Friday, May 15, 2015

Global Economic Collapse: Part 2 Can It Really Happen?




If you haven't read part 1 I encourage you to do so, it will help you understand where we are now.


The US as a Global Economic Power

How has the US had it so good for so long?

The US prior to world war two had some severe ups and downs economically. Since world war two we have had it pretty good. Yes we have had some hard times and a few recessions, but nothing that could compare with the great depression.

Have we just been lucky? Have our leaders done that much better a job than other countries? Is it just because the American spirit is so strong? Nope, nope, and nope.

The Gold Standard


After world war two the world's economy was pretty much in shambles. Out of all of the countries involved in World War II the United States came out the best. The US had very little damage to infrastructure, the US had been in overdrive producing everything they could to support the war effort, so profits were high. Plus when all of the men came back there were fewer of them so the labor pool was smaller. I know that sounds cruel, but it is true. You cannot give a job to someone who died on the battlefield.

In July 1944 delegates of the United Nations and what would become the IMF (International Monetary Fund) met in New Hampshire to try and restore stability to the global economy. At the time the United States controlled 2/3 of the world's gold. An agreement made the US dollar the anchor of all of the other world currencies. This agreement insured that every country could convert US dollars to gold at a set rate $35.00 per ounce. The US would support other nations and their central banks within set regulations.

The Bretton Woods Conference thrust the Untied States into the lead role of the world economy. What did that do for the US? It guaranteed that the US and its citizens could borrow money at a lower interest rate than really anyone else in the world.  Since the US dollar was guaranteed to be convertible to gold at a rate of $35.00 per ounce the demand for the US dollar increased which strengthened the dollar. This hurt US exports, but benefited everyone else in the country. This agreement is what ushered in the prosperity that was seen during the 1950's.

This system didn't last very long.

The Nixon Shock


President Richard Nixon took the United States off of the gold standard. This action basically nullified the Bretton Woods agreement. However Nixon had another idea in mind. This is when the US went to a fiat/debt backed system. Nixon negotiated Saudi Arabia a deal where anyone who wanted to purchase oil from their country would have to do so in US dollars (petrodollar). Within just a few years all of the OPEC nations agreed to the same terms. This thrust the US dollar into reserve currency status. 

'Reserve Currency' A foreign currency held by central banks and other major financial institutions as a means to pay off international debt obligations, or to influence their domestic exchange rate.
Every time any country wanted to buy oil they would have to purchase US dollars to do so. In fact it actually went farther than that. If two countries wanted to to business with each other and they did not have a direct exchange rate, country one would have to buy US dollars to pay for the goods they wished to purchase from country two. After the transaction was completed country two would then have to sell the US dollars back to the US for their own currency. Each time a transaction like this took place the US got a small cut, a transaction fee if you wish.

Why would the OPEC nations agree to this? Well, Nixon promised that the US would protect their oil fields and that we would sell them weapons. Most wars really are about money.

So What Is the Problem Here? 

I know this all sounds great, but there is one massive problem. The US is losing its place as the reserve world currency. Iran, Venezuela, and Russia are all large oil producing nations, they do not use the US dollar as the Petrodollar. They negotiate a direct exchange rate. China is working to circumvent the US as a reserve currency, even our close ally Australia has entered an agreement with China for a direct exchange rate, leaving the US dollar out of the loop. Then we get to our debt, holy cow does the United States have debt.

Could The US Experience a Collapse?

I really wish I could tell you not to worry, this will never happen here, but I can't. The truth of the matter is that something will happen along these lines. What an economic restructuring or collapse will look like in the US is anyone's guess. If someone tells you they know exactly what it will look like they are either lying to you, themselves, selling something or a combination of all of the above.

The current official inflation rate in the US is right around 2.5%. This would have been considered really high throughout most of history with a gold back currency, but on our fiat/debt based system this is about average. Every year the dollars buying power is eroding.

