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The Flutter of a Butterfly's Wings?   (September 23, 2005)

NOAA Storm Tracker website The cliche is that the flutter of a butterfly's wings may spawn a hurricane. Perhaps, but then what does a hurricane spawn?
The cliche is based on chaos theory, in which changing the initial state of a system by a small amount can cause enormous changes in the eventual outcome.

So who can say with certainty what the outcome of Katrina and Rita will be in six months? No one, of course, but we can look at the initial state of the system, in this case, the U.S. economy, and draw some conclusions from its current precariousness.

The Economist has assembled an in-depth look at the growing imbalances in the global economy. To quote from one of the essays:

"It is commonly argued in America that if the housing bubble were to burst, and falling house prices threatened to choke consumer spending, the Fed would slash interest rates to prop up the economy, as it did after the stockmarket bubble popped in 2001-02. But then inflation was falling. Today, with inflation rising, the Fed would no longer have that option. If the economy hits trouble, investors and homebuyers should not expect to be bailed out again."
Take a look at the chart, and note how our nation's household savings rate has fallen below zero (the lefthand scale) even as our net worth (righthand scale) has climbed along with housing values. The trap is all too visible here: household net worth dropped precipitously after the 2000 dot-com stock market meltdown, but then shot back up as housing prices skyrocketed. Now that peak has topped out and net worth is starting to decline as Americans pull vast amounts of cash from what they now consider their "savings account," their house.

Lest you reckon I am exaggerating, then feast your eyes on the next chart, which reveals our household debt payments are rising to unsustainable levels. As the quote suggests, the Federal Reserve will not be able to pump up housing values next time around because now we have inflation to worry about.

As a result, we can safely predict three effects of Katrina and Rita: inflation caused by rising transportation and energy costs will filter through the supply chain, raising prices of everything, gasoline-pinched consumers will have a harder time paying their debts or acquiring new debt, and interest rates will have to rise, not drop, to combat the hydra-headed monster of inflation.

Put more simply: the cash machine called the American house will jam, interest rates will rise, making debt ever more costly, and inflation and energy will take a bigger piece of Americans' dwindling paychecks. If you consider the charts and reports objectively, there are no other possible conclusions.

Thus do the butterfly wings flutter.

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copyright © 2005 Charles Hugh Smith. All rights reserved in all media.

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