Mid-Term Election Shifts Control of Congress But Not the Outlook for Hyperinflation.  Also last week, the U.S. mid-term elections changed the composition of Congress.  While the actual federal deficit and economic structural problems are likely to get a good airing, particularly before the House, little is likely to change that could alter the course of the government’s effective bankruptcy or the short-range prospects of the structurally impaired economy, where the latter issue requires a major overhaul of U.S. trade policy.

Most who talk about "balancing" the budget are talking about the cash-based-accounting budget, which Bill Clinton was able to get into a reported "surplus."  The actual deficit, based on GAAP-based accounting, including the annual change in the net present value of the unfunded liabilities for Social Security and Medicare, however, did not show a surplus during the Clinton Administration.  Currently running in the $4 to $5 trillion range, the actual deficit is uncontainable from a practical standpoint.  Taxes cannot be raised enough to offset it, and every penny of spending could be cut, except for the "entitlement" programs and the federal government still would be in deficit.

Accordingly, meaningful resolution of the actual deficit problem means severe slashing of the Social Security and Medicare programs, in addition to whatever other government costs can be slashed.  Even with the shift in Congress, I do not see any political chance of the types of cuts needed being made in Social Security and Medicare.  Further detail on this, again, is covered in the Hyperinflation Special Report. 

U.S. Economy Still Faces Double-Dip Recession.  The longest and deepest economic contraction of the post-World War II era, the 2007 to 2009 U.S. recession, is far from over.  The downturn in the U.S. economy is re-intensifying, with no near-term stability or recovery on the forecast horizon.  After an initial plunge, broad-based business activity bottom-bounced at a low-level plateau for more than year.  Shy of short-lived bumps in activity from stimulus measures, there has been no meaningful recovery.  Nonetheless, with the National Bureau of Economic Research (NBER) having called an end to the recession in June 2009, the current downturn eventually will be recognized as a double-dip recession

Reflecting an intense real (inflation-adjusted) annual contraction in broad systemic liquidity (SGS-Ongoing M3 estimate), the economy has started to contract anew, as reflected in the accompanying graph.  As discussed in numerous Commentaries this year (see Commentaries No. 323 and 328, for example), declining year-to-year change in real (inflation-adjusted) M3 signals a pending economic downturn or pending intensification of an existing economic contraction, with contracting broad liquidity invariably constraining broad economic activity.  The signal is generated when real M3 first turns negative year-to-year, which occurred in December 2009 in the current economic cycle.  The signal is not generated by, nor dependent on, either the length or the depth of the M3 downturn.  The downside shift in business activity usually follows within six to nine months.  Due to the NBER’s current business cycle timing, the current downturn will be classified as a double-dip recession. 

The following updated graph plots annual real M3 growth versus periods of recession formally recognized by the NBER.  It includes an approximate annual real contraction in the SGS Ongoing-M3 Estimate as of October 2010.  The inflation-adjusted October M3 estimate used here is an annual contraction of roughly 4.6%, versus a 4.9% contraction in September.

Structural problems tied to lack of real consumer income growth — and worsened now by the credit-intensified contraction in consumer liquidity — pushed the economy into recession by early 2007, almost a year before the officially-clocked onset of December 2007.  Such helped to trigger the credit collapse, which exacerbated the unfolding downtown and threatened systemic collapse.  Despite extraordinary efforts to prevent a failure of the banking system, the structural consumer liquidity issues have not been addressed.  Until they are, sustainable growth in U.S. business activity will be lacking.

The current double-dip contraction likely will meet my definition of depression (a greater than 10% real decline in peak-to-trough activity).  In response to a likely hyperinflation, the current circumstance would evolve into a great depression (a greater than 25% real decline in peak-to-trough activity).  Ongoing contractions in the world’s largest economy have sharply negative implications for global economic growth, but the hyperinflation risk for the United States likely will not spread to the more-stable major U.S. trading partners.

U.S. Financial Markets.  The domestic equity market have shown some initial euphoric insanity in response to the Fed’s promised activity, but the stock market is not recognizing an ongoing systemic solvency crisis, yet.  The domestic equity and credit markets also both should be hit eventually by the looming U.S. dollar selling panic, which would encompass the selling of U.S. dollar-denominated stocks as well as credit instruments.

In the ongoing dollar debasement process, markets likely will be highly unstable and volatile, particularly when central banks try to affect activity.  Looking at the longer term, though, strategies aimed at preserving wealth and assets continue to make sense.  For those who have their assets denominated in U.S. dollars, physical gold and silver remain primary hedges, as do stronger currencies such as the Canadian and Australian dollars and the Swiss franc, which recently having hit or broken parity with the U.S. dollar.  Holding assets outside the U.S. also likely will have some benefits.

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