Jobs are moving overseas. Not just manufacturing jobs, but management, service and even knowledge jobs. The unemployment rate in the U.S. is an illusion, maintained at an artificially low level by a very simple trick: Not counting people who have been unemployed for over 26 weeks. Those poor, discouraged workers – they must not be trying hard enough. As the joke goes, “There are plenty of jobs in America. Look at me, I have three of them.” It would be funny, if it weren’t so grim.

Last year was good year for the stock markets. The second great depression has been postponed, but not averted. Deflation is still knocking at the door. How does deflation happen? Deflation is a monetary phenomenon, and describes a reduction in the money supply. Imagine for a moment a poor soul who owes Chase Manhattan bank $10,000 on a credit card. Since losing his good job at IBM (it moved to India), he hasn’t been able to keep up on the payments, but not willing to sacrifice either his pride or his good credit rating, he’s been using his Citibank card to pay off the Chase card. By making the minimum payments, he’s barely reduced the principal with Chase, but has managed to rack up another $5,000 with Citibank. This is not an uncommon tale. Funny how accounting works, because both Chase and Citibank view these sums as *assets* on their balance sheets. Lets get this straight: Two multibillion-dollar corporations are relying on an unlucky, unemployed worker (and millions like him, with no prospects for new jobs), who are swapping paper back and forth between banks. There is no value created here, it is only accounting trickery. When the unemployed debtor finally declares bankruptcy, the ‘assets’ of the bankers disappear. Viola, deflation. Deflating assets caused by defaults domino through the economy. With bankrupt consumers unable to secure credit (it is suddenly too risky to lend), they have no ‘money’ to spend, so demand dries up, and prices fall further. The deflationary spiral deepens.

How long before it starts in earnest? I have a shelf full of books from the late 1970’s when pessimism ran high, claiming that fiat currency and the ‘massive’ U.S. budget deficit would spell doom for U.S. economy. Today with the debt 10 times higher, and increased risks on every front, no one seems to be the least bit worried. How long can unsustainable activity be sustained? By definition, not forever. If you have ever thrown a sheet of newspaper onto a campfire, you know that it ignites quickly and burns brightly for a few moments, but it goes dark just as fast. In 2004, the effects of monetary stimulus will dry up, causing a sharp reversal of fortunes. A sudden return to reality sparked by a ‘surprise’ event could be in the offing.

Last year, I began my list with a prediction of war. A year ago, it was the U.S. attacking Iraq. This year, I will not go so far as to predict a full-blown war, but hostilities are definitely in the air across the Taiwan Strait, and these heightened tensions are likely to have disruptive effects on world markets. Presidential elections in democratic Taiwan are coming up on March 20th and the incumbent is also offering up a referendum, requesting that China remove over 500 missiles pointed at the island. Of course such a referendum will pass – who wants missiles pointed at them? But China views such activities as ‘splittist’ (although Taiwan has never been under communist China rule), and has vowed to ‘protect the homeland at all costs.’ Explicitly, they have stated that they are willing to sacrifice their prospects for the 2008 Olympics, as well as the past decade of economic growth to maintain a unified China.

The U.S. is involved because of its pledge to defend Taiwan in case of attack by the mainland. However, China is very important to the U.S., because China is one of the main purchasers of U.S. Treasury securities. That is, they are one of the main countries sustaining our unsustainable consumption binge. And the US is very important to China also. Why? Because the U.S. is consuming Chinese products, keeping its factories humming. Additionally, a huge portion of Chinese wealth is tied up in dollar-based assets.

As we move closer to the election, cross-strait tensions will increase. Nervous investors will flock to gold. What happens next is anyone’s guess. The last time tensions boiled over in 2000 (also over Taiwan elections) the Chinese lobbed a missile over Taiwan and the U.S. sent warships to the Strait. This time, all three players have drawn their lines in the sand. Taiwan is intent on holding the referendum. China is intent on blocking any Taiwanese steps toward independence. The U.S. intent on defending Taiwan, but China wants the U.S. to stay out of its ‘domestic affairs.’

Recent rises in commodity prices, including oil and gold, can be traced back to the booming economy in China, and its tremendous appetite for resources. But the growth in China is being driven by massive amounts of FDI pouring into the country. This is leading to overcapacity in every industry, and a bust is sure to follow. Any signs of ‘uncivilized’ behavior by China would cause investors to flee, and markets to collapse – not only China’s booming asset markets, but worldwide commodity prices as well, including oil and gold.

