Hello 1997!

I’ve been saying for a while that the growth the US economy (and, in a broader sense, the global economy) has been enjoying for the past two decades or so has been largely artificial.  The credit markets were a phenomenal growth engine, but only in the most synthetic sense.  Built on a weak and unsustainable foundation (consumer credit), a collapse was inevitable.  You can’t build an entire ecosystem on the premise of money being infinitely borrowed and reborrowed with no new real capital being created.  It wasn’t just a pyramid scheme, it was the entire Giza Plateau.  The answer to the “why” and “how” this was allowed to happen probably lies in the roots of the end of the Cold War.  Outspending the USSR as a strategy for “winning” the Cold War has never really been properly examined by history, but it is likely that the hyper growth engine that was not only allowed, but encouraged, is a product of that core government initiative.  The result of course is a globally collapsed economy and a Russia that is stronger and far more dangerous than the USSR ever was.  Be careful what you wish for is the lesson here.
There are lots of interesting things that can be learned from historical data.  One thing in particular becomes clear from studying any of the long term indicator data: the end of rational, linear, growth happened around 1997.  The Cold War had ended and the engine that had been used to speed its demise was free to crank into overdrive unfettered.  After that point, the growth year over year in the DJIA was exponential.  And that DJIA growth is reflective of the exponential growth that was happening in the housing and credit markets.
I had predicted that housing would return to late 90s valuations and that has been happening steadily.  There is no reason to expect that the Dow doesn’t follow suit.  This leaves us with a DJIA in the mid 6 range (adjusted for a decade or so of reasonable growth on top of late 90s norms).  My thinking is that the bleeding continues through 2009 and into H1 2010.  At that point we arrive at a “new normal”.  Not a recovery, but a new normal.  That part is important.  There is no recovery because this isn’t a “Great Depression replay” (as many like to claim).  Instead it is much worse.  It’s the mother of all corrections.  What this means is that the market will deflate to a truly sustainable size and then, well, sustain.
The scary thing is this leaves a lot of people disenfranchised which will mean an expansion of government safety nets and higher taxes for those employed.  My guess is 12-15% unemployment (adjusted for reality) becomes the new norm (look for government admission of around 9% maximum).  For those with protectionist leanings when the topic of unemployment gets ugly, I’ll cut right to the chase here: globalization was inevitable, is inevitable and will be a big part of the stablization.  In shifting capital to other centers of gravity, it was essentially somewhat protected from the out of control insanity that was happening in the US.  Sovereign wealth funds being willing to buy TBills at negative interest rates is clear evidence that we are all in this together.  Capitalism requires infinitely expanding markets to sustain and the real cause of the Great Depression was mercantilism, rampant protectionism and bad monetary policy.  In short, anyone who thinks “them foreigners are to blame” had probably better jump in bed with “them communists” because that kind of thinking just doesn’t fit with free market theory.  That said, the government and the US elites really sold the country down the river in completely dismantling our manufacturing base for short term gain.  This was a very bad move and one which will cause lots of additional pain in the coming years.  In an era when tangible goods are returning to the top of the value chain, we have utterly surrendered our capacity and ability to produce them.
I’d like to put some real analysis behind the employment question by looking at both emplyoment rolls for 1997 and population growth/decline since that time.  Adjust for shifts in market conditions and demands, and lack of retraining by most people.  Further refine for legal and illegal immigration and you can probably put a real expectation behind the actual size of the workforce that industry will be able to support come 2010.  Personally, my only real goal between now and that time is to remain a part of it!
There are some wildcards here of course.  The current global economic crisis leaves the sane world very exposed to attacks from the insane world of violent extremism.  Any attack would be devastating psychologically at this stage.  Similary, the impact of any natural disaster will be magnified.  On the flip side, adverse times are often the richest in terms of innovation.  Folks putting their ingenuity to work and doing more with less.  Tremendous new opportunity, and even entire new markets, can emerge with some luck.

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