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My Book Reviews

Category: Economics
Published: 1991
Read: 2010
Reviewed: Jul 2010

This book predicted that the 1990s would be a decade of depression in the U.S. Its premise is based mostly on the high cost of the US economy, indicated mainly by the huge amount of government debt and lack of productivity (due to the costs of the legal system, the engineering gap, and health care spending). The fall of the British Empire in the 1930s and the U.S. depression of the 1930s are used as analogs to create a template for the then-anticipated U.S. economic decline.

The book makes macro predictions (about inflation, interest rates, economic activity, and financial markets) as well as micro predictions (the price of oil, particular industries, and social changes). The book is ambitiously broad in scope. It is rich with historical lessons and detailed references to related political and social phenomenon. The authors themselves state that the book needs to be "broader than just the economy or markets". Since the book deals with long-term trends, this multidisciplanry backdrop adds needed depth to the analysis.

Even though certain topics (like the history of primitive violence) inadvertently taint the book's generally non-alarmist tone, the authors don't fall into the common trap of being falsely apocalyptic (which is especially admirable considering that the book predicts a major decline). This temperance is due to a couple of reasons. The first reason is that the book is well-researched and the concepts covered are analyzed thoroughly. There is tons of logic and depth to the author's thoughts. It is clear that the authors of this tome have a genuine interest in modeling long-term economic declines and are not just dispassionate journalists casually digging up facts in order to write a half-hearted book. The second reason for the deliberately-tempered negative tone is that the authors make a point to remain objective in their predictions. They dosn't take a moralistic, anti-government stance that many amateur investment bloggers do. The authors show admirable restraint in admitting that things may not even develop as badly as they think. They admit that "it would be wrong to overdraw the parallels" of history, so they include a list of ways that the 1980s are different from the 1920s (unfunded liabilities, high trade deficit, debtor nation status, no gold standard). They rightly point out that capital "is like padding that protects social institutions from megapolitical shocks" when explaining how the depth and breadth of the modern US economy acts as a buffer against declines.

Even though the authors take a little too much credit for claiming their predictions came true (which they do in the updated version of the book), the accuracy of book's predictions, overall, was indeed very impressive. The predictions that the authors made were bold enough, and specific enough, that the book's only-moderate accuracy rate still creates massive profit opportunities. One misconception about long-term trends is that you have to place your bets before the trend begins. Fortunately, this isn't true. You can wait until the warning signs appear, or even wait until the trends begin, and still profit significantly. The book's financial predictions are (understandably) more accurate than their social predictions (the book overestimates the amount of social instability). This isn't bad though since the financial predictions are the ones where the most profits are to be made.

Here are some predictions that came true.

  • The rise of terrorism (September 11th).
  • The US military assets will be largely ineffective against the threats of the 1990s (failure of the war in Iraq).
  • Loose money policy will not work after the big decline occurs (this one was easy).
  • Politicians will make the decline worse because of inflexible leadership (politicians ran up the deficits even more).
  • A large drop in real estate prices.
  • Government employees will be fired (state employee layoffs in California).
  • The entire financial system teeters on collapse with a large number of bank and insurance company failures coupled with abandoned properties (Countrywide, AIG, foreclosures).
  • Quadrupling of the deficit from $200 billion to $800 billion during the economic downturn.
  • Large losses on government-guaranteed debt from Fannie Mae, Freddie Mac, and Sallie Mae.
  • The economic decline will increase wealth disparities because the biggest losses will be in real estate, and the middle class has the largest proportion of their assets in real estate.
  • Hyperinflation unlikely.
  • These industries will do bad - auto, construction, media, restaurants - especially expense account dinners (Ruth Chris). These industries will do well - pawn shops, home-based businesses.
  • Counter-intuitively, luxuries will suffer at first but will rebound very well (Coach handbags have done well).
  • Brand loyalty will decline.
  • The infrastructure will start to crumble (Minnesota bridge collapse) and infrastructure, like roads, will be privatized.
  • The transfer of information over the telephone lines (the internet).
  • International drug wars (Mexican drug gangs), and legalization of drugs (California).
  • The decline of the suburbs. (this came true - relatively speaking)
  • Oil will fall near record lows (it did in 1998 before rising).

