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What Will Happen When We Hit the Cliff

Executive Summary

A rising dollar would negatively impact stock market profits and valuations
Interest rates ultimately will rise, and that will be a game-changer
Investors will eventually realize that "risk-free" assets (e.g., U.S. Treasurys) are NOT safe havens
Why there will be few places for financial capital to find shelter in 2013

If you have not yet read Part I: The Structural Endgame of the Fiscal Cliff, available free to all readers, please click here to read it first.

In Part I, we covered the basics of wealth and political power in the U.S. and found that the Fiscal Cliff is only a symptom of a structural endgame in which the imbalance between what has been promised and what can be collected in taxes will continue growing until it triggers a financially driven political crisis that I believe will inevitably become a full-blown Constitutional crisis.

Though there are many facets of this long-term political crisis that are worthy of further exploration, we will to start with three financial aspects that could start impacting households in 2013: a rise in interest rates and a resultant destruction of bond valuations, a rise in the U.S. dollar that negatively impacts U.S. corporate profits and thus stock market valuations, and a reduction in upper-income households’ spending as a result of higher taxes that depress discretionary consumer spending.

A Rising Dollar Negatively Impacts Stock Market Profits and Valuations

Let’s start with a topic that I have covered in depth over the past year, the structural reasons behind the rise of the U.S. dollar (USD). The recurring fantasy that Europe’s fiscal and debt crises are “fixed” and the Federal Reserve’s money-printing/Treasury bond purchases have recently depressed the USD, but in the longer term, the USD has been tracing out an unmistakably bullish pattern of higher highs and higher lows since May 2011…

What Will Happen When We Hit the Cliff

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Executive Summary

A rising dollar would negatively impact stock market profits and valuations
Interest rates ultimately will rise, and that will be a game-changer
Investors will eventually realize that "risk-free" assets (e.g., U.S. Treasurys) are NOT safe havens
Why there will be few places for financial capital to find shelter in 2013

If you have not yet read Part I: The Structural Endgame of the Fiscal Cliff, available free to all readers, please click here to read it first.

A Rising Dollar Negatively Impacts Stock Market Profits and Valuations

The Structural Endgame of the Fiscal Cliff

To understand this endgame, we need to start with the financial and political basics of wealth and power in the U.S.

1. Wealth and thus political power are highly concentrated. The dynamics of rising wealth disparity and the increasing concentration of wealth are debatable; the disparity is not. Roughly 70% of all financial wealth is held by the top 5%; within this top layer of ownership, the top ½ of 1% hold an outsized share.

The Structural Endgame of the Fiscal Cliff

To understand this endgame, we need to start with the financial and political basics of wealth and power in the U.S.

Real Estate: Is the Bottom In, or Is This a Head-Fake?

Everyone interested in real estate is asking the same question: is the bottom in, or is this just another “green shoots” recovery that will soon wilt?

Let’s start by reviewing the fundamental forces currently affecting real estate valuations.

Real Estate: Is the Bottom In, or Is This a Head-Fake?

Everyone interested in real estate is asking the same question: is the bottom in, or is this just another “green shoots” recovery that will soon wilt?

Let’s start by reviewing the fundamental forces currently affecting real estate valuations.

Forecasting the Future of Rental Housing and Home Valuations

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Executive Summary

Why the momentum for household formation is still downwards, despite the gains in recent years
Why "rental price fatigue" is putting today's increasingly rosy housing valuations at jeopardy
Why the fiscal and monetary stimulus that has boosted the housing market in recent years cannot continue further
How housing may turn from the “can’t lose” investment into an anchor of debt and a “now I can’t move to a better job” debacle

If you have not yet read Real Estate: Is the Bottom In, or Is This a Head-Fake?, available free to all readers, please click here to read it first.

In Part I, we reviewed the fundamentals that have been pushing housing prices higher in 2012. Many of these forces are the result of explicit real estate-supportive Federal and Federal Reserve policies, while others, such as restricting the number of defaulted properties on the market, are implicit policies of the financial cartel that has much to gain from a recovery in housing.

What, if anything, could derail this manufactured housing recovery?

Before we get to specifics, we should start by discussing unintended consequences. What happens when politically expedient policies are imposed with a simplistic goal?

