Anticipating The Ultimate "Crash" Scenario

¹²Anticipating The Ultimate "Crash" Scenario
Scenerio
By Peter Schiff | 11 October 2010

Most people assume that the "crash" I referred to in my 2007 book "Crash Proof: How to Profit from the Coming Economic Collapse" occurred in 2008. Those who actually read the book know otherwise. The 'financial crisis' that resulted from the bursting of the housing bubble, accurately foretold in my book, was not the crash itself, but merely the overture to a much more tragic economic opera for which the curtain is just now rising.

I argued that the housing bust would threaten the financial system with collapse and that the government would react with stimulus and bailouts— thereby making the situation much worse. That is exactly what happened. I did not believe then, and I don't believe now, that the process of liquidating bad debt would kill us. But I do believe we will succumb to Washington's "cure" of endless stimulus.

Many now claim that government deficits and Fed easing prevented a repeat of the Great Depression. From my perspective, calamity was not averted but merely delayed. The price for the reprieve will be a far more severe downturn, which I now think will surpass the Great Depression.

In Crash Proof, I talked about how our economy suffered from the co-morbid diseases of asset bubbles, excessive debt and consumption, and insufficient savings, capital investment, and production. These conditions did not arise as a result of market forces, but from foolish monetary, fiscal, and regulatory policies that distorted market forces. The proper cure would have been to remove the distortions and allow the markets to correct.

Unfortunately, as I forecast, the opposite occurred. Washington lacked the economic understanding and the political will to allow for a painful adjustment to take place. So, instead, they cranked up the printing presses and administered the equivalent of economic heroine.

The drugs succeeded in postponing the pain, but at the expense of exacerbating the underlying condition. As the high wears off, a more debilitating hangover will set in. By electing to bail out the financial sector, prop up housing prices, allow excess spending and borrowing to continue, and maintain superfluous government and service-sector jobs, the government has pushed our economy to the edge of a very dangerous precipice.

The right choice is to admit past mistakes and reverse course. The Fed must raise interest rates aggressively, shrink its bloated balance sheet, and allow the real recession to finally run its course. It will be much more painful now than it would have been in 2008, but at least this time the pain will end and real recovery will take hold. By forcing the federal and state governments to slash spending, sound monetary policy will allow market forces to rebuild a solid foundation upon which future prosperity may be built.

The wrong choice is for the Fed to continue 'quantitative easing' as planned, allowing the government to grow at the expense of the economy. This will widen the economic imbalances that lie at the root of our problems. As a side effect, the US dollar will continue spiraling downward as it becomes clear to foreign creditors that the Fed has no interest in protecting their investments. A weaker dollar will lead to higher inflation and higher interest rates, which will make the Fed's task that much more difficult.

In the end, our bubble economy will not just deflate, it will burst. The dollar will collapse, consumer prices will skyrocket, real credit will completely evaporate [[as it threatened to do in the summer of 2008: normxxx]], millions more will lose their jobs, and our economy will change in ways few of us can imagine. Our standard of living will plummet and legions of middle- and upper-class Americans will be impoverished. It is not a pretty picture, but unfortunately, it's the one our government is painting. Unfortunately, we are running out of time to change artists.