The Light At The End Of The Tunnel, Is An Oncoming Train!

Peak Oil, sovereign insolvency, and currency debasement will permanently transform the economic landscape.

The US isn't yet on the final path to recovery, and there are one or more financial "breaks" coming. Underlying structural weaknesses haven't been resolved, and the kick-the-can-down-the-road plan is going to encounter a hard wall in the not-too-distant future. When the next moment of discontinuity finally arrives, events will unfold much more rapidly than most people expect.

I am figuring out which macro trends are in play and then helping people adjust accordingly. Based on trends in fiscal and monetary policy, I favoured accumulation of gold and silver in 2007. These weren't "great" calls; they were simply spotting trends in play, one beginning and one certain to end, and then taking appropriate actions based on those trends.

We happen to live in a non-linear world, a core concept of the Crash Course. But far too many people expect events to unfold in a more or less orderly manner, with plenty of time to adjust along the way. In other words, linearly. The world doesn't always cooperate, and my concern rests on the observation that the world economy still face the convergence of multiple trends, each of which alone has the power to permanently transform our economic landscape and standards of living.

Three such trends (out of the many I track) that will shape our immediate future are:

-Peak Oil
-Sovereign Insolvency
-Currency Debasement

Individually, these worry me quite a bit; collectively, they have my full attention.

History suggests that instead of a nice smooth line heading either up or down, markets have a pronounced habit of jolting rather suddenly into a new orbit, either higher or lower. Social moods are steady for long periods, and then they shift. This is what we should train ourselves to expect.

No smooth lines between points A and B; instead, long periods of quiet, followed by short bursts of reformation and volatility. Periods of market equilibrium, followed by Minsky moments. In the language of the evolutionary biologist Stephen Jay Gould, we live in a system governed by the rules of "punctuated equilibrium."

Accepting "What Is"

The most important part of this story is getting our minds to accept reality without our passionate beliefs interfering. By "beliefs" I mean statements like these:

“Things always get better and are never as bad as they seem.”

“If Peak Oil were ‘real,’ I'd be hearing about it from my trusted sources.”

“Dwelling on the negative is self-fulfilling.”

Peak Oil

Peak Oil is now a matter of open inquiry and debate at the highest levels of industry and government. Recent reports by Lloyd's of London, the US Department of Defense, the UK industry taskforce on Peak Oil, Honda (HMC), and the German military are evidence of this. But when I say “debate,” I'm not referring to disagreement over whether or not Peak Oil is real, only when it will finally arrive. The emerging consensus is that oil demand will outstrip supplies “soon,” within the next five years and maybe as soon as two. So the correct questions are no longer, "Is Peak Oil real?" and "Are governments aware?” but instead, "When will demand outstrip supply?" and “What implications does this have for me?”

It doesn't really matter when the actual peak arrives; we can leave that to the ivory-tower types and those with a bent for analytical precision. What matters is when we hit “peak exports.” My expectation is that once it becomes fashionable among nation-states to finally admit that Peak Oil is real and here to stay, one or more exporters will withhold some or all of their product "for future generations" or some other rationale (such as, "get a higher price"), which will rather suddenly create a price spiral the likes of which we haven't yet seen.

What matters is an equal mixture of actual oil availability and market perception. As soon as the scarcity meme gets going, things will change very rapidly.

In short, it's time to accept that Peak Oil is real -- and plan accordingly.

Sovereign Insolvency

Once we accept the imminent arrival of Peak Oil, then the issue of sovereign insolvency jumps into the limelight. Why? Because the hopes and dreams of the architects of the financial rescue entirely rest upon the assumption that economic growth will resume. Without additional supplies of oil, such growth won't be possible; in fact, we’ll be doing really, really well if we can prevent the economy from backsliding.

Virtually every single OECD country, due to outlandish pension and entitlement programs, has total debt and liability loads that Arnaud Mares (of Morgan Stanley) pointed out have resulted in a negative net worth for the governments of Germany, France, Portugal, the US, the UK, Spain, Ireland, and Greece. And not by just a little bit, but exceptionally so, ranging from more than 450% of GDP in the case of Germany on the "low" end to well over 1,500% of GDP for Greece.

