Monday, February 7, 2011

The Egyptian experience is instructive

Lots of people know that something significant is happening in Egypt but few people understand the big picture.  Consider Mish's latest article on the situation there.  While you are absorbing that, consider also that Egypt is no small country in terms of population.  It has nearly 80 million people living there.  What's really happening is that Egypt is experiencing massive inflation and it is threatening the very survival of the lower economic classes.  We are exporting our QE1 / QE2 inflation and they are receiving it.  Mish reports short term interest rates may reach over 12% - high interest rates are generally an indication of high inflation.  That relationship exists because creditors fear that their wealth will get inflated away so they demand higher interest rates to compensate them for it.  The high inflation is making it more difficult for people to make ends meet but more importantly it is making it more difficult for government to borrow and then subsidize the economy.  As government subsidies wane people who got used to having them get restless and concerned for their own well being.

Egypt has several big problems.  First, it is a victim of Bretton Woods 2, the system whereby the US can print money from thin air and it directly impacts the value of the currency of other sovereign countries who have to print like crazy in order to keep the currency peg with the US dollar.  If they were on a gold standard right now they would be in 10x better shape but they bought into our scam and now they are paying for it.

The next issue is that they embraced fractional reserve lending.  This scam allows all manner of imbalances to occur in the economy.  It creates the super wealthy and the super poor even though the poor probably work harder than the rich do.  You know something is very wrong when a man cannot support himself and his family through the sweat of his brow while at the same time the elite are rolling in money for doing little to no work at all.  If they had rejected fractional reserve lending then they would just be laughing at all this right now and the level of inequality in their country would be far less.

Next, and this is mainly a symptom of fiat currency and fractional reserve lending, the poorer people have gotten used to government subsidies.  They have been taught to think it is normal for an adult able bodied man to require government assistance in order to survive.  Inflation steals from the poor and middle class and gives to the elite rich.  The middle class can normally handle it because the inflation is generally slow enough that they can still buy food.  However, the poor people have no wealth buffer or savings so they would starve without the subsidies which are put in place so that they don't revolt.  Subsidies like food stamps and section 8 housing are control mechanisms to keep the corrupt system from breaking down.

Once this system is in place the rich just borrow like mad until the state can not borrow anymore due to high interest rates.  At that point the elite have basically cleaned the country out and there is nothing left for subsidies.  The poor people get squeezed out and they riot.  The middle class also feels the pinch and they see the plight of the very poor and they (rightly) fear that their time is coming too so they riot as well.  The wise elite skip the country while the arrogant ones stick around hoping they can weather the storm of the angry herd.

The next problem is that middle class invested in the stock market which is basically a Ponzi scheme.  When things went down hill, few knew to cash out and get out.  Now their life savings are locked up in a system which is shut down until further notice.  When it opens back up they can expect an immediate haircut of at least 20% while everyone who is panicked rushes to get their funds out.  Taking your funds out means selling, and mass selling makes prices plummet.  A bird in the hand is sometimes worth a heck of a lot more than 2 in someone else's hands.

The next problem is that everyone trusted the banks with all their cash.  When the crap hit, the banks shut down without a care that people were left without access to their cash for more than a week running.  When the banks did open back up everyone had to stand in lines 100 deep hoping there would be money left by the time they got to the window.  This is a run on the bank and this kind of lack of confidence is what causes the buying power of the currency to drop.  So, while people are in line at the bank, the buying power of their savings, which they can only get out bit by bit, is evaporating before their eyes.  Years worth of work down the tubes just like that.

Of course the biggest mistake of the Egyptians was to blindly trust in government.  This trust drove complacency to the point where few understood the real risks associated with fiat currency, fractional reserve lending and with all paper assets when a credit crisis comes home to roost.  They are all paying for that complacency right now.

Have you ever seen the Youtube videos of people standing on the beach as the water gets suddenly sucked out of the bay?  Even the locals who should know better can be seen poking around the newly exposed flats when they should be gathering their stuff, sounding the tsunami alarm and running for high ground.  It's just human nature not to internalize the danger until the waves are nearly breaking over your head.  How bad will the economic tsunami become here in the states?  Nobody can really say for sure.  We are at the very top of the Pyramid Ponzi and it would take a pretty damned high tsunami to get our pant legs wet.  But anyone who says that the coming tsunami absolutely cannot be bad enough to cover the entire pyramid is completely out of touch with reality.  We are looking at a global credit bust the likes of which has not occurred, according to very smart guys like Bob Prechter, since the collapse of the South Sea bubble in the early 1700s.  Yes, it really can be that bad. 

There's no reason to risk everything on the debt tsunami.  Either get prepared now or at the very least figure out what the signs are and look for them on a daily basis.  If you see them, run first and ask questions later just as you would do with an ocean tsunami.  The main signs that could mean big trouble:
  • a rapid and dramatic rise in short term interest rates and in CDS on US debt.
  • significant levels of civil unrest where violence breaks out.
  • rapid declines in the stock market
  • rapid rise in gold and silver prices
  • government making overt statements that everything is under control (this is when you know things are really bad).
All of these things signal that the herd is restless and that the smart money is selling paper assets and buying hard assets for safety.  Above all else, dispel the notion that we are somehow special or better than other people.  The only reason we haven't gotten creamed already is that we control the world's reserve currency and when things got bad in late 2008, 2009 and 2010 we just told banks to ignore their losses while Bernanke printed up well over a trillion new dollars from thin air to paper over the problems.  That game will likely soften our hit to some degree but there is no telling how long we can get away with that obvious con job.  Nothing says we cannot have another electronic run on the dollar as happened in 2008.  If you don't know what I'm talking about, listen to a US Congressman explain it.  Did you know that we were so close to a global economic meltdown as described by Kanjorski?  Very few people who I talk to have any clue.  Had that tsunami hit home people would have just been blown away in the carnage.  We would have been walking like Egyptians.
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