(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.
Since recession or depression are considered unpalatable alternatives, the central banks of the world will most likely continue to inject fresh new liquidity into the financial system (staving off such a result) until, in the classic manner, they lose control of the process and price inflation enters the runaway stage.
Historically, this has been the result at other times when other governments faced overwhelming debt. The main difference this time is that the phenomenon is taking place globally and on a vastly 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.
But chaos theory has shown that huge 5-sigma and 10-sigma events—"avalanches"—can seem to come out of nowhere when a system has reached the critical state, and that in such a condition a systemic tsunami requires only a suitable triggering event to set it off.
Because the global financial system is now in such a critical state, it is highly likely 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, too, it is very likely that the world will see erratic movements towards both recession and further price inflation. In the coming years the world will probably lurch between one and the other, and increasingly both,
in what's known as an inflationary depression.
But as the doses of liquidity become greater and more desperate it is likely that price inflation will become progressively greater until it enters the "runaway" stage known as hyperinflation.
Stocks, bonds and real estate, in real terms, will probably not do well in all this. As inflation climbs so will interest rates, causing these markets to enter a relentless decline. Before it's all over, all three will likely fall over 90% in real purchasing-power terms.
That may sound like fantasy-land, especially the part about housing falling perhaps 90% in real terms. Yet housing fell 80% during The Great Depression of the 1930s. 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 much larger than the stock market, a collapse in the real estate bubble will
have particularly severe effects on the economy.
A bubble in real estate? The price-to-rent ratio, a kind of price/earnings ratio for housing, is 32% higher in the U.S. than its average of 1975-2000. In France, 46% higher. In Britain, Australia and Spain, 60% higher.
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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