Talk of the 3rd Bubble, and Fiscal Armageddon

So, everywhere I turn these days, I hear quiet, terrified whispers about a growing 3rd bubble from guys I like to call 3rd bubble theorists. What is this 3rd bubble and what is a 3rd bubble theorist?

3rd bubble theory basically maintains that in the past 10 years we have gone through 2 violent economic bubbles and that a third one is now forming. The first bubble was the Internet bubble. It burst some time in mid September of 2000. The second bubble was the real estate bubble. It burst in mid September of 2008. Each bubble formed for about 6 or 7 years, then it exploded. You might argue that the internet bubble got underway in 1994. This when Al Gore held the famouse "Information Superhighway" conference at my dear UCLA... when I was a senior there. The second bubble got started early in 2001 when Alan Greenspan dropped interest rates to nearly nothing to cope with the onrushing crisis of the Internet bubble collapse. Household finance was cheap. Mortgages were considered safe. Banks rushed in.

Now we are building a 3rd bubble: The Government debt bubble. To cope with the explosion of the real estate bubble, the U.S. Federal Government is sucking in huge masses of capital in the form of T-Bills, whist prepping massive deficit spending packages to bail out giant corps and stimulate the dying economy. Terrified to put their money is stocks, corporate bonds, or just a plain old bank account, scarred investors are all to happy to slam their cash into a T-Bills. It is considered the only risk free investment.

These theorist maintain that we are in for a protracted period of grinding deflation. Everyone in the world is trying to deleverage at once. This is a fancy way of saying we're all trying to get out of debt... except the government. Firms and Families are taking all revenues and paying down debt. This is why spending has dried up, and the governments of the world are rushing to fill the gaps as spenders of last resort.

As the use of leverage goes away, the size of M1 and M2 money supplies dries up. As buyers take all profits and pay and pay down debt, demand slips. Together, these two forces produce enormous deflationary pressure. Business must offer fire-sale prices to attract any buyers at all. Ergo the prices of gasoline, Townhouses, Blu-ray disks and Tabasco sauce drop.

In this scenario, the value of the dollar increases. The value of commodities, goods and services decrease. Your dollar becomes more and more valuable as time goes on. Corporate profits look worse and worse. It doesn't make sense to buy stocks, commodities, or invest in new business when you are in a deflationary cycle.

In this scenario, investors will just keep stuffing their money into Government T-Bills. Since they are stuffing their money into Government T-Bills, Government debt increases. Since they are not stuffing their money into good, productive, profitable private enterprise, GDP does not grow. Rather, it is likely to shrink. Because GDP does not grow, but rather shrinks, Government tax revenues shrink. Because the government is likely to cut taxes as a stimulus, revenues will shrink here as well. [Beware of the Arthur Laugher curve, but not in this environment.]

So here it is: Another bubble of insolvency. With ever increasing debt, and with decreasing revenues to pay for it, the Government debt bubble eventually burst. What does the end of the world look like when the 3rd bubble bursts? What features will this Fiscal Armageddon manifest?

First, the Government will default on its debt. It will not be able to pay loan service without printing money. When the government defaults, probably after attempting to print itself out of this mess, the good 'ol Dollar bill will bust. The value of the USD will basically fall off to nothing. We will experience hyper-inflation of 3,000% per month, as producers of goods and services around the world shun our money. The Government will have to introduce a new currency, which I will call the VDollar, or virtual dollar. This will be an electronic currency only. There will be no paper or coin. It will probably be Gold-backed, but only in theory. Attempt to trade your digital bits for actual gold and you will get the cold shoulder. Nevertheless, expect the Government to spin-up some yarn about gold securities in Fort Knox, or something like that.

If the U.S. Federal Government busts the dollar bill, it will be a defeat the dimensions of which we have never experienced. It will be a route from which no honor can be salvaged. I don't want to imagine which Hell or what chaos will be visited upon the world if this scenario comes to pass.