Book Summary & Notes: The New Depression by Richard Duncan

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Dear Reader,

Below are my notes and additional thoughts. I did my best not to let my opinions creep in. I am not a current economist nor do I consider myself a guru on fiscal, monetary, or foreign policy. I do have a sense for when stuff is out of whack (like it is in current times) and a desire to learn, understand, and capitalize on the trends.

There are no predictions of the future in this summary.

If you have questions, please email me and I will do my best to answer them. If you read the book yourself and disagree with something I wrote or see something that I missed, please let me know as well.

I hope the below is of service to you. Vlad


Capitalism is dead! Well… kinda. It’s on a respirator.

Capitalism is an economic system driven by savings and investments. Think back in the 1950s for example. Americans worked, saved money, invested in their own businesses or in public ones, either made money or didn’t and then the cycle continued. Today, that’s no longer the case. Americans do not save money. Americans (and the world for that matter) borrow money. And we, as a people, do not invest the money, we spend the money.

Welcome Creditism!

Our economy is now dependent on credit expansion. In fact, credit contraction or expansion below 2% leads to a recession or worse.

How did we get here?

Suddenly. Not gradually.

In 1968, President Johnson removed the requirement that the Federal Reserve hold gold to back up the money it creates. That essentially allowed the Fed to create as much money as it needed to achieve their goals. In 1971, President Nixon removed the US dollar from the gold standard and our currency became what's known as fiat currency (side note: fiat currencies are common throughout history. 100% of them have gone out of existence in the long-run). The rest of the world followed with fiat currencies.

There were “good” reasons at the time to do this. One of them was the fact that the US did not have enough gold to back up all of its spending stemming from the Vietnam war.

At around the same time, the reserve requirements that banks had to hold were also decreased. Banks must hold a percentage of their deposits on hand to maintain reserve liquidity. The lower the ratio, the more money they can lend.

These two events caused a much higher money supply which led to (almost) hyperinflation of the 1970s. To battle inflation, the Fed jacked up the interest rates causing stagnation of the 1970s.

So how come we don’t have inflation now?

Two words: global-ization!

Inflation (increase in prices), typically, occurs when there is an increase in income levels. When that happens, we can spend more and that pushes up demand for goods and thus the prices for those goods. Pretty simple.

What happens if you now have access to really really really cheap goods? In other words, what if supply of goods goes through the roof at the same time? You then have a drop in price levels and actually deflationary pressures.

Access to really really really cheap labor overseas causes the prices of those goods to be really cheap and thus prevents inflation in the country that buys those goods. In fact, the Fed has been battling deflationary pressures since the 1990s more so than inflationary ones. It's not a surprise given that the United States is the biggest importer in the world by far. That keeps prices on most goods relatively low. (side note: think about the price of everyday clothing. It’s highly likely that you paid less for it yesterday than 10 years ago. That’s globalization).

What about asset prices?

Low interest rates and more available money/credit, pushes everything up - equities, real estate, commodities, etc. What else would you expect? (side note: inflation rates as economists measure them do not include asset prices).

What about China and the trade war?

China has been using its access to really really really cheap labor to beef up its economic standing in the world. The United States is China’s biggest trading partner. “Partner” is an overstatement in my opinion.

In typical times (when a country's currency is backed by gold), a country's trade has to balance. For example: the US buys $5B worth of goods from China and China only buys $1B of American goods, we would have a $4B trade deficit with China.

That trade deficit would balance out given currency exchange. If we sent $4B more to another country than we received, our currency would get weaker compared to that of the other country and thus make our goods more attractive to them and their goods less attractive to us. Over time, the trade imbalance would be balanced. And before the 1970s (the golden times), that’s what happened.

In the world of fiat currencies, the trade does not have to balance because a country can manipulate the currency exchange. China has done it first by pegging its Yuan to the US dollar and then by using its fiscal policy. Both keep its currency at the same level relative to the dollar and thus their goods more attractive to us and thus keep us, and the world, buying their stuff. China’s largest trade surplus is with the United States.

China has been using a really cool trick in keeping the Yuan weak compared to the US dollar.

Using the example above, when there is an extra four billion of our dollars that end up in China, the government does not allow that money to be exchanged “freely” inside China. That would increase the supply of USDs, push the exchange rate down and make Yuan more expensive along with Chinese goods.

Instead, China prints just enough Yuan to buy all of the excess USDs while maintaining the exchange rate and the trade imbalance.

But hold on! Now China has all of these extra USDs, what does it do with them? China has two options:

  1. Spend them outside of the US and depreciate the dollar against other currencies. That’s not good for China.

  2. Spend it inside the US and keep the exchange rate neutral. That’s good for China.

#2 it is then! So what should China as a country buy? U.S. government debt! And that’s how China became the largest holder of U.S. sovereign debt and why the yields on those have been so low for long.

By the way, the reason you heard about tariffs in the past and will probably hear about them in the future is that tariffs make foreign goods more expensive and thus less attractive. In the globalized world of fiat currencies, that may be the only option that a country has to somewhat control its trade imbalances.

So what happened in 2008?

It started with credit defaults, credit contraction, and spike in interest rates. The Fed jumped in with massive stimulus (second only to what we’re experiencing now in 2020) to limit credit defaults, expanded credit through banks, and brought down interest rates. And that was not easy.

The economy was like a patient in cardiac arrest. The Fed had to apply massive shocks multiple times through quantitative easing (QE) - purchasing long term securities in the open market. That increased money supply and decreased interest rates, thus making borrowing more attractive.

Creditism was saved. Borrowing went up. Consumption went up. Asset prices went up.

Where do we go from here?

Note: this book was published in 2012 and well before Covid-19. The author accurately predicted the next rounds of QE and what happens with the asset prices - equities, real estate, etc.

To start off, embrace Creditism. We have no other choice. Our country’s, and the world’s, economy is based on access to, and expansion of, credit. Hitting the reset button and going back to the golden times, will be a disaster of global proportions. The last time that it happened was in the 1930s and it took a world war to get out of it. We have to understand what that would look like in today’s environment. Devastation would be much greater.

Secondly, replace/balance consumption with investment. There is nothing wrong with debt if it’s used to produce a higher return than interest paid - loan for an investment property vs credit card debt.

Finally, the United States can afford a lot more debt than it has now. We are a very wealthy country that can borrow more if needed. Our debt to GDP is in mid-100s. Japan has been around 230% for decades and has not gone under. Being over-leveraged does not mean that default is imminent. As long as your income cash flow is higher than debt service, you’re able to sustain the debt.

Is this the end of the world as we know it? Far from it. And we do have some choices to make.

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