Living on Borrowed Time

Living on Borrowed Time

In my latest book, Conspiracy of the Rich: The 8 New Rules of Money, I write about two types of depression. The first is an American-style depression where prices fall and deflation wreaks havoc on the economy. The second is a German-style depression that’s marked by hyperinflation where prices rise faster than incomes can keep up. In that section of the book, I asked which style of depression might the US face in the coming years—if we were to have a depression at all.

When I wrote the book, I wasn’t sure we’d be able to avoid a depression, and now, a year later, I’m even less convinced that we’re experiencing a true economic recovery. Instead, I think we’re just seeing the calm before the storm.

I believe that we’re headed towards experiencing both types of depression. And right now we’re living on borrowed time.

American-Style Depression

The Great Depression was caused by governments trying to cheat on the gold standard. Heavy debts were incurred during World War I. Governments had a hard time paying off those debts because their currencies were pegged to gold. Gold made it so only so much money could be printed. If you had a million ounces of gold and you could only print three dollars for every ounce, you could only print three million dollars. Yet, governments tried their best to find a way around the gold standard.

As debt mounted and defaults rose, banks failed and millions of people lost their life’s savings. There was no FDIC, so if a bank failed you lost everything. As people began losing money, they spent less, which caused prices to crash. Unemployment rose quickly, which caused even less spending, and caused even more deflation. It was a devastating spiral that led to the worse economic crash in US history. Because the US was on the gold standard, they couldn’t print their way out of the crash.

German-style Depression

In Germany it was different. The German government decided to abandon the gold standard and began printing currency as quickly as the presses could handle. The result was massive hyperinflation. From 1919 to 1923, Germany’s currency supply increased from 29.2 billion marks to 497 quadrillion marks—a multiplication of 17 billion.

There’s an old joke about a woman who left her wheelbarrow full of German marks outside while going into a store buy a loaf of bread. When she came back out, her wheelbarrow was stolen but the money was left behind. That is the devastating effect of hyperinflation. The currency becomes essentially worth nothing because so much is being printed so quickly.

Fast Forward

Today, the world is facing many of the same problems that were being faced before the Great Depression set in. The world’s governments are facing massive and unsustainable debt. According to a recent Newsweek article entitled, “Depression 2010?”: “In 2009, Greece's budget deficit was almost 14 percent of gross domestic product (GDP)—its economy. Its accumulated debt was 115 percent of GDP. Meanwhile, Italy's deficit was 5 percent of GDP and its debt 116 percent of GDP. Spain's deficit was 11 percent of GDP and its debt 53 percent. Germany's deficit was 3 percent and its debt 73 percent. The U.S. deficit—calculated slightly differently—was 9.9 percent of GDP; the debt, 53 percent of GDP. Most developed countries, representing about half the world economy, are caught in the same trap.”

If you’ve watched the news, then you know there is serious trouble happening in Greece as they cut their massive entitlement programs and seek international help to bail them out. Those problems are affecting the world economy and consumer confidence. It’s no coincidence that the Dow fell over 1,000 points and nearly crashed on May 6th.

The bailout for Greece is massive, and it’s coming from countries that are already facing heavy debt burdens. Already the citizens of Greece are revolting as massive riots are happening all over the country in response to the cutbacks.

All over the world people are paralyzed. They’re clinging to their money for security. This is bad news for established countries like the US that rely on consumer spending for the majority of their economic growth.

Currently people are hoarding their money, prices are falling in many asset classes such as real estate, and in response the Fed and other central banks are printing more and more money.

So What?

The problem in the first Great Depression was countries’ inability to pay off war debts because of the constricting nature of the gold standard. Since Nixon removed the dollar off the gold standard in 1971, the US and other countries are now able to print their way out of debt—and they’re trying.

The most-likely cause of the next depression will be countries’ inability to pay their promised entitlements like Social Security and Medicare. As Robert J. Samuelson writes in Newsweek, “There are eerie, if crude, parallels [to the Great Depression] now. The welfare state is today's equivalent of the gold standard. With aging societies, advanced countries have promised more benefits than their tax bases can support.” The debt is simply too much to sustain growth—both on the government and personal level. In response, the government continues to print more and more money out of thin air, making it worth less and less.

All this shuffling of one government’s debts to cover another government’s debts is like a big room full of traders handing each other IOUs but with no one really paying up. The only thing these bailouts are buying is time. The problem is that you could have all the time in the world but you’ll be no better off if you don’t fix the true problem—the massive and unsustainable piles of toxic government debt.

Right now people aren’t spending because their personal debt levels are so high, so the governments are stepping in. But because consumer spending drives economic growth in the US and developed countries, the government spending is not having the impact it could. Still they’re trying to throw piles and piles of money at the problem. But as long as we don’t spend, deflation will continue, and an American-style depression will set in.

At some point, however, people will begin to feel confident again, and they’ll start spending all the money they’ve saved. All those dollars printed at breakneck speed will hit the market and prices will start rising—and fast. A German-style hyperinflation may happen as a result.

How do I survive?

Many people will be paralyzed by fear during the coming years. But for the financially intelligent, this will be the opportunity of a lifetime. For those who aren’t financially intelligent, I’d suggest at the very least purchasing some gold or silver—as much as you can afford—to protect yourself from inflation. If you have a high financial intelligence, be on the look out for deals. As asset prices crash, be ready to swoop in and buy them up.

The important thing to remember about depressions is that wealth doesn’t disappear—it’s simply transferred.

This is the biggest transfer of wealth in modern history. You have the choice to be on the receiving end—or to lose it all. The dividing line will be those who are financially intelligent and those who aren’t.

Original publish date: May 11, 2010