Finance and imagination

Wherein I envision various economic scenarios and what may precipitate them. Perhaps only indirectly related to the blog's election theme, for which I apologize in advance.

1) Everything stays roughly the same (with or without a bailout)

Irrespective of whether a bailout is passed, perhaps the US economy will chug along as it is now doing. We continue plodding along with a weak economy, but not an economy that is in crisis. The dollar's value doesn't change dramatically, unemployment doesn't rise significantly, inflation persists but not on a 1970's scale, the Dow stays above, say, 9000. This scenario allows for the seemingly inevitable weakness in the economy putting pressure on individuals, but not undue pressure: 401K values go down, but still retain meaning, those folks on fixed pensions have tougher time, but can cope, people can still get jobs.

This scenario is the most likely of the scenarios which is not to say that it is probable. We will call this the default scenario: what happens in the absence of some other economic pathology.

2) Commodity driven inflation
Let's say oil and food prices surge. Perhaps this would result from a weakening of the dollar combined with a weak American economy relative to other nations. In this case, other countries may begin to purchase our food driving up our prices and oil prices remain high which creates a flow-through effect on all aspects of the American economy (since we are so oil-dependent).

The good news is that we are essentially undergoing this right now. As such, people are adjusting. The rise in oil prices has already changed worldwide demand for oil, so it appears that this isn't a problem that is likely to get dramatically worse.

3) Dollar-collapse hyperinflation
The hyperinflation here need not be Weimar-scale hyperinflation which would be unlikely given the importance of the dollar worldwide. It is, however, entirely possible, that at some point the national debt becomes so difficult to service and might create a substantial inflationary effect that is accompanied by a further devaluing of the dollar. This is what Ron Paul predicts is the eventual effect of the borrowing our goverment does combined with the arbitrary creation of money from the Fed (i.e. we're off the gold standard).

If a dollar loses a mere 75% of its value in the next 6 years (a mere 12% annual inflation rate) any citizen relying on a fixed pension (including social security) would be devastated. For example, a $50K annual pension would then be worth $12.5K in real terms. Given the nascent retiring of the baby boom generation and the huge cohort of senior citizens already squeezed by an inflationary effect that erodes their fixed income this rather minor economic calamity is both a realistic and tragic potential.

It should be noted that there is strong pressure against hyperinflation (aside from the senior citizen lobby) in the sense that it would be an "easy" way to pay off our national debt; thus, creditor nations would endeavor to protect the value of their loans to our country.

3) Depression-style deflation
What if the dollar retains its value? This scenario could be equally troubling. Let's say that unemployment rises to a mere 10% - which is substantial given the revising of the definition of unemployed to artificially lower that figure for political purposes. There's plenty of downward pressure on wages since there are plenty of jobseekers. Further, there is downward pressure on prices because the economy is weak and wages are down. What if this precipitates a slight downward drift in wages combined with a bearish stock market and low interest rates?

This scenario creates its own problems. How will we service our massive national debt with declining wages? How will the enormous fixed pensions be paid out when the stock market isn't providing notable returns and interest rates don't provide a substantial return. Fixed benefit pensions are predicated somewhat on an investment environment that can grow to cover the expenses. Many private and even public pensions have solvency issues already and they would only get worse if the money coming in is lower than the money going out.

This scenario is similar to the current mortgage problems in that huge debts are incurred and then economic problems make it difficult to service those debts.