Thursday, October 16, 2008

Dismal Math

They call economics the dismal science.  I think that's partly because it turns everything that people feel and think and create into math.  Economics is effective,  if inconclusive, because the math works.  Eventually.  This is important because right now, the math isn't working.  The result of the current economic crisis should be a run on the US dollar.  I've predicted it before and been 100% wrong.  Instead of dropping, the US dollar has gone up like a rocket over the last few weeks.  The law of economic panic (since WW2) still applies: when in panic buy US Treasuries.  And demand for Treasuries has been so strong in recent weeks that they are trading at yields close to zero.  But it can't last.  The stock market panic is beginning to fade.  The banking crisis looks to be if not under control, then at least contained.  Investors are now assessing the damage to the US economy.  Confidence in the Euro was tested by the lack of a co-ordinated response to the banking crisis.  It became painfully clear that the EU cannot stand behind the Euro as the US can stand behind the dollar.  The Euro cannot replace the dollar as the world's reserve currency at this time.  That precludes a dollar crash.

Nevertheless, the math says at some point the US dollar will get hurt, and badly.  The real hangover from the credit binge of the last 10 years has yet to begin.  No matter how you look at it, the US is printing money to buy itself out of the crisis.  In addition, the wars in Iraq and Afghanistan are generating US government deficits of a half a trillion dollars per year.  At some point after the current panic fades, foreign investors are going to start demanding a real return.  This is not a matter of intention, but of math.  If the US keeps selling Treasuries to finance its deficit, then to the extent it sells them to foreigners, it is selling dollars.  More supply equals a lower price.  Like tectonic plates straining, the sudden release will be like an earthquake.  The math will work and the dollar will fall far and fast.  Interest rates go up, economic activity goes down.

I don't think we are going to have anything like the Great Depression.  Governments have learned too much in the interim.  But we will all have to look towards a future with less acquisition of material possessions.  This crisis is far from over, and nobody knows what will be in play before it ends.