Exhibit #1 is the Federal Reserve policy of lowering interest rates and increasing liquidity to boost “risk assets” such as stocks. This had the unintended consequence of inflating a stock bubble that burst with painful consequences in 2000-02.

Like all central-planning agencies, the Fed followed this policy error by doing more of what had failed: It lowered rates even more, enabling an unprecedented bubble in housing, which subsequently burst in 2007-08 with even more devastating consequences, as that implosion nearly took down the global financial system.

With FHA having replaced the bankrupt Fannie Mae and Freddie Mac agencies as the mortgage-guarantor of last resort, the Federal government has also doubled down on the failed subsidies that enabled the housing bubble.

What are the unintended consequences of pushing investors into the “crowded trade” of rental housing? If we answer this, we will be closer to understanding whether housing has bottomed or not.

Let’s start by reviewing the fundamentals of supply and demand that influence housing and rentals.

Forecasting the Future of Rental Housing and Home Valuations

PREVIEW

Executive Summary

Why the momentum for household formation is still downwards, despite the gains in recent years
Why "rental price fatigue" is putting today's increasingly rosy housing valuations at jeopardy
Why the fiscal and monetary stimulus that has boosted the housing market in recent years cannot continue further
How housing may turn from the “can’t lose” investment into an anchor of debt and a “now I can’t move to a better job” debacle

If you have not yet read Real Estate: Is the Bottom In, or Is This a Head-Fake?, available free to all readers, please click here to read it first.

What, if anything, could derail this manufactured housing recovery?

Before we get to specifics, we should start by discussing unintended consequences. What happens when politically expedient policies are imposed with a simplistic goal?

What are the unintended consequences of pushing investors into the “crowded trade” of rental housing? If we answer this, we will be closer to understanding whether housing has bottomed or not.

Let’s start by reviewing the fundamentals of supply and demand that influence housing and rentals.

Why Gold & the Dollar May Both Rise from Here

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Executive Summary

Triffin's Paradox leads to four principal conclusions that indicate why the U.S. dollar may well continue to strengthen from here
Why the euro's troubles have been good for the price of gold
Why the dollar can strengthen despite the United States' wishes
Why the future may well see the price of both gold and the U.S. dollar rise

If you have not yet read Part I: Gold & the Dollar are Less Correlated then Everyone Thinks, available free to all readers, please click here to read it first.

In Part I, we examined the commonly offered correlations between the dollar, gold, interest rates, and the monetary base, and found no consistent correlations between any of these and the domestic economy. Clearly, the trade-weighted value of the dollar and the value of gold have at best marginal impact on the domestic economy.

Perhaps the dollar’s primary impact is on the international economy, as suggested by Triffin’s Paradox, which begins with the premise that the needs of the global trading community are different from the needs of domestic policy makers.

Prior to 1971, the dollar was backed by gold, which acted as a supra-national anchor to the dollar's reserve status. As the U.S. monetary base expanded while gold remained artificially pegged at $35 an ounce, roughly half of America’s gold reserves were shipped overseas before the policy was jettisoned.

Here is the Wikipedia entry on Triffin’s Paradox:

The Triffin paradox is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. This dilemma was first identified by Belgian-American economist Robert Triffin in the 1960s, who pointed out that the country whose currency foreign nations wish to hold (the global reserve currency) must be willing to supply the world with an extra supply of its currency to fulfill world demand for this 'reserve' currency (foreign exchange reserves) and thus cause a trade deficit. (emphasis added)

The use of a national currency (i.e. the U.S. dollar) as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: some goals require an overall flow of dollars out of the United States, while others require an overall flow of dollars in to the United States. Net currency inflows and outflows cannot both happen at once.

This leads to some startling conclusions that many have great difficulty accepting…

Why Gold & the Dollar May Both Rise from Here

PREVIEW

Executive Summary

Triffin's Paradox leads to four principal conclusions that indicate why the U.S. dollar may well continue to strengthen from here
Why the euro's troubles have been good for the price of gold
Why the dollar can strengthen despite the United States' wishes
Why the future may well see the price of both gold and the U.S. dollar rise

If you have not yet read Part I: Gold & the Dollar are Less Correlated then Everyone Thinks, available free to all readers, please click here to read it first.

