Japan Will Take the World’s Breath Away, Part II

The National Bureau of Economic Research marks June 2009 as the end of the Great Recession.  That means the United States economy has been in recovery for nearly three years.  Semantically this is accurate…all the stimulus and monetary easing has successfully pushed GDP into positive over this time.  But just what type of recovery is this?

According to the latest CNBC All-American Survey, 36 percent of the American public believes the economy will improve over the next year.  Apparently, this is a 9 percent increase over the survey results from November 2011.  Yet, despite the marked improvement, what this means is, 64 percent of Americans still believe the economy will not improve over the next year.

Clearly, the populace has become aware that something has gone seriously wrong with the economy.  Across the republic, people are coming to grips with the fact that it’s not possible for an economy to borrow and spend its way to prosperity indefinitely.  Eventually the debts must be reckoned…either by default or inflation.

Earlier this week we scribbled some thoughts on the current pickle Japan finds itself in; namely, a debt to GDP level of 200 percent, its first annual trade deficit in over 30-years, and the likely propensity to cover the budget gap through debt monetization.  Several reader comments requested a part 2, specifically detailing what they should do to prepare for the looming crisis.  While we don’t have the answers, we do have some anecdotes…and we are glad to offer them…

To begin, the approaching Japanese debt crackup will be a warm up for the subsequent U.S. debt crackup.  In fact, for a time, as Japan blows up, the U.S. may appear to be in good shape.  When investors exit Japanese government debt it’s likely that some will enter U.S. government debt.  This will push treasury yields down…giving the U.S. government a little more rope to hang itself with.

Nonetheless, the U.S. will eventually have its turn in the barrel.  At some point, foreign creditors will exit their treasury holdings and the Federal Reserve will be forced to print money to paper over the government’s budget shortfall.  This will be the ultimate conclusion to the dollar standard era.

During periods of rapid currency debasement, tangible assets, like gold, silver, oil, and farmland, are proven vehicles for wealth preservation.  No doubt, those with the means to do so should consider diversifying some of their savings into established inflation hedges.

But for the rest of us working stiffs struggling to make ends meet – aside from purchasing food storage, stocking up on gravity flow water filtration systems, and planting a vegetable garden – the best thing to do is to try to stay out of the way.  In a moment, we’ll provide some practical ideas, including a 12-point plan that anyone can follow to do so.  But first some thoughts on what to expect, garnered from experiences visiting in-laws in Mexico City…

How Governments Impoverish their Citizenry

Mexico City, if you’ve never been, is quite a sight.  It’s more than double the population of Los Angeles.  What’s more, the pace of activity makes Los Angeles feel sleepy and southern California’s Highway system seem, calm, organized, and sound.

The juxtaposition of pre-colonial ruins, Medieval Spanish architecture, and modern skyscrapers is extraordinarily fascinating.  But for us, with each visit, what we find fascinating is the ever present instruction of what happens when overzealous governments overspend…then inflate their currency to pay their debts.  So, too, we find ominous warnings of what may come for the United States because of the government’s financial imprudence.

Like the United States, Mexico’s economy experienced robust growth during the mid-part of the 20th century.  The period from 1930 to 1970 was later called the “Mexican Miracle” by economic historians for this reason.  Mexico’s GDP increased 4.2 percent between 1929 and 1945 and then it accelerated to 6.5 percent between 1945 and 1972.  Even during the inflationary 1970s, Mexico’s abundance of oil and other resources helped sustain a 5.5 percent GDP between 1972 and 1981.

But the high water mark for Mexico, culminating with the 1968 Olympics in Mexico City, had already surged, and the flow of wealth had begun to recede, so that by the late 1970s living conditions were second rate for the broad population.

What went wrong?

During the 1970s, the successive administrations of Luis Echeverría Álvarez and José López Portillo, dramatically expanded the Country’s social development policies.  In other words, they increased public spending and financed the spending with debt.

During this period, Mexico’s external debt soared over 300 percent from $6 billion in 1970 to $20 billion in 1976.  The effect was many violent devaluations of the peso, from 12.50 pesos per dollar in 1954 to 20 pesos per dollar in late 1976, which devastated the middle class.  In 1981-1982 oil prices crashed on the international market just as interest rates spiked.  After that, the government really made a mess of things.

