The Global Economy Is Sitting on a Volcano. What Happens Next?

Contents

1. We’re living on a volcano
2. Let’s look at the volcano
3. How big an eruption might we get?
4. What can we do to prepare?
5. For More Information

(1)  We’re living on a volcano

Why do people choose to live on a dangerous explosive volcano?  People are too comfortable to move, and it pays to live there. The soil is often rich.  Some volcanoes have rich mineral deposits or tourism. And they probably will get lucky, as large eruptions occur decades or even generations apart.

Why do we choose to live with a grossly unstable economic structure?

• I believe my government can prevent or mitigate a crash.
• I do not understand the risk, the odds of a crash and its potential magnitude.
• We believe this system is the morally best choice or the economically optimal choice.
• I believe that I can withstand a crash, or even profit from it (The rich often do, like Mr. Potter in It’s a Wonderful Life).

The Great Depression shattered most people’s faith in the West’s forms of free-market systems.  But not the faith of those rich folks who benefited, like the Kennedy’s.  Many of them found the New Deal’s efforts to mitigate the Depression’s effects more objectionable than the depression itself.

Now three score and ten years later we face a similar crisis.  Fortunately the world’s leaders learned the danger of allowing a deflationary collapse to take hold.  Facing an event roughly the same magnitude as 1929, they acted boldly and stabilized the global economy.  That restored confidence in our systems — but that complacency prevented reforms (like those during the New Deal).  Only the horror of the depression provided the impetus to overcome entrenched powerful interest groups.

The first aid was successful, but the underlying illnesses were not treated.  So in the fourth year since the crash we see the pox reappearing.  Cracks in the structure showing through the hastily applied paint.

(2)  Let’s look at the volcano

We face a different Act Two than experienced in the 1930s.  We avoided the long depression that led to WWII (which ended it, although not a “cure” in any usual sense).  The same arguments emerge, about the same economic theories. We’ve learned so little.

Last week we described The unseen but perhaps decisive grand alignment of the nations — how the EU, Japan, China, and USA all face major (but different) developmental challenges simultaneously.  If we all make good decisions, our successes will re-enforce one another.  Positive synergy.

And vice-versa.  That’s the volcano.

(3)  How big an eruption might we get?

In a May 2012 presentation Raoul Pal, publisher of Global Macro Investor, describes aspects of the volcano.

1. The world has no engine of growth, with most of the G20 countries approaching stall speed at the same time.
2. For the first time since the 1930’s we are entering a recession before Industrial Production, Durable Goods Orders, Employment and Private Sector Employment and Private Sector GDP have made back their Previous highs.
3. These are the weakest ever-foundations on which to enter a recession.
4. There are almost no brakes in the system to stop this, and almost no one realizes the seriousness of the situation.

The first three points have been frequently noted on the FM website and elsewhere. After a crash and four years of slow and uneven recovery, much of the world is weak — with exhausted reserves, of both money and will.  Another downturn will hit us hard.  Key institutions might break, as in 2008-09, sparking a spiral decline.

(4)  What can we do to prepare?

The last point, #4, is ludicrously wrong.  Many experts, such as Paul Krugman, have warned of our peril — and the misguided policies that have brought us to the brink of ruin.  Also, we have the tools to deal with these problems, using economic theory developed and tested during the past century.

For largely political reasons vast effort has been made to erase this history from our minds, erase the theory from our minds — and replace them with a form of learned helplessness.  Just like during the 1930s, when men like Robert Taft and Andrew Mellon advocated letting nature take its course.  The painful path that supposedly led to long-term prosperity (see Schumpeter here).  Unlike the actual policies followed in the US and UK, which they forecast would lead to serfdom (see Hayek here).

President Hoover wrote in his Memoirs that Mellon, as Secretary of the Treasury, had

… only one formula:  liquidate labor, liquidate stocks, liquidate the farmers, and liquidate real estate…. It will purge the rottenness out of the system.  High costs of living and high living will come down.  People will work harder, live a more moral life.  Values will be adjusted, and enterprising people will pick up from less competent people.

The side-effects of this course — destruction of the middle class, further concentration of wealth and political power — were pleasing to the people that mattered, the stake-holders in America.

But we need not surrender to fear.  This is just an economic event, probably not as bad as 1928-1939 or 1883-1896.  It’s not a physical event, like a volcano, plague, or war — something that devastates our homes and factories.  Even in the worst possible economic crash nothing important changes.  It’s just a social event, the result of poor organization.  Wisdom and social cohesion can easily and rapidly repair the damage.  It’s a matter of choosing the right leaders and being good citizens.  Solidarity, common sense, and hard work are effective medicines.

In this way events during the next few years might determine the shape of the 21st century world.  For details see Which nations will make wise decisions under stress? Who will screw-up and fail?

(5)  For More Information

For more about living with a volcano see:

• Why do people live near volcanoes? at The Geography Site
• “Living With Volcanoes“, National Geographic, January 2008
• “Living with volcanoes: The sustainable livelihoods approach for volcano-related opportunities“, Ilan Kelman and Tamsin A. Mather, Journal of Volcanology and Geothermal Research, 20 May 2008

For more about these matters see the posts listed at these FM Reference Pages:

• Financial crisis – what’s happening? how will this end?
• End of the post-WWII geopolitical regime

This post originally appeared at Fabius Maximus and is posted with permission.