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Thanks HISF. This is a huge issue. It won't be possible to stave off a true valuation of these 'assets' indefinitely, and when it happens we are likely to see a scramble for the exits (ie every institution for itself). IMO a deflationary crash is inevitable and not far off.
I do not believe that prior estimations or existing economic theory will necessarily apply as we move through peak and beyond. A deflationary crash? How about horrible deflation and inflation at the same time just in different parts of the economy? How about assets deflating in value in real terms as Helicopter Ben starts printing dollars at lightspeed trying to keep the economy afloat?
Economics is not science. Don't take my word for it. Read the words of Dr. M. King Hubbert himself as he explains the incompatibilities between science and economics and how in our upside down world, economics has control over science (for now).
Economics is the killer. Economics is what will drive us to make collectively bad decisions. And if the decisions are late enough and if energy decline is too rapid, we won't get a second chance.
Ghawar Is Dying
The greatest shortcoming of the human race is our inability to understand the exponential function. - Dr. Albert Bartlett
Ben Bernanke said he would throw money from helicopters, but he didn't throw free money - he threw free debt (ie he fostered a huge credit expansion by keeping nominal rates artificially low). The money supply increased dramatically and asset prices went through the roof. It is that credit expansion, following on from the Greenspan mania, that must now correct.
I am convinced the crash will be deflationary - in the Austrian sense, meaning that the money supply will be contracting. As for price changes (a symptom of changes in the money supply), I think asset prices will collapse across the board, although everything will simultaneously become less affordable as purchasing power will be falling even faster. So essentially I agree with what you said, provided we agree on a common definition of inflation.
My view is that credit will cease to be available to anyone who is not already extremely wealthy, and therefore a relatively low risk. Even for those lucky few, I would expect the nominal rate of interest to be high and the real rate to be higher still (ie the real rate is the nominal rates minus negative inflation when the money supply is contracting). Most people would have little or no purchasing power, hence demand would collapse, as demand presupposes purchasing power.
Risk has been ignored during the mania as real interest rates were negative. Everyone has been chasing yield without realizing they were chasing risk, but risk-awareness is about to make a comeback. The Fed may lower short term rates, although even zero won't be low enough under conditions of money supply contraction (ie real rates would still be high). Long term rates will be another story - they are headed much higher in order to reflect risk. Credit spreads will widen dramatically in order to reflect risk as well, and the dollar should increase in value significantly (for a while) as people try to cash out.
IMO we will see another Great Depression (as the BIS warned last week). I think that will bring down much of the banking system and international financing over several years. When the US is cut off from international financing, I think it will turn to the actual printing of money as opposed to fostering credit expansion as it has done so far. There is a big difference between credit expansion and currency hyperinflation - credit expansion ends always in deflationary of the credit bubble, whereas currency inflation can persist as a chronic scourge for long periods of time. IMO we will probably experience hyperinflation after the deflationary impulse is spent.
Thanks for all of your links to subprime stories today. I think your synopsis makes a great deal of sense. If you take your scenario a step further--we are facing a GD, our nation is grossly in debt to foreign bond owners and in the way of our own entitlements, yet we need to increase government spending to get us out of our GD as well as lower our interest rates (like you say to zero), then what happens or rather how can that increased spending happen, or is that where your actual printing of money comes in? At the same time, I suppose we'd nationalize our health care and infrastructure and energy problems, if not our entire transportation and agriculture systems (since they've all collapsed), with inadequate success, adding government work programs for the unemployed, and rationing coupons for essentials, so that we would hardly look like a democracy anymore. Also, if you have any book recommendations for those of us interested in reading about the GD, I would appreciate it.
The best book on the subject at the moment (IMO) is Financial Armageddon by Michael Panzner. Another I would really recommend for historical perspective is The Great Wave: Price Revolutions and the Rhythm of History by David Hackett Fischer - it's a history of inflations and their aftermath going back over several hundred years. It's much more accessible and readable than it sounds.
I don't think we'll see an increase in government spending in the sense that you mean (ie Keynesian) during a depression. A liquidity crunch means that there will be very little money available, and not nearly enough to cover even what people would regard as necessities. (Trying to run an economy with insufficient money is like trying to run an engine with the oil light on - it doesn't take long to seize up.) I think the US government will repudiate its obligations, particularly to its own people, as these are already unpayable even without an economic collapse. The indebted middle class will be ruined, as they were during the Argentine financial crisis for instance (see And the Money Kept Rolling in and Out by Paul Blustein).
I don't think we'll see money printing until all access to foreign financing is lost (hence the need to continue servicing obligations to foreign bond holders in order to avoid being cut off - the bond market is a hard task master). I'm not sure how long this would take as we've never had a credit bubble the size of the one we have now - one that penetrates into every corner of the economy. It makes it difficult to guess how long it might take to unravel. My best guess is that we will see at least a decade of deflation and depression and that hyperinflation could set in some time after 2020.
I agree with you about not looking like a democracy anymore. When there is nowhere near enough to go around, you would tend to get either anarchy (if rationing is by price and the poor are simply expected to do without) or totalitarism (ie central control of essential supplies is imposed). My opinion is that a much greater degree of central control will be imposed. Emergency powers legislation to suspend constitutional checks and balances and impose a unitary executive already exists, ostensibly to deal with a major terrorist event. Unfortunately powers granted rarely lie dormant and are almost always abused at some point (I have a law background, so these issues are of particular interest to me). See this article for instance.
Stoneleigh
Thanks! That helps. I was trying to imagine how the government could possibly increase spending in such a situation, and you answered it. It can't!
And you anticipated my next question--what kind of time periods would be likely?
What amazes me, is that there seem to be a majority of financial persons who do not think this scenario is possible.
The global ramifications of this are enormous as well--the nations who've financed our debt, and a global inability to fund extraction of remaining oil being no small part of the picture. I've always suspected that an economic collapse could trigger a faster drop in oil supplies than people ever envision.
I suppose the nation's that might fare best are those who have the least amount of interaction with us (the US) now, and, also those richest in natural resources and food production, which still puts the US and Canada in a better situation than many other countries.
Thanks for the reading recommendations.