I don't need to say that we live in historic times. I'm Canadian and up here our downturn is "normal" compared to our neighbors in the south and in Europe but I believe our economy is lagging by one year thanks to the commodities boom that only ended about 9 months ago. I'm deeply concerned about the long-term future of the world economy. I don't need to tell you that the actions taken by the US government are unprecedented. They are doing everything they can to avoid the end game of the super cycle theory of debt. I first read about this theory from BCA research and I'm a believer. Basically, the theory is that since WW 2, we have avoided severe downturns (depressions) because the authorities have reacted to downturns with reflation policies (i.e. increased government spending, lowering interest rates) to prevent the system from completely wringing out the excesses from the prior boom. As a result, the recessions are not as deep as they otherwise would have been, however, imbalances are created (essentially higher public and/or private debt levels) which will result in bigger problems down the road. Basically, we keep going deeper into debt to mitigate economic weakness and stimulate recovery but there has to be and end game to this. We can't go into infinite debt and throughout the years the marginal utility of debt has been declining. In other words, it's taking more and more debt to get a $1 of GDP. In the 1950's The ratio of total debt (both government and private) to GDP was about 1.5, by the early 90's it hit 2.5, by 2001 it was 4.5 and now it will probably be approaching 6! This is scary stuff...and it has to end one day and when it does it means economic collapse.
The question I ask myself now is are we at the endgame right now or will the actions of the government result in one last hurrah? Stock market mega bears as early as the 1980's were premature in calling for the end of this super cycle of debt. Every time we had a downturn they said "this is the end" but the economy and the market still managed to recover and if they put their money where their mouth was, they went broke several times over. But like the boy who cried wolf one day they will be right I'm afraid. Is that time now??? Maybe.... but beware if you intend to profit from this. A lot of people thought that the bursting of the tech bubble in 2000 was the end game of the super cycle of debt. The similarities to the 1929 crash were uncanny and the mega bears were certain that time we would see a depression. Instead we got a mild recession and although the market crashed 50% it was far less than the 89% crash after 1929 and 5 years later the market recovered those loses whereby it took 25 years to recover after the 1929 peak.
I'm quite open to the possibility (no solid evidence of it yet) that we could see another economic revival like in 2003 to once again extend the end game of the super cycle of debt but if and when that occurs, the next downturn will likely be catastrophic because we can't go to negative interest rates next time to stimulate borrowing and we probably can't see governments increase spending to a multiple of today's already massive levels. It's important to realize that all of the above concerns are long-term in nature and if you try and profit from this timing is critical otherwise like all of the perm bears in history you will be broke several times over before the end game arrives.
Also keep in mind the possiblity that somehow this super cycle of debt problem will resolve itself or extend a lot further due to a new technological wave that sparks a massive growth cycle like the IT age of the 80's and 90's. Always keep an open mind and be flexible.
My next post will be about where I see the markets in the intermediate term.
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