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World Crisis scenarios for the 21st century – Worldwide economic depression (update 14)

Posted by Adrian on May 22, 2008

World Crisis scenarios for the 21st century – Worldwide economic depression (update 14)

The relatively short eye in this financial storm that we are currently all residing in, is now moving and it appears back to the market turbulence of the last 6mths – maybe the worst is yet to come. The credit market and liquidity issue, which was a credit crunch that froze up the banking markets or money markets. Was essentially a precursor or a delay to an inevitable systematic crash of the financial system.

The Federal Reserve as we all know cut rates right down to 2.00%, amidst rapidly climbing oil prices (scarcity) and food prices (scarcity); which everyone on the planet is feeling i.e inflation on food and oil. Also the commodity markets have been a hedge against inflation and a declining US dollar; this has also boosted oil and food inflation (what, rice etc).

But the banks are still contracting, the only aspect of the markets that showed signs of normality was the stock market, although the so called market normality was a buying back into volatile markets. This of course will be very short lived.

The US and quite possibly the world will fall into a severe stagflation based recession. To what extent this will develop into a depression, especially in the US is still speculative. But with high inflation eroding incomes, even if people do adjust (somewhat) to inflation, asset values, employment will all decline. Oil will do the rest by slowing down or shutting down industry.

Funds managers may have their eyes on stocks, and an persistent bull market – that in all retrospect is still a very volatile stock market, from May 19th 2008 the Dow it’s self pushed back up to 13028 points – which indicated the return of the bull market. But, in two days (20th, 21st of May 2008 ) the Dow has dropped -427 points. These are big drops in a short period of time.

The Federal Reserve is closer, in a ambiguous way, in accepting that the US is in recession, from CNNmoney:

The Fed said in its minutes that members now expect the economy to shrink in the first half of the year — the clearest signal yet that Federal Reserve chairman Ben Bernanke and other bankers believe the economy is in a recession.”

With most central banks now caught in an inflation, or more particularly a stagflation trap. They can either cut rates, in which the European central bank may do, or leave rates on hold as the Bank of England and Federal Reserve will eventually end up doing. But in the US, inflation (which statically could be higher than what it is now) could move into the upper 5% and 10% range, refer to graph:

With interest rates so low in the US and mixed with a extremely fragile economy, even if they begin to increase rates it will send the US into a sharper economic decline, and quite possible into a severe recession (or depression). A terrible situation of economic uncertainty. The erosion of prosperity and wealth by inflation and declining asset values, just needs to be topped with higher unemployment – as it was seen in the stagflation/inflation period of the 1970’s and early 1980’s refer to graph that shows the higher unemployment,

I’ll finish with what David Tice of Prudent Bear fund said recently on Bloomberg

“Tice predicts U.S. equities will enter a bear market that may exceed the 15-year slump from 1965 to 1980. Moreover, he says if the Fed and Wall Street don’t break their addiction to easy credit, the economy will eventually crash in a depression — a condition marked by reduced purchasing power, unemployment and corporate failures.

The U.S. can’t continue to inflate bubbles in stocks, real estate and other assets without crippling the financial system, Tice says.

`Drunken Sailors’

“We’ve become a country of drunken sailors” he says, snapping his fingers as he makes his point. “If you spend, spend, spend, there are going to be consequences to that — you can’t borrow your way to prosperity.”

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