Just how ugly will this global economic & credit depression become...?

"HOW BAD do you think it will get?" asked a friend in an e-mail yesterday, writes Dan Denning, down-under in Melbourne to head up The Daily Reckoning in Australia.

Our friend has a Master's Degree in Classics (Latin and Greek). So we know that when he starts wondering what's going on in the economy – pace the depression – there are probably a lot of other people starting to sit up and question their basic economic beliefs, too.

So here, partly for the benefit of those who are new to The Daily Reckoning, is what we told him.

> First, our long national love affair with debt is over. When you first
> fall in love, you're happy to ignore all the little blemishes, faults,
> and habits that later drive you insane. The dependence on
> revolving credit, home equity lines of credit, and zero percent
> financing didn't seem like a bad thing as long as people had steady
> incomes and could pay the interest.
>
> But now, asset values are falling...but the principal on the debt
> remains. People will shake themselves vigorously and wake up to
> the credit depression we live in. They will learn to live within, or
> even below, their means. Wherever that level is, it's a lot lower
> than today. The upside is that it's probably more natural and
> relaxing and less stressful. Stress kills the brain. So people may be
> poorer and hungrier. But some of them may actually be happier.
> Not all, mind you.
>
> Second, as people dial back their spending and consumption
> habits, it sends ripples throughout the economy. For example,
> Friday's jobs figure in the US will likely be the worst in sixty
> years. Over 700,000 Americans will have lost their jobs in
> December. This is on top of 400,000 in November.
>
> A million people axed in two months...? Job losses result in fewer
> incomes, and incomes are the source of business profits. As jobs
> and incomes fall, so do business profits, and thus business hiring.
> A feedback loop.
>
> Plus, in these kinds of times, people save more and spend less. In
> an economy based on consumption (not production) lower levels
> of spending are bad for stocks and jobs. The government will try to
> fix this by giving people more money to spend. But the problem
> isn't with people. It's with the model.
>
> An economy structurally oriented to consumption is not one that
> produces real wealth or long-term capital assets. It just produces
> people who have debts they cannot pay, albeit in a house with a
> nice TV and great digital programming. And as household and
> business consumption (spending) fall, the government, under the
> banner of Keynes, will take to the field en masse. The armies of
> Fed money will be deployed, street by street, to patrol the economy
> in little platoons of stimulation.

> The ammunition for these armies will come from either Japanese
> or Chinese savers (via bond purchases) or from nowhere (the Fed
> creating more money). Either way, the result seems unambiguously
> bad.
>
> If borrowed, the stimulus money must be repaid, and presumably
> at increasingly higher rates of interest the more rapidly America's
> fiscal position erodes. And either way, with interest expense
> already nearly 10% of the Federal budget, you can expect it to rise
> when the US government has to pay interest on a trillion dollars of
> new borrowing.
>
> To meet these interest payments, the government is going to have
> to raise taxes or cut spending. Of course that's hard to do when
> you're deliberately spending more to begin with. If spending is
> going to be cut, it'd have to be from Defense, or Social Security
> and Medicare/Medicaid benefits (raising the retirement age, means
> testing benefits).
>
> But even with more borrowing and higher taxes, it's likely the Fed
> is going to have to simply print new money to conduct its
> unconventional monetary policy. Money supply will grow. And
> what does that really mean? Inflation. Much higher inflation.
> Rising prices for everyday goods like food and fuel and clothes.
>
> Inflation is also a huge tax on savers and those who live on a fixed
> income. You know, the prudent people who saved for their own
> retirement. Inflation accelerates the depletion rate of their
> accumulated savings by steadily reducing purchasing power.
> $10,000 saved in 1970 ain't what it used to be. This should be good
> for Gold Investment, however.
>
> As inflation punishes those living on a fixed income, it will also
> push them closer to needing some sort of government aid. This in
> turn raises the percentage of federal spending going to Social
> Security and Medicare and Medicaid. It's a transfer of old age and
> pension provisions from the private sector to the public sector.
>
> But can America really afford it? Clearly not, which more than
> sucks for people who've lived their whole adult lives believing
> they'd be able to retire comfortably through a combination of a
> diversified portfolio and a supplementary check from the Social
> Security Administration.
>
> It's looking more and more like the entire project of spending a
> quarter of your adult productive life idle and living off the income
> generated from your assets (houses, stocks, savings)
> is...well...dead. It simply ain't gonna happen for most people. And
> by most, we're talking 99%. People will work longer, harder, and
> leave leaner and meaner than they ever thought they'd have to.
>
> The rest of the world will not be ready to continue funding
> America's desire to live beyond its means. Why would Chinese and
> Japanese savers continue to invest in US bonds and notes
> (effectively keeping US interest rates low AND loaning Uncle Sam
> the money he needs to keep the promises he's made)...?
>
> In a world where investors are focused only on annual rates of
> return on their capital, you could argue that global savers would
> pour money into the US government bond market now and until
> the cows come home. It's the safest bet in the world. But that's not
> where we live anymore. In the world we live in – the one with a
> credit depression – capital (meaning accumulated savings...or
> surplus income from your hard work) is a scarce and jealously
> guarded asset.
>
> You have to reckon people will be more worried about the return
> OF their capital than the return ON their capital. Again, that's good
> for Buying Gold. But all of this means America's days of
> borrowing at low interest rates from the rest of the world...in order
> to build an economy based on buying things...are over.
>
> What to do? Find a job with a real skill that people are willing to
> pay for. Get your money out of stocks (though they'll bounce in the
> next few months probably). Look for a home you can really live in
> and want to own (and aren't trying to flip). But generally, your
> greatest assets will probably be your real skills that can be traded
> for goods or services (and not financial instruments you hold in a
> portfolio). It'll be hard for people to live off income generated from
> financial assets...mostly because those assets are going to keep
> falling in real terms for quite a while.
>
> That's how bad it could be. But of course, human beings are hardy
> and resourceful. We'll find a way to put food on the table.
>
> Speaking of which, it's lunch time! Gotta go...
> Dan
>