Such shortfalls can't possibly be funded out of anything other than a very, very bright economic future. Something on the order of Industrial Age 2.0, fueled by some amazing new source of wealth. Logically, how likely is that? Even if we could magically remove the overhang of debt, what new technologies are on the horizon that could offer the prospect of a brand new economic revival of this magnitude? None that I'm aware of.

In the US, the largest capital market and borrower, even the most optimistic budget estimates foresee another decade of crushing deficits that will grow the official deficit by some $9 trillion and the real (i.e., “accrual” or “unofficial”) deficit by perhaps another $20 trillion to $30 trillion, once we account for growth in liabilities. This is, without question, an unsustainable trend.

It’s time to admit the obvious: Debts of these sorts can't be serviced, now or in the future. Expanding them further with fingers firmly crossed in hopes of an enormous economic boom that will bail out the system is a fool’s game. It's little different than doubling down after receiving a bad hand in poker.

The unpleasant implication of various governments going deeper into debt is that a string of sovereign defaults lies in the future. Due to their interconnected borrowings and lendings, one may topple the next like dominoes.

Currency Wars

The currency wars have begun, and the implications to world stability and wealth could not be more profound.

When pressed, the most predictable decision in all of history is to print, print, print. So I can't take credit for a "prediction" that was just slightly bolder than "predicting" which way a dropped anvil will travel; down or up?

The only problem is, widespread currency debasements will further destabilize an already rickety global financial system where tens of trillions of fiat dollars flow daily on the currency exchanges.

You can be nearly certain that every single country is seeking a path to a weaker relative currency. The problem is obvious: Everybody can't simultaneously have a weaker currency. Nor can everybody have a positive trade balance.

If a country or government can't grow its way out from under its obligations, then printing (a.k.a. currency debasement) takes on additional allure. It's the "easy way out" and has lots of political support in the home country. Besides the fact that it's already started, we should consider a global program of currency debasement to be a guaranteed feature of the US economic future.

Conclusion

Three unsustainable trends or events have been identified here. They aren't independent, but they're interlocked to a very high degree. At present I can find no support for the idea that the economy can expand like it has in the past without increasing energy flows, especially oil. All of the indications point to Peak Oil, or at least "peak exports," happening within five years.

At that point it will become widely recognized that most sovereign debts and liabilities won't be able to be serviced by the miracle of economic growth. Pressures to ease the pain of the resulting financial turmoil and economic stagnation will grow, and currency debasement will prove to be the preferred policy tool of choice.

Instead of unfolding in a nice, linear, straightforward manner, these colliding events will happen quite rapidly and chaotically.

By mentally accepting that this proposition isn't only possible, but probable, we're free to make different choices and take actions that can preserve and protect our wealth and mitigate our risks.

What changes in our actions and investment stances are prudent if we assume that Peak Oil, sovereign insolvency, and currency debasement are "locks" for the future?

When it comes to markets riding on a flawed fundamental premise, perception is everything.

Consider that in December of 2007, the world had plenty of food, but by February of 2008, we saw food riots and the international perception of food scarcity. Almost nothing had changed with respect to the fundamental quantities of food stocks between December and February, and that's the point.

Or consider that one month Iceland was in fine shape and the next month desperately broke. Ditto for Greece. Again, there was nothing that had fundamentally changed from one month to the next, in terms of cash flows or debt levels, that would justify the size of the adjustments, but they happened nonetheless, and they happened quickly.
However, it's when we consider the impact of the widespread realization of Peak Oil on the story of growth that the whole idea of sovereign insolvency really assumes a much higher level of probability. More on that later.

For now we should accept that there's almost no chance of growing out from under these mountains of debts and other obligations. We must move our attention to the shape, timing, and the severity of the aftermath of the economic wreckage that will result from a series of sovereign defaults.