The current US national debt is 18.2 trillion ($18,200,000,000,000). Current personal debt in the US is 16.8 trillion. The US current unfunded liabilities is 95.8 trillion. Our gross debt to GDP ration is 102.67%. All of these numbers are going up and the economy is supposed to be doing so much better. At our current spending and revenue levels we will eventually not be able to service our debt. You can see a running total of all of these at www.usdebtclock.org.

If the US has an economic collapse the whole world will go down with us. Why do I say that? Because the world is so interconnected.  Over 6 trillion of our debt is help by other countries. If foreign countries  only hold 6 trillion, who do we owe the other 12 trillion to? Truth is it is a mixture nearly half of the 18.2 trillion dollar debt is owed to ourselves.

If we owe most of the debt to ourselves why not just cancel it out? Well it is not that easy. First the Social security trust fund really doesn't exist. There is no money that has been set aside with your name on it. In fact there isn't even an account somewhere with all the contributions in it. All of that money has been spent, there is nothing there but an IOU. So you see if we just forgave all of the debt held by US citizens, a lot of those citizens who have paid in the longest would starve to death. The balance is held by corporations and foreign investors. 

How can we be so in debt and still give away so much money? That one is tricky. We actually take part of the money that we borrow and give it to foreign countries. Why on earth would be do that? Well, there are a couple of reasons, one is simple and one is just sad.

(1) We give money to our friends to help them out. I have known people who have done this. They have taken out a loan to be able to help a friend. I can see how this would appear to be an honorable act, but it most cases it is not very smart. If a friend is in serious trouble taking out a loan to help them, could give them some temporary relief. If they are a good friend that will at a minimum show thanks and hopefully pay you back at some point. However if the root of the financial problems of your friend are not addressed it will not be long before they are in the same situation if not worse. The same thing is true of nations. If there was a massive natural disaster I am all for financially helping an ally. If however, the hard times are caused by the authorities using the national coffers to enrich themselves or their friends, or they are used to garner favor with their people I am opposed. Just look at Greece above. Austerity had to be put in place in order to start fixing their problems. Greece is not out of danger even today.

(2) We give money to groups and countries hoping they will become our friends. This one is just sad and most of the time it doesn't work. Maybe you will remember when we were helping the "insurgents" all throughout the Middle East. Most of these groups have turned into the bane of our existence today. The Islamic State was actually once supported by our government. Look at what they have turned into now.

Not only are we giving money away to other countries, we are spending money here like there is no tomorrow. I cannot even begin to tell you all of the stuff we spend money on that should be done by private enterprise. Bottom line is we spend too much money.

If we fail there is no one big enough to bail us out. Not to mention there are a lot of countries that are in as bad if not worse shape when it comes to their budgets.

I know it is difficult to see but trust me its not good.

Of our allies Australia's external debt is 97% of GDP (gross domestic product), England 318% but going down due to austerity measures, France 200% and rising, Germany 159% and rising, Greece 218% and falling due to austerity measures, Ireland 822% and falling due to austerity measures, well anyway you get the picture. Most of the nations of the world are either getting deeper in debt or are having to get their budgets inline with what they actually bring in. Which countries are doing best? It is not good news for the US. China, Brazil, Russia, India, and Saudi Arabia are the best performers.

Gross Domestic Product - the total value of goods produced and services provided in a country during one year.

BRICS

Brazil, Russia, India, China, and South Africa are working hard to unseat the US dollar as the world reserve currency. Not only that they are attempting to set up a bank that would rival the IMF. They feel that the IMF has too much of a western influence.

When Will a Collapse Come?


At some point one of three things will happen that will force an economic event. 1) The interest on national debt will become so great that the US will no longer be able to make the payments or 2) People will loose trust in the United States and will require higher interest rates to buy bonds, 3) The US will have an administration that believes that it can print or even tax its way out of debt.  Any of these is bad news. 

You may remember in 2011 when the US credit rating was downgraded from AAA to AA+ by one of the credit ratings companies. There were people who thought that was the end of the world, does it cost the US a little more than it did to borrow money? Not yet, the other two of the big three reporting companies still have the US at a AAA. If the US were to go through something like Greece has where their rating has been reduced to a B rating or "junk" status, the US would have a hard time.

