(This is Part 5 of a series. Go back to Part 4.)
The triggering event this time could be any of a dozen things, ranging from a collapse in the dollar to a Chinese banking system failure to a terrorist attack.
However, the response of the U.S. Federal Reserve Board will almost certainly be exactly the same in any event. It will flood the system with liquidity.
Recession and/or depression are considered unpalatable alternatives, so the U.S. central bank and other central banks worldwide will continue to inject new liquidity into the system until they lose control of the process and price inflation enters a runaway stage.
After all, this is what happened historically when other governments faced overwhelming debt and deficits; the only difference this time is that the phenomenon is taking place globally and on a much larger scale.
The U.S. is the key player in this scenario because it has built up by far the largest debt structure. Paradoxically, this makes the U.S. economy the most fragile even though it is the wealthiest in the world and seems to be humming along at the moment.
Chaos theory has shown, though, that large 5-sigma and 10-sigma events—"avalanches"—can seem to come out of nowhere when a system has reached a critical state, and that in such a condition a systemic tsunami may require only a suitable triggering event to set it off.
It is highly likely, actually, that the world will see a series of such triggering events or crises, each of which will be met with a fresh and massive dose of liquidity. Thus it is also very likely that the world will see erratic movements towards both recession and further price inflation.
The globe will probably lurch between one and the other at various times, and increasingly both in what's known as an inflationary depression.
But as the doses of liquidity become greater and more desperate it is almost a foregone conclusion that price inflation will become worse and worse until it enters the self-reinforcing "runaway" stage known as hyperinflation.
In real terms, the interest-rate markets—stocks, bonds, real estate—will probably not fare well in all this. As inflation climbs so will interest rates, which will cause these markets, adjusted for inflation, to enter a relentless decline. Before it's all over, all three will likely fall at least 90% in real purchasing power terms.
To many that may sound like fantasy-land, especially the part about housing falling perhaps 90% in real terms. Yet housing fell an average of 80% during The Great Depression of the 1930s and did not recover for 25 years. Do we think it will be different this time? And let's remember, the global credit bubble this time is an order of magnitude larger than it was back then.
Because the real estate market is a good deal bigger than the stock market, a collapse in the real estate bubble will have particularly severe effects on the economy.
A bubble in real estate? Consider that the price-to-rent ratio, a kind of price/earnings ratio for housing, is 32% higher in the U.S. than its average level of 1975-2000. In France that figure is 46%. In Britain, Australia and Spain the figure is over 60%.
I'm looking at two charts at the moment. The one on the left is household stock holdings as a percentage of GDP from 1985 to 2000. It's a parabolic chart, a picture of a classic blow-off.
On the right is a chart of household real estate holdings as a percentage of GDP from 1995 to the present. The interesting thing is, the two charts look identical. The housing bubble on the right has now reached 140% of GDP—as the stock bubble on the left did in early 2000, just before it crashed.
(This is the end of Part 5. Go to Part 6.)
—jim sloman, 03.07.05
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