2012 As 1980: We've Been Here Before

Over at Zero Hedge we get a gaming out of the worst-case scenario in 2011 and 2012: the inflation of the Carter years leading to the GOP taking back everything in two years.   How bad is it?  President Sarah Palin bad.

The $887 billion stimulus wad has now been mostly spent or committed, delivering us with a couple of quarters of decent growth. The effect was no doubt help by the Fed’s ZIRP strategy and massive housing subsidies. The “V” is in. Once the effects of this spendfest wear off, we slip back into a deep recession, setting up the classic “W.” Unemployment stays stick in the high nines, and around 18% when you throw in discouraged job seekers, jobless college graduates, and those with expired unemployment benefits, and the underemployed. This afflicted Franklin D. Roosevelt in the thirties.

So Congress passes another $1 trillion reflationary budget. Everybody gets wonderful new mass transit upgrades, alternative energy infrastructure, smart grids, and bridges to nowhere. But with $2 trillion in extra spending packed into two years, inflation really takes off. The bond market collapses, as China and Japan boycott the Treasury auctions. The dollar tanks big time, gold breaks $2,300, and silver explodes to $50. Ben Bernanke has no choice but to engineer an interest rate spike to dampen inflationary fires and rescue the dollar, taking the Fed funds rate up to a Volkeresque 18%. %. The stock market crashes, taking the S&P well below the 666 low we saw in March. Housing, having never recovered, drops by half again, wiping out more bank equity, and forcing the Treasury to launch TARP II.

The bad news accelerates into the 2012 election year. Obama is burned in effigy; Sarah Palin is elected president on a “Tea Party” platform, and immediately sets to undoing all of his work. Republicans, reinvigorated by new leadership, and energized by a failing economy, retake both houses of congress. National health care is shut down as a wasteful socialist mistake, boondoggle subsidies for alternative energy are eliminated, and the savings are used to justify huge tax cuts for high income earners. We invade Iran, and crude hits $500.

If you’re over 50, and all of this sounds vaguely familiar, it’s because we’ve been through it all before. Remember Jimmy Carter? Remember the “misery index,” the unemployment rate plus the inflation rate, which hit 30, and catapulted Ronald Reagan into an eight year presidency? A replay is not exactly a low probability scenario. This is why virtually every category of risk asset has melted down in the last two weeks. It’s also why the investing public is gun shy, favoring bonds over stocks by a ten to one margin. Are the equity markets pricing in these possibilities? Not a chance.

The risk of economic Armageddon is still out there. Personally, I give it a 50:50 chance. Batten the hatches, and please pass the Xanax.

Even a coin flip chance of this happening should scare the utter crap out of everyone.  What's worse, this doesn't begin to price in the true costs of the Deepwater horizon oil spill, either.  Certainly it's a worst-case scenario.  But it's important to remember what's at stake here in the economy, the Fed, and in the 2010 elections to boot.