An unsustainable situation cannot be sustained forever. Whether it is China or another event, this year or next, something will expose the massive vulnerabilities in U.S. economy. Whatever the event, it will merely be the trigger, not the cause, that starts the collapse of the U.S. economy in earnest.

The predictions for the year: Batton down the hatches, its going to be a rough year: The bubble in China will pop. The Dow, SPX and Nasdaq will streak lower and break their 2002 lows. After a brief rise in gold and decline in the dollar, rapid reversals will occur, sending gold on a downward spiral, and the dollar will show perplexing strength. Deflation will show its face for all to see. Economic disruption will cause recession, and the economy will contract in 2004. As a result of the economic disruptions, President Bush will lose in a landslide to the democratic ticket of John Kerry and Wesley Clark.

Happy New Year.
Michael Nystrom

Posted by manystrom at January 19, 2004 03:14 PM

Well written and I think spot on.

Posted by: S Higginbotham at January 24, 2004 06:19 AM

Hey Michael.

I think it'll be a Kerry/Dean ticket and they'll lose one way or the other (maybe Kerry/Edwards too - I don't think Clark will make the cut).

The Bush campaign will be multi-faceted as the geo-political end game of NWO construction marches forward in the face of looming economic meltdown which needs to be contained and shaped.

So, with that said.........OSB will be delivered up as a media circus event, the economy will be stable, the dollar will not drop much more, the daily economic numbers will be doctored-up real good and peace will break-out -- even (eventually) in Iraq where the UN will be made to jump in with major compromises to the Shiite's in the South and the Sunni's in the North (I would guess the Kurd's will get the shaft as always). That conflict will keep brewing, the UN strategy would have to be to send in troop from Morocco, Pakistan, Libya, Nigeria, and a few other non-aligned nations that are bought in to the grand scheme of things - that would stop the radicals blowing up Muslim UN troops, etc.

I think Colin Powell will quit within the next few months, or be forced out.

After that WMD "remnants" that are not traceable back to one of our "allies" or the US, will be found in some remote part of Northern Iraq. Of course finding WMD that are traceable back to the deals made with Saddam in the 80's would be very bad for the military industrial complex that supplied them - so these babies will need to be neutral somehow!

Africa will be focused on as a charity case and much needed aid provided (but so much of this will be window dressing). AIDS is ravaging the place and the decimation of the population is occurring to muted response currently from the west.

Syria will suddenly reform itself - shutting down all terrorist affiliations and swearing off WMD - allowing UN inspectors in and announcing reforms for women. Iran will make similar noises (but neither will truly embrace the current US regime/NWO - they'll be reacting at the end of a barrel - oil or gun?).

Taiwan will be sold down the river, its already happened. The US needs China's cooperation, China wants Taiwan next - done deal. There could be trouble brewing over that one, but it'd be darned hard for any Asian nation to stand up to Chinese aggression and desire, especially a Chinese nation. I'm sure a deal will be cut - perhaps something like the one for Hong Kong - a guarantee of self rule for a while through the integration process, etc.

Pakistan is a wild card, Musharraf has been so close be being topped - if he goes then what next? Civil war could erupt there, which could destabilize relations further with India - not a pretty picture. I think it is definitely another wild card.

North Korea will continue to look like a rogue nation led by a bizarrely coifured, fruit cake dictator (which is undoubtedly the case) - but his puppeteers I'm sure will keep him on a tight string and playing out his role as the wild card no one can second guess.

It's crazy baby - but I see Bush in the White House again - one way or the other - followed by the inevitable crash thereafter and God-only-knows-what.

In the end (decades away perhaps) peace will arrive and we'll march onwards as a race of spiritual beings inhabiting this physical plain in a transitory stage of our maturation. Humanity will evolve one way or another in to a global community that pays deference to culture and local communities and traditions - whilst being integrated on a global geo-political and economic level -- but this will take a long, slow and painful realization of the futility of any other type of governing mechanism.

Ultimately humanity will be freed from tyranny, I think we're in the death-throes of tyranny a round about now!

But hey, I've been wrong before!!!

Cheers Rich

Posted by: Rich Lancaster at January 26, 2004 11:02 AM


I agree with you. Bush will lose in a landslide. We are very late in the development of the Elliot wave pattern. The timing of the fall is critical to who will be the Democratic nominee.