In 1982, President López Portillo, just before ending his administration, suspended payments of foreign debt, devalued the peso and nationalized the banking system, along with many other industries that were severely affected by the crisis.  Any hope for a quick return to economic progress vanished.

But ten years later it looked like Mexico had finally turned a corner.  After 12-years of economic malaise, it appeared Mexico was primed for an economic boom.  NAFTA had been approved and everyone just knew that Mexico was going to be the next big thing.  The world took note and foreign investment flooded into the country inflating the value of the peso.

The administration of then President Carlos Salinas de Goratri couldn’t believe their good fortune.  Like any good government…they spent their bonanza – and then they spent some more.  By the end of 1994 Mexico was running a deficit that was 7-percent of GDP and foreign investors had seen enough.  They dumped their holdings and the peso crashed in spectacular fashion.  In the space of one week the peso fell 44-percent against the dollar.  Mexico’s economy crashed too.

Currencies, both north and south of the Rio Grande, ain’t what they use to be.  Not long ago they were as reliable as a rooster at dawn; now they’re as crooked as a politician’s spine.  We know this not by reading the history books, nor by hearsay, but by the honest, verifiable, silver dollar and silver peso we’re holding in our hands.

The Peace Dollar is a United States dollar silver coin minted in the 1920s.  At the time of its mint, one coin equaled one dollar…and each dollar contained 0.77344 troy ounces of silver.  The 1932 Un Peso is a Mexican silver peso.  At the time of its mint, one coin equaled one peso…and each peso contained 0.3856 troy ounces of silver.

The exchange rate was real simple.  Based on their silver content, two pesos equaled one dollar.  Nowadays, both pesos and dollars are merely paper promissory notes from the government.  Their value is derived by their government’s track record of stewardship and the international currency market’s acceptance of the government’s ability to make payments on their debt.

Today it takes about 13 pesos to buy one dollar.  As you can see, until recently, the Mexican government has been less upright in managing its currency than the United States has over the last 80 years.  But when you use silver as the measuring stick, the picture changes…

Where it took about $1.29 dollars to buy an ounce of silver in the 1920s, today it takes $31.98 dollars to buy an ounce of silver.  This means silver costs 2,479-percent more in dollar terms.  In pesos, however, it’s a downright disgrace.  Where it took $2.58 pesos to buy an ounce of silver in 1932, today it takes $407.75 pesos to buy an ounce of silver. Astonishingly, silver now costs 15,804-percent more in peso terms.

Here’s the point…

It doesn’t take much time touring around Mexico City to discover that behind the hustle and bustle, not only has the government successfully vaporized their currency, they have successfully vaporized their middle class.  You can actually see its nonexistence everywhere you look…and, if you squint your eyes just right, you can see the ashes of its prior existence within the cracks of decay.

Mexico is a textbook lesson on how governments impoverish their citizenry.  One day, perhaps soon, similar consequences of government money mischief will be splattered across El Norte too.

What to do about it?

How to Survive the Economic Crisis

Several years ago, following many reader inquiries, we attempted to offer – from the heart – practical, discretionary advice on what to do to survive the economic crisis.  At the time, it served our readers well.  For your benefit today, and by reader request, we’ll revisit it…with some minor updates…

1.  Always take what’s yours…plus a little bit more.  You’ll undoubtedly need it with Barack Obama in office for another term.

2.  Never shake hands with your right hand, without first crossing the fingers of your left hand securely behind your back.

3.  Always look out for No. 1, save stepping in No. 2.

4.  Never give a beggar your pocket change, except when to do so is to buy them a drink.

5.  Know the difference between honesty with yourself and honesty with others.  The former must be rigorous; the later must be flexible…especially when applying for insurance.

6.  Never kick a man when he is down; so too, never hasten to help him up.

7.  Always stiff your waitress…barring the rare occasion they actually earn the tip.

8.  Never con widows and orphans; all others are fair game.

9.  Do not worry about money; what you don’t have should be of little concern.

10.  Never forget that there’s a fool on every corner and a sucker born every minute.  Avoid being one of them when at all possible; for it is both demoralizing and expensive.

11.  Do not take it personal when you lose your job…this economy stinks; a lot of other good people will have lost theirs too.

12.  Remember always that this too shall pass; though never fast enough.  So keep your head up.  For even during a depression the birds still sing, the flowers still bloom, and those of sound mind and body get through it a little wiser…if not a lot slimmer.

Thanks for reading.


MN Gordon
for Economic Prism

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