Often investors justify high stock or other asset (e.g., real estate) valuations by thinking “it is different this time”. Usually they are wrong as the natural or group psychological pendulum swings from greed to fear and back again. The recent real estate bubble is a good example of this mindset. However, the ground has been laid by persistently bad US monetary (money creation) and fiscal (spending above revenue) policies over the last half century, at least, so that the current economic state we are in will likely evolve into the worst crisis the US has ever faced, leaving past wars aside. First I will summarize the current state and give how each aspect will likely evolve: 

1. House prices and construction spending are down dramatically from the peak in 2005 and the decrease is accelerating. While the acceleration on the downside may end soon it is likely that the decrease in the real estate and construction sectors have years to run. The excess building inventory, rising unemployment, interest rate resets, and contracting credit (i.e., lenders are tightening loan standards) are some of the reasons.
2. The real cost of living is increasing at about 10 percent per year. This stealth wealth eroding process is not likely to improve in the near future as the supply of commodities continues to come under pressure (i.e. shortages) and federal money creation continues unabated. Gasoline pump prices should hit $4 per gallon before 2008 is finished. Any significant oil supply disruption from the various unstable portions of the world, where most of the oil reserves are located, will push the price at the pump to $5+. A severe global recession could negate this prediction until further into the future. Food prices are also rapidly increasing with the help of corn and other grain shortages, which in turn are caused by the government promotion of ethanol—possibly the dumbest policy of its size ever federally mandated.
3. Fixed income folks that do not have much in the way of other savings are feeling the pinch due to Social Security cost of living adjustments(COLA) remaining below 4 percent, as their expenses increase at twice that amount year after year. In general, they get little relief from stable or decreasing property taxes. As the recession takes hold, and other revenue received by governments decrease, this situation will not likely change. As a result you will see more senior citizens back in the workforce doing menial work at low wages.
4. The US is in an unofficial recession currently, defined here as negative year over year GDP growth, and has been for several months. Keep in mind that the government issues phony economic statistics, especially the inflation indicators (3 percent reported—they got to be kidding!) so they can claim the economy is growing and COLA can be kept low.
5. Stock indices have decreased from 10 to 15 percent from their peaks in 2007. Sectors such as banking, finance, construction, and retail have done much worse. Many financial commentators who either have no knowledge of stock market history or are deliberately deceiving their audience and clients say the “market is already pricing in recession” so the bottom in stock prices is near. The fact is that stock averages decrease about 30 percent from peak to trough in the average recession. The current evolving recession is not likely to be just average, but considerably worse. Why? In brief, excesses are normally following by strong reactions in the opposite direction. Assets of almost every kind have gone through very large, sometimes record, increases in nominal value. This includes stocks, bonds, real estate, and commodities. All, except possibly the latter are, or will be, swinging in the opposite direction. Decreasing wealth from asset devaluation and practically zero national savings rate is more than enough reason to believe the current recession will be a severe one. If that is not enough also consider that debt levels are historically high at every level, except corporate.
6. The federal government has unfunded liabilities in the tens of trillion dollars due to continuing budget deficits year after year and staggering costs going forward for Social Security and health care related payouts for the rapidly increasing number of seniors. This fact plus the very likely politician remedy to cries from the public “to do something” about the economic woes will exacerbate the buildup of debt. Congress will either increase spending for some new program or offer tax cuts which may decrease overall tax revenue. Revenue tends to decrease anyway in recessions. What it all means is: a continuing devaluation of the US dollar as the currency market senses more and more dollar supply and a weak US economy. More dollars means each is worth less. The increasing supply is facilitated by the Federal Reserve creating more dollars to cover and “diminish” the government debt load. This is called monetizing the debt, which is probably the only way this debt can ever decrease significantly, given the demographic changes and entitlement increases. As the dollar value decreases the flight to gold and silver is assured. I strongly recommend that every investment portfolio include as least 20 percent in these assists. Today this is easy to do via purchase of CEF, GLD, or SLV shares on the stock exchanges. Also, an organization called Goldmoney makes the conversion from dollars to gold and back again from online accounts very easy. The best bet for gold and silver bullion is the purchase of CEF shares since it holds bullion outside the clutches of the US government and is denominated in Canadian dollars—a stronger currency. In the 1930s the US government confiscated gold, so it could easily happen again. Look for gold to go over $1000 and silver to $20 per oz. within a year, and eventually to $5000 and $100 respectively, as people all over the world come to recognize that fiat (paper) currency, not backed by anything, is being devalued at a rapid rate. Most of the large economic entities (i.e., nations) are increasing their money supply at 10 to 20 percent on an annual basis. This is nothing more than adding more of their currency to the market, thus decreasing its value.

So, I believe it IS different this time—worse than any financial circumstance in the nation’s history, including the 1930s. Further, it is NOT a replay of the 1970s when significant inflation, recession, and a bear stock market also occurred. Back then the nation recovered from these with help of a Federal Reserve which did the right thing by raising interest rates to cool inflation pressures, that in turn helped defend dollar value. As I scan the current political and economic landscape  I see: 

• Weak, self centered political leadership in the White House and Congress
• A Federal Reserve which is failing to use its independence to do what is in the nation’s best interest in the long term
• A national savings rate near zero
• Current and projected national debt loads at mind boggling, unsustainable levels
• Financial products created in the last 20 years that have underestimated risk, have current total global value in the hundreds of trillion dollars, AND are intertwined in the financial fabric of all global markets such that a domino effect could occur which would bring the whole global economy to a standstill as fast as you can say “stop loss” to your brokerage.
• The increasing influence of hedge funds on financial markets many of which employ client money to invest in financial derivatives using various levels of leverage. When the unintended or unpredictable happens, as in the recent sudden devaluation of mortgage backed securities, some of which were rated AAA (highest safety rating) by rating agencies, will result in the forced liquidation of other financial holdings such as stock shares. This deleveraging could precipitate a ‘crash’ in the related AND unrelated financial markets.
• A US economy which has been growing less productive year after year as more goods are imported and each unit of new debt incurred produces less and less increase of GDP (i.e, less bang for the funny money buck).
• Real inflation at high levels, but not recognized by most of the public, allows our political leadership to continue the ‘big lie’ that all is basically well and will continue without significant sacrifice or pain, thereby promoting their reelection. (As an aside presidential candidate Ron Paul, a non-charismatic congressman from Texas is the only candidate who seems to have a clue about the real state of affairs. His grilling of Ben Benanke at a recent Congressional testimony was the highlight of my day and reportedly resulted in cheering on the floor of the Chicago Board of Exchange).

It IS different this time, as the current “slowdown” is going to be much worse than anything experienced before, and the consequences of past government policies and our own collective greed will have very significant social consequences as well as economic ones. Batten down the hatches—the next decade is going to be very unsettling. 
 

Commentary written by Robert Harnack on Jan.13, 2008. The research and insights provided by many experts outside the Wall Street mindset is greatly appreciated. They include Frank Barbera, Jim Puplava, Peter Shiff, and many others which have their commentaries available at Financial Sense Online. This site and the publications and web sites of all of the foregoing are highly recommended to all.