Here is the Wikipedia entry on Triffin’s Paradox:

The Triffin paradox is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. This dilemma was first identified by Belgian-American economist Robert Triffin in the 1960s, who pointed out that the country whose currency foreign nations wish to hold (the global reserve currency) must be willing to supply the world with an extra supply of its currency to fulfill world demand for this 'reserve' currency (foreign exchange reserves) and thus cause a trade deficit. (emphasis added)

The use of a national currency (i.e. the U.S. dollar) as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: some goals require an overall flow of dollars out of the United States, while others require an overall flow of dollars in to the United States. Net currency inflows and outflows cannot both happen at once.

This leads to some startling conclusions that many have great difficulty accepting…

Gold & the Dollar are Less Correlated than Everyone Thinks

Whenever I make the case for a stronger U.S. dollar (USD), the feedback can be sorted into three basic reasons why the dollar will continue declining in value:

The USD may gain relative to other currencies, but since all fiat currencies are declining against gold, it doesn’t mean that the USD is actually gaining value; in fact, all paper money is losing value.
When the global financial system finally crashes, won’t that include the dollar?
The Federal Reserve is “printing” (creating) money, and that will continue eroding the purchasing power of the USD. Lowering interest rates to zero has dropped the yield paid on Treasury bonds, which also weakens the dollar.

The general notion here is that, given the root causes of our economic distemper – rampant financialization, over-leverage and over-indebtedness, a politically dominant parasitic banking sector, an aging population, overpromised entitlements, a financial business model based on fraud, Federal Reserve monetizing of debt, and a dysfunctional political system, to mention only the top of the list – how can the USD appreciate in real terms?

Gold & the Dollar are Less Correlated than Everyone Thinks

Whenever I make the case for a stronger U.S. dollar (USD), the feedback can be sorted into three basic reasons why the dollar will continue declining in value:

The USD may gain relative to other currencies, but since all fiat currencies are declining against gold, it doesn’t mean that the USD is actually gaining value; in fact, all paper money is losing value.
When the global financial system finally crashes, won’t that include the dollar?
The Federal Reserve is “printing” (creating) money, and that will continue eroding the purchasing power of the USD. Lowering interest rates to zero has dropped the yield paid on Treasury bonds, which also weakens the dollar.

Understanding the Economic Impact of Peak Government

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Executive Summary

The U.S. is less prepared for contraction than the U.S.S.R. was
The pressure to print money and the spectre of runaway inflation
What we must learn from the Japan example (the U.S. is unlikely to tread a similar path)
Why you must expect and prepare for the rules to change

If you have not yet read Part I: Anticipating the Devolution of Big Government, available free to all readers, please click here to read it first.

In Part I, we surveyed the four critical dynamics that will lead to the devolution of Peak Government: massive borrowing, institutionalized mal-investment, erosion of trust in government, and diminishing returns on public debt. In Part II, we consider how the devolution of Peak Government may play out in the real world.

We are indebted to author Dmitry Orlov for examining how apparently stable global empires can suddenly destabilize, much to the surprise of everyone involved. Orlov experienced the collapse of the Soviet Union first hand, and in his book Reinventing Collapse, he contends that America is actually less prepared than the former U.S.S.R. to weather the collapse of Central State institutions.

As I noted in my first series on Peak Government, this does not mean government ceases to exist; what it does mean is that government shrinks and assumes a different role in society and the economy.

Though there are many obvious differences between the former U.S.S.R. and the U.S., Orlov’s primary point is that complex, apparently stable governments can destabilize rather quickly once invisible “tipping points” are reached…

Understanding the Economic Impact of Peak Government

PREVIEW

Executive Summary

The U.S. is less prepared for contraction than the U.S.S.R. was
The pressure to print money and the spectre of runaway inflation
What we must learn from the Japan example (the U.S. is unlikely to tread a similar path)
Why you must expect and prepare for the rules to change

If you have not yet read Part I: Anticipating the Devolution of Big Government, available free to all readers, please click here to read it first.

As I noted in my first series on Peak Government, this does not mean government ceases to exist; what it does mean is that government shrinks and assumes a different role in society and the economy.

Anticipating the Devolution of Big Government

With the US elections approaching next week, as well as the threat of another fiscal cliff showdown looming, we asked contributing editor Charles Hugh Smith to revisit his eariler work on how the expansive Central State has come to dominate both private society (i.e., the community) and the marketplace, to the detriment of the nation’s social and economic stability.

