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The Great Depression that started in 1980 is ending along with WW III.

The US debt and GDP growth from 1980 to 2010 is very similar to the 1920 to 1950 time period. By projecting similar debt and GDP growth as in 1950 to 1980 30 year period we arrive at the following number for 2040 (see hyperlink below for spreadsheet):

http://www.flickr.com/photos/shakercherukuri/6143679891/

US Debt in 2040 = 50 Trillion (Nominal)

US GDP in 2040 = 140 Trillion!!! (Nominal)

So why is the next 30 years going to be similar to the 1950 to 1980 time period?

1) WWIII is ending. Financial Pearl Harbor has lead to currency wars. We are approaching the climax. Euro will be replaced by Yuan as the second reserve currency. The Euro zone’s contribution to world GDP will diminish. BRICS will be larger than Euro zone soon.

2) Winners will be people who own Assets and make money via capital gains, dividends, real estate etc. Loosers will be everyone else on fixed income (Social Security and/or fixed wages).

3) The new boomers are in BRICS and other emerging BRICS.

4) US will arrest the growth of debt by limiting the growth of entitlements, depreciating the dollar and inflating the assets (same as in 60s and 70s). It is already happening.

5) The US stock market, 80% of the market cap is the S&P 500, will benefit from the deprecating USD since the majority of the S&P 500 corporations have most of their receivables in other currencies and most of the payables in USD. The new healthcare law is also a huge boon for the S&P 500 corporations (see item 6 below).

6) The healthcare law is actually a huge boon for the free marketeers since there is no public option and people need to buy private insurance. This whole fight against this new law is a farce. The insurance industry and the corporations got exactly what they wanted with some minor concessions. Lifestyle change is what is needed to fix the big four root causes (diabetes, high blood pressure/heart disease, obesity, bad diet/no exercise) that are responsible for 80% of the cost. The insurance companies in collaboration with the corporations will enforce this via incentives. Most of the regulations will impact small business that do not provide any healthcare to their employees. This requirement will limit their ability to compete with the S&P 500 corporations.

7) US consumer will eventually benefit once the inflation shows up in the wages (most likely in 2020 and beyond trickle down) and their major expense, the mortgage, is fixed at the current low 4%. So lock in those rates!!

The new entrants to the US labor force in 2020 and beyond will not be able to afford homes. They will have to settle for apartment like most of the consumers in rest of the world. The $3000 automobile and $30,000 homes of the 50s are $30,000 automobiles and $300,000 homes today. Most of the US middle class has still been able to buy those due to credit expansion. In the not too distant future (in less than 20 years) we will see another ten fold increase and less credit. So the writing is on the wall. The wages will not rise to keep up with this sort of inflation.

The reason for appreciation in Japanese Yen could be due to hedges against a depreciation in the US dollar. If one needed to place a vast hedge for USD in a investment that is safe, liquid, available in unlimited quantity and not cause the underlying asset to move a lot then Japanese Yen is the best bet.

It seems to me that the vast majority of the Japanese (mostly savers in Postal Savings) should benefit (finally!) due to buy and hold strategy (of Japanese Yen) over the course of next few years as the USD (world’s reserve currency) depreciates.

The corollary to that is that the US equities will appreciate (especially those that have most of the receivables in other currencies and most of the payables in USD) and other equities would depreciate (more so if the local economies’ growth was due to exports to the US).

Most of the emerging market equities markets will collapase due to collapse of exports to US. US corporations and consumers will look for cheaper sources of goods internally as the US dollar depreciates over the course of the next decade (managed USD depreciation since this is the only way to fix the trade imbalance and create jobs for the long haul – a structural shift).

This will continue the momentum in the US equity market which started in March 2009 after the massive monetary injection by the Fed (see link below for details).

(http://process-improvement-solutions.com/blog/2009/03/19/the-fed-goes-all-insort-of/).

There is a lot of debate going on about our Energy Problem and how the current stimulus is trying to tackle our Energy crisis. Yesterday, President Obama unvelied a $2.4 Billion grant to the private sector with the primary objective being to boost innovation in battery technology.