No one can really give you a date that a collapse will occur. Why not? Well because the collapse has already started. The world will not wake up one day and the global economy be on the rocks. To some it will look like it, but it will have been a slow downward spiral. We are already seeing the US dollar lose its place as the Petrodollar. This will continue to happen and it will erode the dollars buying power because the dollar will no longer be in as big a demand. We will continue to see the buying power of the dollar decrease as a result of inflation. We will continue to see the US government spending money on things they shouldn't and spending money they don't have. It is like putting an alcoholic in charge of a brewery, they cannot help themselves.



 Can This Be Prevented?

At one time I would have said yes without a second thought, now it is a very shaky maybe.  Politicians are doing everything they can to delay a major economic adjustment, that is short of addressing the actual problem. I have heard politician talk about cutting spending, but it has all been smoke and mirrors. Allow me to explain.

In the Untied States budget there is built into almost every category an automatic spending increase. When politicians talk about cutting spending, even when they say they are trying to cut spending all they are doing in decreasing the increase. If a program receives $1000 this year and it is supposed to have an annual increase of 10% next year that budget would be $1100. A politician will tell you they are cutting spending for this program by 10% that does not mean that next year the program will receive $900, what that means it the program will receive $1090. They have cut the increase by 10%. Research it you will find that to be true.

In order to fix the United States economic problem would require true cuts in spending or austerity. Austerity is not popular. Remember the riots in Greece? If you tell people they will not be receiving what they were promised or even worse what they believe they are entitled to, they get angry, very angry.

On tax increases. There are a lot of people who think tax increases are the way to go. You can hear their mantra "Tax the Rich". A tax increase only works for a short period of time. It doesn't take long for the mega rich to figure out a way around paying those taxes, they can afford the attorneys to do so. The ones that wind up getting hurt the most are the upper middle class and middle class. They cannot afford those attorneys and most of them have worked hard the get where they are.

A graduated tax system actually discourages people from trying their best. I remember one year, I received a raise at work and my paycheck actually went down. I went to HR and asked about it. I had gone up a tax bracket. Granted it didn't go down much but the fact is still I was making more money and getting to take home less.

Tax decreases have been talked about as a way to stimulate the economy as well. More economic growth means more people get jobs, which means a larger tax base, which means more money flowing into the government coffers. This can be true. If people have more money to spend they normally will. People spending more money means more people go to work, but if the jobs created are low end jobs the growth may not cover the tax loss. This has become increasingly the case as more and more manufacturing jobs have been moved overseas. Corporations have realized that it is cheaper to have something built in an emerging country and have it shipped to the industrialized nations than it is to build the items at home. There are some exceptions, but they are getting fewer: industrial machinery and a lot of the advanced medical equipment.

We might be able to produce ourselves out of this mess. The United States has become the number one exporter of natural gas in the world. This is one reason we have seen fuel prices decline in the past year. If (if is the biggest two letter word in the world, by the way) the government would take the additional revenues generated by the boon of natural gas sales and apply that to the national debt, we might escape.

The truth is that many politicians know that the system as it is set up is unsustainable and they do not care. All they are doing is putting it off as long as they can. Why would they not care? They are getting the goodies as long as they last. The ones who will benefit from a US restructuring are the banks that have bought and paid for these politicians. Now, I want you to notice I have not mentioned either of the dominant political parties. They are both owned by these same individuals and corporations.

Heck there are even some "experts" who claim that paying off the debt would be a bad thing.

The restructuring could be a reevaluation of the currency, issuance of a completely new currency, or an all out default.

What Can the Individual Do to Prepare?

 

Get out of Debt

I know this one is really tough for those of us who are working our tails off trying to make a better life for ourselves and our families. There are even those that say "If there is going to be hyperinflation, wouldn't it be better to be in debt that way you could pay it off in dollars that are worth less". This statement is true to some extent, but it only works if what the world winds up facing is hyperinflation and they are able to service the debt until a collapse comes. If the world faces deflation these people are in serious trouble.