Anticipating the Devolution of Big Government

Finding Authentic Happiness

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Executive Summary

Why buying into the Status Quo undermines personal empowerment
Echew debt and consumerism. Instead, focus on cultivating resilience and social capital
The importance of differentiating hedonia vs eudaimonia
The key roles of Expectation, Narrative, and Challenge
The foundations of happiness

If you have not yet read Part I: The Pursuit of Happiness, available free to all readers, please click here to read it first.

In Part I, we challenged the assumption that the successful pursuit of happiness is based on material prosperity and what we might call the psychology of the atomized individual.

If material prosperity is necessary but insufficient, and our social and financial order is sociopathological, what does an authentic pursuit of happiness entail?

For answers, we can survey recent research into human happiness, and consider “powering down” participation in a deranging social and financial order.

Pondering Power

The primacy of power in human society is omnipresent. Humans scramble for power in all its forms to improve social status and the odds of mating, living a long life, and acquiring comforts. What is remarkable about the current American social order is the powerlessness of the vast majority of people who have “bought into” the Status Quo.

When the public vehemently disapproves of a policy, such as bailing out the “too big to fail” banks, they are routinely ignored, and for good reason: They keep re-electing incumbents. Most have little control over their employment status, workflow, or income, and most devote the majority of their productive effort servicing private debt and paying taxes that service public debt.

The one “power” they are encouraged to flex is the momentary empowerment offered by purchasing something; i.e., consuming. The corporate marketing machine glorifies acquisition as not just empowering but as the renewal of identity and the staking of a claim to higher social status – everything that is otherwise out of the control of the average person.

The dominant social control myth of our consumerist Status Quo is that wealth is power because you can buy more things with it. But the power of consumption is one-dimensional and therefore illusory. The only meaningful power is not what you can buy – a good, service, or experience – but what you control – your health, choice of work, income, surroundings, level of risk, and your circle of colleagues and friends.

The “wealthy” who own an abundance of things but who are trapped in debt are not powerful. Their choices in life are limited by the need to service the debt, and their pursuit of happiness is equally constrained.

The kind of wealth that enriches the pursuit of happiness is control over the meaningful aspects of life. It is no coincidence that studies of workplace stress have found that those jobs in which the worker has almost no control over their work or surroundings generate far more stress than jobs that allow the worker some autonomy and control.

Financial and material wealth beyond the basics of creature comfort is only meaningful if it “buys” autonomy and choice.

We all want power over our own lives. Once we free ourselves from social control myths, we find that becoming powerful and “wealthy” in terms of control does not require a financial fortune. It does, however, require sustained effort and a coherent long-term plan…

Finding Authentic Happiness

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Executive Summary

Why buying into the Status Quo undermines personal empowerment
Echew debt and consumerism. Instead, focus on cultivating resilience and social capital
The importance of differentiating hedonia vs eudaimonia
The key roles of Expectation, Narrative, and Challenge
The foundations of happiness

If you have not yet read Part I: The Pursuit of Happiness, available free to all readers, please click here to read it first.

In Part I, we challenged the assumption that the successful pursuit of happiness is based on material prosperity and what we might call the psychology of the atomized individual.

If material prosperity is necessary but insufficient, and our social and financial order is sociopathological, what does an authentic pursuit of happiness entail?

For answers, we can survey recent research into human happiness, and consider “powering down” participation in a deranging social and financial order.

Pondering Power

Financial and material wealth beyond the basics of creature comfort is only meaningful if it “buys” autonomy and choice.

The Pursuit of Happiness

What is the point of prosperity?

Though few people ever voice this question openly, the general assumption is that prosperity and wealth increase happiness. The pursuit of happiness (famously grouped with “life” and “liberty” in the Declaration of Independence as an inalienable right) has become the pursuit of prosperity and wealth.

That physical comfort and security grease the skids of happiness is self-evident; living a hand-to-mouth existence inside a cardboard box is not as conducive to human happiness as having a comfortable home and secure income.

But it is equally self-evident that a secure dwelling and income do not guarantee happiness; rather, they provide the physical foundation for the much more elusive qualities of happiness. We can make the same distinction between the civil liberties that underpin the pursuit of happiness and the actual pursuit of happiness.

The Pursuit of Happiness

What is the point of prosperity?

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