Solar firms in California have been significant receipts of grants in the energy renewables sector. This specific grant targeted towards battery technology in the automotive space was targeted towards firms in the midwest especially in Indiana and Michigan such as EnerDel (automotive lithium-ion batteries will receive $118.5 million in a matching grant), Delphi Automotive Systems LLC ($89.3 million), Allison Transmission ($62.8 million), Remy Inc. ($60.2 million) and Purdue University ($6.1 million).

Just as the Strategic Defense Initiative (SDI) program (aka Star Wars) funded research (mostly in the defense industry) in the 80s spawned numerous innovations even though the SDI as envisioned did not pan out, this (the current fiscal stimulus) too is likely to sow the seeds for innovative solutions for our gargantuan “Energy” problem.

The entire eco-system needs evaluation and new solutions – transportation and its power source (i.e engine/motor), fuel, fuel source, power generation, distribution, consumption. The current stimulus actually hits all of these aspects of the energy eco-system and is using the private sector and consumer incentives to change the behavior and investment/development focus.

Obviously not everything will bear fruit, even if 20 to 30% of all these efforts succeed, we would be well on our way to becoming an energy efficient society.

Shaker Cherukuri
Managing Principal
Process Improvement Solutions, Inc.

The Federal Reserves decision yesterday to purchase over 1 Trillion dollars worth of US Treasuries and other securities is akin to going all in. The fed has three basic weapons in its arsenal to tackle the monetary policy to aid and abet the fiscal policy decisions of the administration and the congress:

1) Interest Rates
2) Open Market Operations
3) Reserve Requirements

So far, the Fed has been using 1 and 2. Interest rate target is now zero. The mechanism for this is buying and selling the US treasuries until the short term rates reach is target. Essentially the Fed is adjusting the demand until the rate reaches its target. Once the target is zero, this weapon is exhausted.

Under open market operations, the Fed is basically using its power to expand its balance sheet to flood the system with money by going into the open market and buying “stuff”. By doing so, the fed is pumping money into the system. The fiscal policy just called for 1 Trillion stimulus. The Fed is accommodating that buy announcing 1 Trillion monetary stimulus. Most of this will go to the Treasury and the Treasury will issue Bonds to the Fed.

Before all this started (before September 2008), the M1 money supply was about 1 Trillion (M1 is the actual amount of dollars in circulation in the global economy and consists of physical currency (M0), checking deposits and bank reserves with the Fed). From September 08 to March 09, this doubled to 2 Trillion since the Fed pumped money into the banks (as The Chairman stated in his 60 minutes interview, the Fed simply inflated the banks’ accounts with the Fed). No actually bags of money were shipped to the banks just as no bags of money gets shipped to ones bank account when one gets his/her paycheck – this is the difference between M1 and M0 and are usually quite close.

Now the Fed has announced that it is going to buy 1 Trillion dollars worth of securities, which is adding another trillion dollars to the M1 money supply. So this effectively takes the M1 from $ 1Trillion to $3 Trillion!! Sounds ominous for the US Dollar. However, when you think about it, the world economy is about $40T (US is about $14T, 35%). Since most of the commerce is conducted in US dollar, the $40T world GDP was supported by a mere $1 Trillion of M1 money supply. Now that has/will triple to $3 Trillion and will most likely require expansion of the M0 as well (that is the actual physical dollars – printing money).

Most of the Federal deficit until now has been financed by selling US Treasuries to others (domestic and foreign entities) which brings the existing US dollars back to the US. It appears that now, the need for government borrowing has exceeded the supply of global savings hence the Fed is accommodating that need by expanding its balance sheet and increasing the money supply. The M1 supply is still (at $3 Trillion) only about 20% of US GDP and less than 10% of world GDP.

The Fed has kept a tight lid on the M1 money supply and is now opening the flood gates slowly when needed. The US dollar is the biggest asset/weapon US has. Let us hope the problem gets fixed before the weapon gets blunted due to overuse (i.e the preferred vehicle for world savings shifts away from US dollar). There is still the option 3 (reduce reserve requirements), but that might exacerbate the leverage situation, hence has not been used right now (they might be too low begin with). It will be used to take the liquidity out when economy recovers and inflation shows up.

The situation today is akin to WWII. The war and weapons are different. US went all in then; it is doing so again now….
Shaker Cherukuri
Principal
Process Improvement Solutions Inc.
3209 W. Smith Valley Road, Suite 224
Greenwood, IN 46142
317-258-3552