The Perversion of American Capitalism

By: Naufal Sanaullah of Dorm Room Derivatives

The United States does not rely on industry for growth. Its economic backbone is money. America finances the globe’s corporations and emerging markets, its dollar is the world’s preeminent reserve currency, and its citizens’ puchasing power allows for the monstrous consumption that accounts for over 60% of the world’s largest GDP.

It is sad, then, that this nation faces a liquidity crisis out of all possible economic scenarios. The United States economy is based on international reliance for its financing, and a global credit crunch greatly diminishes that leverage.

Since the 1970s, America has gradually shifted from being an industrial production superpower to a consumption-based financial center, concurrently going from a significant creditor nation to debtor nation. It was able to do this because of the leverage it had on the rest of the world’s economies. Trade deficits were allowed and even encouraged because of the supreme strength of the US Dollar, being the world’s most important reserve currency. Newly capitalist post-Cold War economies stemming from the Soviet Union’s collapse offered huge new markets that America financed and invested in, again providing leverage for debt. The United States was the safest investment in the world, with its strong currency, economy, and liquidity.

Then came Greenspan.

As Federal Reserve Chairman, Alan Greenspan manufactured a credit bubble in the 1990s through a series of interest rate cuts. Because of an extremely inaccurate new methodology of inflation calculation introduced by Bill Clinton, interest rates were manipulated to aritifically ease credit, which grossly misdirected capital and created a series of bubbles, in information technology, dot-coms, equity markets, real estate, and credit in general. The 90s were a period of ridiculous economic growth in America, but it was substantially artificial, as overconsumption pervaded the perceived growth. This overconsumption was financed by borrowing using artificially free credit. True purchasing power was significantly below perceived wealth, and thus asset values shot up and, now, are shooting back down twice as hard and twice as quick.

Now that the credit market has collapsed (as well as credit-dependent markets, namely housing and automobile), purchasing power is going to begin a quick descent to real terms. Americans are going to lose wealth quickly, especially through their invested capital in mutual funds and pensions funds, as well as their homes. To ease the flow of credit to get Americans borrowing again and consequently consuming, propping back up the American economy, the Fed has been lowering interest rates again, but this time there is an added problem– inflation.

The recalculation of inflation is now manifesting itself in a weakening dollar, and eventually valuations will finally come to represent true inflationary levels, most likely around 8% already. The problem is the American government is trying to stimulate consumption once more by re-liquifying banks by buying out bad mortgage-related assets, especially derivatives. Consumption does not drive economic growth on the long term, capital investment does. Capital spurs technology, adds liquidity, and increases output, something America has not experienced since its back on industry. America has enjoyed strong inflows of foreign capital because of its equity markets and strong currency, but neither of those are incentives for investment any longer. The government’s plan to buy defaulted credit assets to bailout big banks is in fact worse for its long-run economic growth, because it weakens the dollar even further. The US dollar is now essentially backed by bad mortgage debt, and the only thing propping it up right now is temporary relative strength as the rest of the world experiences its own credit crises and the dollar remains the fundamental reserve currency. But for how long?

American national debt is the last bubble to collapse, and in fact it is still inflating and will continue to until a weakened global economy will force nations to call in their debts outstanding from the United States. This will be the coming of age for the next wave of economic titans: Singapore, Hong Kong, India, China, Australia, and Russia. This will be the downfall of the American Dollar and its replacement as the world’s pervasive reserve currency. This will be the true liquidity crisis, as the United States will essentially be forced into bankruptcy with no surplus to pay off debts and no way of financing through an illiquid banking structure.

This will be the end of capitalism in America. Socialist programs of the ’60s and ’70s foreshadowed the economic collapse, Alan Greenspan ushered it in, George Bush and his debt-financed wars worsened it, and Barack Obama and his socialist taxpayer-funded big government programs and bailouts will make it a perfect storm. I see in the future the possibility of an economy characterized by free credit but no demand and no purchasing power based on ridiculous inflation. Sounds eerily similar to 1930s Germany. Who will be America’s demagogue?

Buy precious metals now to save yourself. Venture capitalists are gone, there are no new IPOs, there is no industry, the currency is going to be worthless, hyperinflation may kick in, and there is no demand curve growth in sight. Buy precious metals.

America’s only hope? After four years of Obama, Barry Goldwater is resurrected from the dead to preach Austrian School capitalism and libertarian social policy.

Long recommendations: GLD, SDS, SKF, QID

Author’s Disclosure: I am long none of these ETFs, but will be after the current countertrend bear rally finishes (expecting around February-March).