Depreciation is a decrease in value. There is a normal decline in value of a physical asset because it simply wears out. Depreciation can occur when a product is no longer in demand relative to its supply. On a global basis, when a currency is excessively created, its supply outstrips demand is depreciates in value. The Federal Reserve is creating a large supply of the U.S. Dollar
Deficits in the U.S. are running at historic highs at an anticipated $1.2 Trillion for 2009. On the balance sheet, a deficit reduces owner equity relative to the liabilities. If the liabilities outstrip the ability of income to service the outstanding debt, insolvency will occur. The assumption that the government has the power to create money is applicable to the degree that the rest of the world is confident in the valuation of the U.S. Dollar.
Debt accumulated by consumers has forced a reduction in consumption in order to pay down the accumulated liabilities. With the consumer accounting for 70% of the Gross Domestic Product (GDP) of the U.S., the economy must contract to allow for a re-balancing of the consumer’s balance sheet.
Dwellings or housing is normally the largest asset held by a consumer. Most of those who purchased houses in the last seven years may have lost a sizable value of the personal net worth. If the asset value declines with the liability still in place, net worth evaporates. When the emotion kicks in that your net worth has declined substantially, your spending habits change drastically. Depending on your leverage (assets divided by net worth), you may have to liquidate holdings in an adverse market thus perpetuating a deflating asset price.
Deflation of goods and services adversely affects accumulated wealth of the individual stock portfolio especially when there is monetary inflation occurring at the same time. When demand decreases relative to supply, prices deflate. However if those goods and services are discretionary, then the price deflation does not help the consumer. If you own a hotel stock in your portfolio but the public has reduced travel plans, you lose. The price for a room goes down, the value of the stock goes down, but you are still dealing with monetary inflation decreasing the value of your purchasing power as you attempt to buy food and energy.
Demographics is a huge issue for the developed countries. Like a broken record, I keep referring to the “baby boomer” generation. The current paradigm of social security will not handle the liability commitment to this generation. Over the last forty years, Congress has misappropriated the social security funds and placed IOU’S in their place. I believe this issue is the reason many legislators have opted to leave public service when there was no apparent reason to step down. Whoever is in power when this issue arrives at the breaking point will suffer the wrath of the baby boomer generation. We worked throughout our adult lives paying into the system while being assured of retirement funds at the age of 65. This backdrop assured the less fortunate of a subsistence level of living. See: http://www.usdebtclock.org/
Derivatives are bets against the future. There is a buyer and seller of the derivative and the seller receives a “time” premium for selling the derivative. The buyer’s incentive is that he wants to cap his risk in the underlying investments. The problem lies in the seller’s financial strength that backs the derivative instrument. If the seller sells more derivatives than his capital structure can support, the derivative’s value becomes worthless thereby resulting in the buyer having no real insurance supporting his investment. Derivatives are now in the quadrillions and a substantial portion of that total cannot be supported by existing capital. As derivatives unwind the losses must be realized on the balance sheets and when this happens capital evaporates and moves the entity toward insolvency.
Devaluations of asset values has an emotional impact on the owner of these assets. As the devaluations move toward a minimum operational level, the equity owner will change their spending pattern. For example, if you have an equity of $1 million you will spend as though you are a millionaire because you have plenty of buffer if you have a negative economic event occur. You will take nicer vacations, make home improvements, and eat at restaurants more often. In other words, your consumption goes up. If you lose $600,000 in equity, you will cut back in all discretionary spending and move to a defense posture. You will defer spending thus increasing deflation of consumption based goods and services.
Dollar, that is the U.S. Dollar, is in serious risk of default. The long term decline (3 t0 5 years) is expected to be 50% of its current value. This translates to an equivalent decline in purchasing value to the average U.S. citizen. Those on fixed incomes will suffer the greatest loss of purchasing power. Workers may have a small buffer by demanding greater wages to offset inflation but will lag behind the dollar decline.
Depression is becoming a real global possibility, mainly for the developed countries. Those economies who shipped their manufacturing jobs to cheaper jurisdictions in favor of a service-based economy will suffer the greatest contraction. Anytime you have a decline in revenue, services get cut first. There is a battle between the government protecting the current paradigm and the reality of the consumer-based de-leveraging requirement. The de-leveraging requirement will win.
Destruction may result from man’s attempt to defy realities created by greed. Resources are being consumed at record rates and the global population growth cannot be supported by the current infrastructure. When this happens war results, maybe a world war. Each country believes it is entitled to resources and when that country becomes desperate, they will take desperate measures.
There are more D’s we could cover but the above provides us a clear view of the current environment. Filled with negatives, the D’s are a result of man’s best attempt to manage the globe without the Wisdom from above. As men become desperate, they will shift their focus from the mirror to the Heavens and seek Our Heavenly Father’s face. Could this be the major paradigm shift many of us have been looking for? The smoke and mirrors of government rhetoric will not bail us out of this time of extended greed. A new era is coming whether it be natural or supernatural!