Monty Pelerin / EconomicNoise.com

The US and other modern industrialized nations are headed for economic collapse. Political excesses created unwieldly and insolvent social welfare states in every modern democracy. The notion of providing for those who cannot or do not provide for themselves has limits. As Lady Margaret Thatcher expressed the problem:

The trouble with Socialism is, sooner or later, you run out of other people’s money.

The Political Problem

Those dependent on the welfare state are unaware that their benefits are not sustainable. Most believe tomorrow will be like today and the checks will keep coming from Mother Government. Political power was gained based on promising these benefits. No politician will risk his position by trying to reduce them. No democratic society has ever rolled them back via peaceful political means.

Governments in the developed world are out of money. They can either cut back the welfare state or attempt to fund it by ever-increasing taxes. The latter route represents economic suicide as increasing taxes destroys the economy. The former route represents political suicide. Dependency, once accepted as a way of life, cannot be cured without jeopardizing the existence of government and society.

The Extent of The Financial Problems

The financial hole dug by most social welfare states is too deep to get out of. The finest turnaround manager in the world, unconstrained by politics, would be unable to remedy the problems. The mathematics of the problem are just too far gone. Radical cost-cutting and proper economic policies can no longer work. Hope and change may work in a political campaign, but slogans carry no weight against the iron laws of arithmetic.

The world is on the verge of massive sovereign defaults. To appreciate the enormity of these problems, see Welfare States R.I.P.

The best resolution of the problems would be to default on the unsustainable promises and debt. While not honorable, it is the only option that can reverse the inexorable debt death spiral that is destroying all welfare states. Without a liquidation of excess liabilities, economic growth cannot resume and economies will shrink and eventually implode. Japan, more than two decades into its economic purgatory, has managed to stall the implosion but not avoid it. The US and other countries are on the same path.

Welfare states have become zombie economies. These “walking dead” are shells of what they once were. A failure in one probably produces a domino effect that dooms all.

Two course of action can be pursued:

1. The Economic Solution

This solution requires that government spending be brought into line with revenues and held there (or below) for a lengthy period of time. That requires reneging on many social promises and possible sovereign debt defaults. A depression would occur. Homes would be foreclosed and businesses closed.

Wealth, defined in terms of physical assets, would be re-allocated. New owners and uses of assets would result. So, too would a complete cleansing of the cancer that prevents economic growth. The economy would be traumatized, but recover rather quickly so long as government refrained from intervening. Pain and suffering are inevitable. Civil unrest is probable and so is the risk that government(s) could be overthrown.

This solution is horrible in every sense but one — it is the better of two alternatives.

2. The Political Solution

There is no political solution, although that will not stop politicians from pretending there is. “Pretend and extend” is all they can do. Intervening with additional stimulus and more printed money buys some time, but worsens the economic problems. Problems and distortions are made bigger, requiring even more adjustment when they inevitably occur. Pursuing this strategy flirts with currency destruction which would destroy the savings and fixed incomes of the middle class.

The end result is the same as the economic solution — a complete and total collapse of the economy. The difference is that the collapse is more severe and that many may be destroyed in a hyperinflationary blow-off. Since 2008, the money supply has almost quadrupled. Most of that money lies dormant in the banking system. Had it been loaned, we would have massive inflation today. Instead, it sits there like dry tinder awaiting a spark to ignite it.

The Road Ahead

The productive world has allowed its wealth to be squandered by profligate politicians and their governments. Unsustainable welfare states (Ponzi schemes in a sense that even Ponzi himself could not have imagined) consumed capital rather than allowing its re-investment and growth. Without capital growth, real wages must shrink and that is exactly what is happening today.

The world is in for a long period of stagnation, retrogression and conflict. The next hundred years could very well be referred to by future historians as an Economic Ice Age.

Short-term, this generation cannot avoid another Great Depression. The proverbial butterfly flapping its wings in Greece, Spain or other places could be the catalyzing event. On the other hand, it might be possible that the form of Japanese purgatory that much of the world has entered could be sustained for a decade or so.

Protecting Yourself

The changes coming are going to destroy people and fortunes. Some entrepreneurial types will stay ahead of events, protecting or even increasing their wealth. Most people, however, will be caught off-guard, trusting investment methods and guidelines that worked in a sane world but no longer work in the new world.

The economy and society could end up in ashes. What is impossible to predict is the route that leads to this point or how long it takes. Knowing an apocalypse lies ahead is not enough. Knowing what lies between here and there is the difficult issue for those trying to protect their wealth.

The period ahead is not a time to be aggressive. Preserving your wealth is apt to make you a relative winner in terms of what is coming. But be careful when you measure wealth. The dollar is no longer a reliable numeraire. Wealth measured in nominal dollars is likely to grow as a result of inflation. Wealth measured in terms of purchasing power, however, is the critical measure. Maintaining the purchasing power of your wealth will be difficult to do.

Soon I will be announcing a new website that will deal with investing in front of approaching doom.

http://www.economicnoise.com/2013/01/03/economic-armageddon-is-coming/