I wouldn't bank on Kerry getting the nod just yet. I think there is a chance of history being made here at the Democratic convention this summer. If one assumes that the markets start to crash in mid February and fall the entire year until the election then we might have a surprise at the convention.

Have you ever read about the 1932 Democratic convention? Apparently Roosevelt was not a shoe in for the nomination until very late in the process. Granted the process was a lot different then but there is still room for so called 'brokered' convention. I don't know how that works but you might see a candidate that looked like he was out of the running come back with a vengence at the convention.

It all depends on the timing of the decline. It must start very soon for this to be a possibility.

On a more personal note one of my close relatives and spouse just bought a house! Can you believe it? My heart is heavy with grief at the pain they will suffer.

I started digging myself out of debt 1.5 years ago and am almost debt free. At the time my debt/savings ratio was greater than 100%. Now its down to 15%. The bulk of it is student loans that I inherited when I got married. I can pay off the remaining debt right now if I choose but my job is going well and will let it ride a bit more until it looks like the crash is on. Then I'll kill it and be debt free. Who knows if the treasury money market account that I hold onto as my last bastion of safety will survive or not. I think it will be sufficient but I may have to buy Tbills directly from the government to get the ultimate safety.

I keep trying to envision what it will be like after the big crash. I don't have much money because I have only been working for 5 years but I may be able to preserve more capital and grow it through the Rydex Ursa on the way down than anyone else in my family. What will I do if they all come to me for help?

I'm wondering if I should start stocking up on food. I felt a little silly doing that for the y2k bug but maybe this is really the time to do it. I'm starting to get really depressed about this depression. The whole thing is just going to be so awful. I don't see any other conclusion.

I'd like to stay psychologically strong during the depression. I'd like to be a leader of sorts for my extended family since none of them see the magnitude of what's about to happen. I'd also like to be able to enjoy myself after all this starts to happen. I like to play, write and record my own music. I like to play sports and various other things. I don't want to get into such a funk that I won't be able to do these things.

I've been having a hard time with the psychological implications of this depression before it even happens. I am a natural worry wart and this whole framework that the leading bearish minds have established feeds into all of my natural worries and thougth patterns. The whole argument is extremely rational and well thought out so I cannot possibly see how the alternate bullish view that they push on CNBC can be correct. I keep having arguments with myself where I say I don't WANT the markets to go down but I'm in such a state of anticipation over the whole thing.

In some ways I feel that if it has to happen lets get on with it already but I know that I'll regret that feeling later. I know that whatever reality the depression brings I will long for the days when the financial system was still working somewhat. My mind is fixated on the depression all the time now. I can't get it out of my mind. I think I need to see a psychologist but how would I explain all of this to him. I talk to my wife but she doesn't seem to really take it seriously. I wish there were a forum where I could talk to other people who have the same opinions about the market. I guess that's why I'm posting all of this now. It has been bottled up for so long. I need some interaction with like minded bears.

Good day and I thouroughly enjoy your website.

Posted by: Michael at January 30, 2004 08:12 AM

After a brief rise in gold and decline in the dollar, rapid reversals will occur, sending gold on a downward spiral, and the dollar will show perplexing strength.

if you hadn't noticed yet, the US government is deflating the dollar INTENTIONALLY


inflation or deflation

without massive intervention by governments around the world, gold would have gone through the roof but they can't stop it in the long run

stagflation is what we will see

china and india will boom for the next decade

that doesn't mean they can't have some corrections to cool off a little

Posted by: qwerty at February 1, 2004 04:20 PM

Nice comments. Thoughts not deep enough, I Think. There are those who feel that this young country of ours was captured and then later groomed to be a catalyst for world reorganization. The mature and longer lived nations have a design and have had it for centuries; ever since the Queen's property was taken from her. A sacrifiial land of a group of various peoples who must travel overseas at some point to continue their family tree. A temporary outpost now slowly vacated by the faceless founders. The carpenter is just about finished his work and its beauty is with a spoken awe. His tools lay on the ground; they were once greased and well taken care of but the job is about done.

Posted by: Richard Patterson at February 3, 2004 09:53 AM

Hi Milke

You predict decine in gold and strenth in dollar. Bur, I am curious to know the reasons for these predictions.

I suspect gold had not finished it's final wave down in accordance with Dow Theory. Why do you think gold will spriral down?

I expected the dollar to go down further. I can not think of any reason why it will go up. Why do you think it will strengthen?

Posted by: Kris Haahs at February 8, 2004 08:27 AM
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