Will The Forthcoming Recession Turn Into A Depression?

[Waiting Patiently]

A scholar of the highly regarded von Mises Institute of Austrian economics presents a worrying scenario :

.......this writer does not have much confidence that inflation will remain moderate. Inflationomics is still in vogue. The Fed is unlikely to raise its rates to a level that would call a halt to the currency and credit expansion and thus reinforce the world-wide trust in the US dollar. Instead, the Fed is likely to limp after the rising market rate and continue its expansion policies until an international dollar crisis calls for drastic emergency measures. In crisis and bedlam, Washington politicos are likely to add their controls and regulations, conditions and restrictions, prohibitions and penalties to the structure they created. In the footsteps of President Herbert Hoover, President Bush may even call for more trade barriers, which would turn the recession into a depression and breed much international conflict.

Ludwig von Mises Institute

[TW11]

Thats a good article.

I would go along with the idea that the US would like to engineer a gradual currency depreciation, but if that slide were to accelerate out of control then things will get interesting.

At that point the world is going to question the dollar's position as the world's reserve currency. I don't think the American elite are going to sit back and allow that to happen. I can't see them buying Euros with a depreciated dollar to fund their oil habit. I think the US will throw their interest rates through the roof and poor old overborrowed Joe Sickpack will just have to fall on his sword for the greater good of the American dollar.

But then what do I know? I'm an engineer

[assetpriceinflation]

What is interesting is that if the differential between Japanese & US interest rates narrows then it precipitates the unwinding of the Yen Carry Trade, so the Fed really has no room to manouvre.

[Assurbanipal]

Interesting.

I think USA are now in the blind way.

Falling dollar could help a lot with huge trade deficit. Those was done in 80s, when trade deficit reached slighty more than 3% of GDP (now is circa 7%). Dollar declined, trade deficit was reduced, import shrinked, export rose nicely.

Now, this simply solution is much harder, due to housing bubble. Declining dollar means inflation (higher energy prices and imported goods prices), this means annihilation of US property market (which is already cooling).

Moreover, consuption will suffer strongly:

-declining dollar will cause strong reduction of US demand of Asian and Europenian goods - what can cause recession/depression in Asia and several UE countries. Those will cause a declining in US retail sector, which account for vast majority of US GDP (and for export rise we have to wait some time). Any jump in unemployment rate in USA can as well destroy property market.

-houses are like cashmashines for US citizens: in 2005 600 billion $ was withdraw from properties and spent on consuption for purchasing next properties.

Fall of the dollar will destroy housing market and consuption. This cause huge jump in uneployment (40% of new jobs in the USA since 2001 was created around property market alone, not mention how many jobs is in the retail sector). High unemployment will make more painfull problems, retail and housing will sink quicker, causing more unemloyment, and this...

-strong dollar means rapidly growing debt of US society year after year - trade imbalance in such case will be still present (US goods to expensive, Asian ones still very cheap).

There is no country which can run such deficit in infinity, sooner or later debts will cause crash - but even more violent that in a case of the fall of dollar in near future. US has to reduce its trade deficit sooner ro later.

Dollar is destined to fall - and US can only stop it for some time (by introducing higher and higher interest rates - but as we know this is bad for property market...). Except trade deficit, are another things danger for dollar now. Foreigners start to be fed up with US debts, and trust in US economy shrinks - TIC (Treasury International Capital) inflows into USA are declining since the end of 2005. In April, TIC reached record low value - less than 50 billion $ (in the middle of 2005 inflows reached circa 100 billion $ per month).

Asian coutries - including Japan - plan to introduce its own international currency. Iran already opened commodity bourse - only in euro. Russia in 2007 will open commodity bourse in rubles. Venezuela is going to follow Iran in trade in euro.

Russia and many other countries is on the way of exchanging dollars in its reserves in favour of the gold and euro.

Lets look than at US economy in 2005. US growth circa about 600 billion $. In the meantime, US citizens withdraw from properties...600 billion. Cash inflow in 2005 to the USA was circa one thrillion $.

When everybody stops buying US bonds, and properties prices grow stops, above would not be possible.

I think US just start to shrink - and after US many other coutries as well.

We are ahaed to next depression like those one from 1929.

Edited June 16, 2006 by Assurbanipal