My Paw Paw (my maternal grandfather) lived through the Great Depression. He said "During the Depression every store had things for sale, but no one had any money. The next Great Depression everyone will have money but there will be nothing to buy."

Learn Hard Skills

A hard skill is something that has value in and of itself, it must be teachable, and it must be able to be measured. Trades are hard skills. Carpentry, plumbing, farming, medical professions, computer programmers, things of that nature. Yup, I said computer programmers. Even after a major economic restructuring, the internet will be here. There are situations that could knock us back to the dark ages, but we are simply talking economics. Sales people would be hard pressed in a true economic collapse.
 

Start Your Own Business

A micro or cottage business  give an individual or family some stability in an unstable time. Not having to rely on a major corporation that has its fingers in all of the political mess is a very good thing. Something like selling firewood, making soap, teaching canning, anything that you have a large knowledge base in that is marketable. 

 For a good primer and an idea generator check out my first book. Micro and Cottage Businesses What You Need to Know and How to Get Started.


 Build Community

Having folks around you who are like minded can really help in a hard time. The old saying "Many hands make light work" is true. I know it means more mouths to feed, but it actually works to the favor of the community. If/when a economic restructuring or collapse occurs it will not be without pain and it will not be without violence, at least in some areas. No one can stay awake all the time for very long.

Hard Assets

The first thing that comes to mind for many when talking about economic collapse is gold and silver. It is true that historically gold and silver have never been worthless to what many would call civilization and that gold has kept its value in the face of inflation. But I am still torn on this one. If no one has anything you cannot eat precious metals, but as long as trade continues precious metals will be of value. I actually like silver more than gold. Why? Well for one it is more affordable to the average person, it is more likely to be in denominations that would be used. When gold was at $1600 per troy ounce a grain was worth $3.33. A grain is quite small. I wouldn't want to try to divide any smaller. Even if gold were to take over silver would still be needed for change.

Not just gold and silver though. Assets can be lumber, nails, seeds, really anything that people need.

Learn to Barter and Haggle

During harsh economic times people are going to try to get as much for what they have for sale as possible. At the same time people are also going to try to spend as little as possible for what they want. Enter haggling. Haggling is the art of price negotiations. If you don't know much about it you can read my post The Art of Haggling: An Introduction. I believe it will help you out even if something like this does not occur.

Barter is the art of trading something you have for something you need. It has been practiced for as long as there have been people. Here is a really old post called Barter is Back. It is not up to my current visual standards, but the information is still valid.

Conclusion

I believe a major economic shift will occur in the next 6 to 10 years. Why do I give it so long? There are several reasons. 
  1. The politicians are going to prolong it as long as possible. We may even see some form of austerity and true cuts to spending, but I believe that like Greece it will be too little too late.
  2. The United States will continue to leverage its natural gas production to keep other countries interested in our survival.
  3. Until the BRICS nations have divested themselves of our debt to them or set themselves up in a way so they can take the financial hit they will continue to help the US.
  4. Currently confidence in the US is still fairly strong. This will erode, but it will be a gradual decent.
I do not know if the economic shift will be a full on collapse, a revaluation of the currency, or an issuance of an entirely new currency, but I can tell you it will be painful and the ones who will benefit from this shift are the mega rich and those who are prepared.
I know this has been very long, but I hope you can tell I have put a lot of research into this topic and I have tried to be brutally honest.
One way or another we are
Bringing Rural Back

Have something to add to this topic join the Forum on The Rural Economist. If you would like to contribute to the conversation we would love to have you join us. It is brand new, but I am sure it will grow. 


Subscribe to our mailing list

* indicates required


You can like The Rural Economist on Facebook follow on The Rural Economist on Gplus. We now have a YouTube channel and we cover all sorts of things. Hop on over and check them out, oh and don't forget to subscribe. I have just joined Instagram if you would like you can follow us HERE. We will be sharing several things over the next year, I hope to see you there. 

Check out The Rural Economist on Pinterest