Forget about Economic Recovery in 2011

The New Year unfailingly raises spirits, even for those who don’t imbibe. It represents a clean slate, a new start and a time to make resolutions to improve ourselves and our lives. It is a time for renewal.

Economists and politicians are not immune to optimism. Many economists project wonderful things for the coming year. Likewise Republican political pundits are especially ebullient, anticipating major political changes. Unfortunately, these expectations are no more realistic than our personal resolutions and have similar shelf-lives.

The Economy

2011 begins with the government-driven mantra that a recovery is under way. “The Recovery Summer,” was accompanied by similar fanfare, only to become the subject of late-night TV jokes. The 2011 recovery meme will be as valid and fleeting as that of its predecessor.

Why the optimism? The government has not changed course. Its previous “solutions” have been ineffective and exacerbated problems. Just as you cannot cure a hangover by drinking more, you cannot cure a debt problem with more debt. Both forms of temporary relief risk irreparable long-term damage.

A year ago, in Happy New Year Now Go to the Bomb Shelter commentary was offered about 2010. The key prediction was that there would be no recovery, and that recognition of the seriousness of our economic plight would become apparent:

The year 2010 is likely to be the pivotal year where pundits stop referring to the recession and begin openly talking about a Depression.

No recovery occurred, despite claims by the NBER that the recession ended in June, 2010. Neither will 2011 see any recovery.

In my opinion, we are in the beginning stages of an unavoidable Great Depression. Recognition is not widespread because of the concerted attempt by government and its media allies to minimize problems. The recovery propaganda machine is incessant, powerful and committed. Nevertheless, understanding is growing that something bigger, more destructive and longer lasting than the typical recession is upon us.

The unsustainable debt piled up over the last thirty years continues to grow exponentially. Deficits are so large that they force the Fed to utilize Quantitative Easing. Last year the Federal Reserve had these options:

1. The Fed continues its QE beyond their planned cessation in March 2010.
2. The Fed raises interest rates to levels that would attract the capital necessary to fund government operations via conventional credit markets.
3. No Fed action is taken. That would cause the government to default on some of its obligations.

It was easily predicted the Fed would continue QE and that QE would not work:

Of the three alternatives, what is best economically is worst politically. This natural conflict between good economics and good politics is not unusual. Economically, the country would be harmed least by implementing alternative 2. From a political standpoint, alternatives 2 and 3 are probably unacceptable. Thus, it is likely that alternative 1 will be used. Again! It is precisely the continual overuse of this alternative that led to the current, sad state.

The best that we can hope for is continued malaise. That probably means the following:

1. Employment does not recover.
2. Stocks, probably overpriced already, might or might not do well as the Fed continues to pump liquidity.
3. Commodities or “hard assets” will likely do well as a play on worldwide fiat currency depreciation.
4. Housing prices will continue down, perhaps as much as an additional 15 – 20%.
5. Bonds will do poorly once it becomes apparent that the government’s only tool is to inflate.
6. QE will continue for the entire year and probably beyond.

QE, at this point, has nothing to do with saving the economy. It is necessary to enable the government to continue paying its bills. It likely will be necessary beyond 2011.

The result of past and present government politices is that we are left with no good ending. For 2011, the best outcome is continued economic malaise. The worst outcome is the “crack-up boom” of which Ludwig von Mises warned:

There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.

I have speculated that this ultimate ending becomes a hyperinflationary depression:

…  we likely end up with the worst of all worlds. In a hyperinflation, money will cease to be a medium of exchange. Markets will cease to work, except on a barter basis. The middle class will be wiped out. Their savings will become worthless along with the dollar.

This ending is not predicted for 2011, although it could begin tomorrow. Recent and continuing policies by government move us closer to Mises’ outcome — a devastation of the economy. When this ending comes, it will be typhoon-like, appearing suddenly and rapidly destroying everything.

Politics

The 2010 election changed the composition of Congress. That change raises hope that Congress will be able to dramatically reduce spending, possibly avoiding the tragic Misesian ending. This hope will soon be dashed.

Politicians are little more than frustrated actors — too stupid for radio and too ugly for TV. They are not the country’s “best and brightest,” courageous or statesmen. The last act of political selflessness was George Washington refusing a Kingship. Offer that today and people would be trampled in the political stampede. You can count on two hands those who might decline the offer. You might need only two thumbs!

While voters recognize the unsustainability of our present course and demand cuts, it is a global demand. “Don’t cut my programs; cut the other ones” is the local demand. This message is the one heard by vote-seeking politicians. The dichotomy between individual incentives and the interests of the country is described by public choice theory:

As James Buchanan artfully defined it, public choice is “politics without romance.” The wishful thinking it displaced presumes that participants in the political sphere aspire to promote the common good. In the conventional “public interest” view, public officials are portrayed as benevolent “public servants” who faithfully carry out the “will of the people.” In tending to the public’s business, voters, politicians, and policymakers are supposed somehow to rise above their own parochial concerns.

Socialist government grows by including virtually everyone as a beneficiary. Behind every dollar spent is a voter-beneficiary. Every dollar taken away harms the voter-beneficiary. Reversing the welfare state cannot occur without alienating constituents. It is this reason why no political solution will be meaningful enough to avoid economic devastation. The cuts required are too massive.

Different noises will emanate from Washington, but little more. The newly elected Republicans will voice fiscal responsibility. The old bulls of both parties will defend (at least privately) the status quo. The battle will not divide along ideological lines, except for the extremes of both parties. Congress will produce cuts and compromises, accompanied by the usual political pomp and self-congratulations. Nothing done, however, will be meaningful enough to alter the path to destruction.

If you are an investor, go long smoke, mirrors and gimmicks. Political demand for these items will soar. Without courage, politicians have nothing left to convince people that things have really changed.

Conclusion

The required cuts are too massive for politicians to implement, and the economy cannot recover without them. Heavy and growing government spending and debt suck resources from the productive sector to support an insolvent government. Each passing day weakens the productive sector further.

The country has a destination-certain with a date-uncertain. It is akin to strolling down “The Green Mile” without knowing how close “Old Sparky” might be. Are we moving fast enough to get there in 2011? No one knows. Our best hope for 2011 is Japanese-style stagnation. Our worst is “Old Sparky.”

Time is the enemy. Inaction and phony political solutions only move us further down “The Green Mile.” Feckless politicians, no matter how clever, will eventually encounter Stein’s Law (named after economist Herb Stein):

That which cannot go on forever won’t.

Then “Old Sparky” has us, and economic Armageddon occurs.

As I commented elsewhere:

One hopes that this tragedy unfolds fast enough that our freedom still remains. If so, we will rise from the ashes painfully but quickly. If not the world may enter an Economic Dark Ages.

Pass the bottle; I intend to pretend it is New Year’s Eve.

This post originally appeared on American Thinker.