The current recession: How will it end?

Some say the world will end in fire

Some say in ice.

From what I've tasted of desire

I hold with those who favor fire

- Robert Frost, American Poet

90% of surveyed economists think that we'll be out of the recession in a year. I am not so sure.

To see where the economy is headed, you need to paint a picture of how the US economy should ideally look. Here's what I think: Ideally, America should have little external debt and about 10% average savings.

Now check how far we are from this ideal situation. The answer is - very far - we have a huge amount of debt which is slated to approach 100% of GDP in a few years, and savings are increasing, but are not near 10%.

OK - so how do we get from current situation to ideal? There are five ways to get to the ideal situation, and all of them involve a lot of pain. America has gotten itself into a situation where it has very little (except its land) to help with the crisis. Here're the five options:

1. Reduce consumption, save more and pay down the debt
2. Increase productivity, work more and pay down the debt
3. Sell some of the riches in the US (like publicly owned land, etc) and pay down debt
4. We could default on the debt. This looks like the most likely outcome to me.
5. We could tax the hell out of the US population in an attempt to pay down the debt.

#1 is in progress - the problem is that reducing consumption causes economic depression and deflation. This will get us to a very painful point, with high unemployment. It also takes a long time to do. Also, as long as China and other nations are willing to loan us money, there is no pressure to reduce consumption drastically. Remember that in the 1970s, Jimmy Carter asked the nation to cut down oil consumption by setting their thermostat 2 degrees lower - and we all know what happened - he did not get reelected.

#2 is infeasible. Remember, US is already one of the most productive nations. To be more productive requires significant changes, improvements in the education system, getting rid of entrenched monopolies like the teachers' union, doctors, drug companies, etc - which takes a very long time (a generation) to accomplish.

#3 is doable. In fact, I think it will happen - with China buying shares of US companies, as well as part of the very rich US real-estate. Warren Buffett referred to exactly this issue back in 2003 with his story about Thriftville and Squanderville. China knows that the US is trying to inflate away their currency - they'd rather buy hard assets in the US and elsewhere while they can. See this New York Times article which explains how they are already doing this. However, I don't think it will be enough to pay down all the debt. For one, there will be political pressure to not sell too much of the hard assets, and secondly, the magnitude of the US debt is huge.

#4 will happen, because #3 will not be enough. When we default, the world will cease to loan us any more money, and we will not be able to rely on loans to buy oil, automobiles and other imports. Suddenly, the quality of life will plummet because imports will become prohibitively expensive.

Note that the US not only has external debt - but also internal debt. It owes money to retirees, the money in US banks, etc - when the US defaults on its debt, it will be impossible to meet Medicare commitments, banks will fail, etc. People will lose their income precisely when the cost of living will shoot up. It will not be pretty.

#5 will also happen, before #4 happens. The government will tax the hell out of the US population. This will make it harder for people to pay mortgages (since their take-home pay will go down). It will cause a wave of defaults, which will depress real-estate prices. Since direct taxation is not politically viable - the US will introduce taxation through inflation. In fact, the US has had a hidden tax of 7% for about 25 years now - see my previous post on the Great Deception. This hidden tax will increase significantly - see Warren Buffett's comments on this topic here.

In short, I think a combination of #3, #4 and #5 will happen by 2012. This will be very painful for everybody in the US. In the next few years, inflation will shoot up, China will buy hard assets in the US and eventually we will default on the debt. The cost of living will shoot up, the quality of life will fall.

Gerald Celente, a US forecaster who predicted the financial collapse and previous crashes (like 2001 crash and 1987 crash), predicts very dire things for the US. From his wikipedia page:

On November 14, 2008, Celente appeared on Fox Business Network and predicted economic depression, tax rebellions, food riots, and more concern for buying food than Christmas presents by 2012 in the United States. Celente also predicted in this interview that governments across the country will be squeezing the little guy for every last dime wherever they can.

I hope it doesn't happen, but I can see the possibility of this happening. I certainly see the possibility of higher taxation and higher food prices.

Now, everytime I bring this up with my family, I get the answer - surely the US will think of an answer. I can't think of any other option than the five I outlined above. If you think of another option - leave a comment, so that I can modify my analysis accordingly.