Monday, June 18, 2007

This Week's Theme: Context

A Semi-Long View

Allow me to summarize the economic Optimists and Pessimists core positions:

Optimists: Today's prosperity is based on China and India's emergence as global industrial and trading powers. It will endure for decades, driving global prosperity to new heights.

Pessimists: Today's prosperity is based on unprecedented growth of money supply, speculative lending and synchronous speculative manias in housing, durable goods and stocks. It is about to pop, which is the inevitable endgame for all speculative bubbles.

Which is right? Or are both right? This week's theme is Context, for establishing the appropriate context goes a long way toward resolving apparent contradictions. In this sense, problem-solving (and forecasting) boils down to assembling a context which accounts for the known facts and the influences of history, culture and events. One philosophic word for this is "totalization" (from Critique de la Raison Dialectique).

By way of an example: consider welfare. Those ideologically against welfare focus on those gaming the system (the scofflaws and cheats), and other deficiencies such as dependency being passed down to the next generation. Those ideologically predisposed to support welfare focus on those impoverished children and mothers whose lives have been improved by welfare, and those who successfully transition from dependency to the workforce.

But the larger context of welfare must include its size in the overall Federal Budget (modest) and various technocratic methods/policies to minimize cheating and encourage job skills and entry-level employment of people who were previously "hard-core unemployed." Belief systems may drive politics but they don't provide context or understanding.

To establish some basic context for any economic forecast, I've drawn a graphic depiction of some major forces which have influenced the global economy over the past 40 years.

Please visit to view the chart.

Note that the lines are not scaled, but they do roughly track trends and key inflection points.

What seems rather obvious:

Sustainable global growth a.k.a. "The Great Bull Market" occured in an environment of dropping interest rates and inflation, relative peace, moderating budget deficits and perhaps most importantly declining oil costs.

Interest rates and inflation are rising, budget deficits are climbing even in "prosperity," the price of oil has skyrocketed, as has that of gold, and bubbles have formed in the Shanghai Composite stock market and global housing markets. We are currently waging two expensive wars, in Iraq and the GWOT (global war on terrorism).

What did not exist during either the period of stagflation or the Great Bull Market is the Yen Carry Trade, a pervasive expansion of global liquidity on a massive scale.

The rise of China began in 1978, a 30-year expansion roughly analogous to the 30 years in Japan's history from 1950 to 1980. Japan's Bubble Economy burst in 1990, followed by 15 years of malaise known as "the Lost Decade." Now that the Shanghai stock market has risen to Nikkei-and Nasdaq-like bubble heights, the possibility that its eventual bursting could presage a relative decline in China's fortunes should be considered.

The vulnerabilities posed by rising interest rates, inflation and debt, inflated asset bubbles and rising energy costs bear some similarities to the conditions prior to the Great Bear Market/stagflation of 1967-82.

Is this an exhaustive "totalization"? Of course not. But as a broad-brush sketch, it does serve a purpose, I think, to set the current "prosperity" in a large context.

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