Here are some predictions that didn't come true, some of which still may:

  • State and muni bond defaults (increasingly likely going forward).
  • The FDIC would run out of money (definitely possible).
  • The withdrawal of the US as a global military policeman.
  • A decline in secular consumerism (although consumer spending declined during the economic decline, the "religion" of consumerism hasn't declined).
  • A resurgence in religion.
  • Japan is likely to be the next big power.
  • These industries will do bad - defense, fashion, services, medical.
  • Higher taxes.
  • Exchange controls.
  • Deflation.
  • Taxes raised.
  • Canada will split apart.
  • Public schools will be privatized.
  • Welfare state goes away.
  • Corrective measures like a taboo on debt or a wealth tax.

Here are a few noteworthy quotes from the book:

The following is an insightful comment about how America will actually be resilient for a while even if it loses its superpower status:

"As American economic supremacy has given way to relentless international competition...the stage has been set for another perilous transition of world power. Such transitions are rare in modern history. There has been only one in the last two centuries. Not surprisingly, therefore, the lessons of the decline of empire have been easy to neglect or misunderstand. In particular, it would be easy to assume that the transition period is one of growing advantage for the rising power. Historically and logically, this is untrue....The declining power itself is likely to be the beneficiary of its own weakness, while other nations, poor or rich, suffer more in the chaos and depression that accompany a breakdown of the world system. It may be only when the new empire finally emerges to predominance, after a trauma of transition that may be decades long, that the old empire settles into its debility."

About the failure of stimulus-based job creation:

"Politically, the representatives of the unemployed, underemployed, and unemployable are going to push to "make jobs", in spite of the insolvency of the government. The government will seek to create work through regulation. These policies will be implemented in conjunction with industries with falling demand, perhaps by mandating a very short work week, or requiring that successful firms "adopt" dysfunctional individuals for "training"".

About the default of mortgage-backed securities:

"In effect, the U.S. Treasury is like an insurance company without reserves. Congress has gambled the good credit of the country by writing trillions of dollars of coverage against the fall of real estate prices in the United States."

The book has a couple of weaknesses. First, it gives too much weight to Japan's influence and relevancy to future events. Even though Japan did end up suffering a meltdown, the big differences between Japan and America (both culturally and economically) caused its economy and markets to become de-coupled from Europe's and America's after 1990.

The other weakness is that the book's focus is sometimes misguided. It goes off on tangents which are interesting but are only marginally relevant at best, like: theories on poverty, a history of violence, the nature of power, and the information age and technology. It also attempts to make predictions about geographical regions which are not relevant to the meltdown, most notably Latin America. The focus on these irrelevant topics is compounded by the fact that the book misses a few obvious areas of exploration. One area is the high amount of consumer debt. The book talks only briefly about high leverage in the private sector and correctly points out that "too many people are tapped out to allow for vigorous growth". But this topic isn't explored nearly as much as it should have been. It should be remembered that consumers do not have the power of printing their own money. This means that a default of consumer debt will happen before a default of government debt.

Another area of interest, this one within the social realm, was the media and advertising. Although the book touches on the rise in celebrity culture, the book should have given more weight to this topic, instead of some of the disconnected history lessons, since the rise of marketing and advertising has been one of the most influential secular trends of the last half century and affects consumer spending so much.

A third obvious area of interest that was skipped was the future economic rise of China, since that subject is especially relevant to the thesis of the book. Thankfully though, the copious amounts of coverage about China's economic rise from other sources conveniently fills this hole.

Overall, the book is very strong. Ordinarily, I wouldn't give a "meltdown" book such a high rating. Most of the books of this genre tend to be similar because their general themes (the economy will crash) as well as their basic reasoning (high debt levels) are obvious. But this book is different because its high level of detail serves as a useful blueprint not just for this specific economic decline, but for major economic declines in general. And its broad scope (with its historical perspective and regard to the related social and political issues) give the book a lot of depth. Many people simply don't know the scale of destruction that results when a major economic decline happens since they don't happen often. Widespread bank failures are a good example.

There are a couple of rules to keep in mind when reading meltdown books. (1) Value the analysis, but ignore the timing. Economic expansions can go on for 10-20 years longer than people think they will. Like other books, The Great Reckoning also got the timing wrong. The book predicts that interest payments would consume 100% of GDP by 2015. (2) Don't become a perma-bear. Don't act until you see the warning signs. I know someone who liquidated his equity mutual funds when the Dow rose from 3,000 to 4,000 because he thought the market was going to "come crashing down". Later on (like 15 years later), he was undoubtedly (and unjustifiably) patting himself on the back after the Dow Jones fell from 14,000 to 8,000.

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