Prepare to Reduce Your Standard of Living—Now!

Could American society even survive a 1930s-style crash? America is not the same nation that faced the Great Depression: Today we have much further to fall. The coming depression will arrive suddenly and be far more excruciating than most people imagine—but when it finally ends, there will be an opportunity for a new beginning!

My grandparents lived through the Great Depression. And you can see how that terrible time left its mark on that generation. Nothing is allowed to go to waste. Every last bit of food should be eaten. The buttons off of old clothing should be saved. Old jeans can be used to make patches to cover the holes in the knees of other work clothes. I even remember a proudly displayed area rug woven out of old rags.

And two things my grandparents made sure to teach us grandchildren were to be grateful for all the things we have, and to plan for tomorrow. “We might have money now,” grandma would say, “but it could disappear overnight.” I have to admit that despite their warnings, saving for a “rainy day” was a bit ethereal, growing up as I did during the economic apex in America’s history.

My grandparents, deeply changed by the Great Depression, wanted to make sure their children and grandchildren would never have to go through the hard times they did. So they worked and saved and did everything they could to get their children and grandchildren started off on the right foundation.

Unfortunately, the generation that survived the last Great Depression is mostly gone, and the lessons learned largely forgotten. America has repeated the financial mistakes of the past—and with a hundred times the leverage.

If debt and speculation were the big causes of the first Great Depression, what we are facing today is infinitely larger. Forget subprime, forget the credit crunch. What is imploding the financial system is the unwinding of the biggest pile of speculation and greed ever. And it is largely contained within what is known as the derivatives market.

If you haven’t heard of derivatives, don’t worry. Just like subprime was a little-known word two years ago, derivatives will probably be the next dirty word to hit big media in the months and years ahead. Derivatives include things like futures, forwards, options and swaps.

The important thing to know is that these financial products that were originally designed to help manage risk, morphed into an unregulated “investment” market where hedge funds and big banks borrowed incredibly vast amounts of money to wage casino-royale-style leveraged bets on the movement of the different types of underlying assets, such as commodities, stocks, residential mortgages, commercial real estate loans, bonds, interest rates, exchange rates, the rate of inflation, or even weather conditions. If you can name it, they probably bet on it.

And making matters worse, the derivatives market ended up being dominated by just a few big Wall Street houses. So even if derivatives reduced the risk or provided insurance for some individuals, they ended up concentrating risk at places like Bear Stearns, Lehman Brothers and aig.

Now, after years of massive profits, something went wrong. The housing market went into free fall. Home sales, prices, mortgage defaults, all crashed way beyond the predictions of mathematical models. The economy started retracting, the Federal Reserve began slashing interest rates, and currency exchange rates were thrown into chaos. Oil first shot up in value then plummeted, other commodities plunged in value, banks began to fail, and the whole derivatives market began acting like a giant black hole sucking money from the derivatives dealers—meaning those on Wall Street. And when banks like Lehman fail, it means that those on the other side of the derivatives trade don’t get paid. Thus, the worry over a domino-style wipe out.

To get an idea of the shear massiveness of this market of gambling, read my July 1 column, “Tower of Babel Economy.” The Bank for International Settlements says the nominal value of outstanding derivatives has reached a practically incomprehensible $1.28 quadrillion. Yes, you read that correctly—quadrillion! A quadrillion dollars is hard to wrap your mind around. It takes a thousand trillion to make a quadrillion. You can think of it as more than 92 times the value of all goods and services produced in America during 2007, or almost 20 times global gross domestic product.

Some analysts will tell you that only $62 trillion worth of that can be lost. But even if this amount is correct, $62 trillion is still enough to wipe out the world’s entire banking sector several times over.

Not only is this a distinct possibility, the wipe out is already in progress. Being on the wrong side of too many derivative trades is what took down aig. If you remember, aig was an insurance company that provided coverage for homes, cars, boats and the like, but their derivative exposure was so toxic that one small division within the institution brought the whole company down. And now that the federal government has nationalized the company, it is sucking down taxpayer money too. Three weeks after the taxpayers gave aig $85 billion, the insurer has burned through a whopping $70 billion. And guess what, the Federal Reserve recently announced it will forward another $37.2 billion to the company!

But taxpayers are only getting started with the bailouts. Now, three weeks after the Lehman failure, all the financial companies and investment funds that wrote credit default swaps (a type of derivative that was supposed to act like insurance policies) on Lehman Brothers’ debts are being called on to pay hundreds of billions of dollars in claims.

“There are billions of dollars in obligations,” said Eric R. Dinallo, the New York state insurance superintendent. “No one knows who owes this money, how much each counterparty owes, or whether any of these counterparties will now be in trouble themselves, with further potential problems for the financial markets.”

Be prepared for more bailouts, more banking dominoes may be about to go.

And that brings us back to the Great Depression.

When all the banks failed during the 1930s, it wasn’t just the fact that many people lost their savings that sent the country on an economic spiral. When banks failed, it also meant people and corporations couldn’t get loans nearly as easily. The remaining banks stopped lending and started conserving cash. This caused many companies that were formerly healthy, but had come to rely on loans to cover short term needs, to run into problems. Job losses soared, and unemployment hit 25 percent.

Are you prepared for an unemployment rate of 25 percent? Today, businesses are more reliant on borrowed money than ever before. If the current credit crunch continues to intensify, it won’t take much to shut down many companies.

Widespread job losses are on the way. With an economy slowing, and consumers retrenching and unable to borrow and spend, the outer edges of recession are already here.

If you still are not convinced that it’s about past time to put your house in order, consider the following headlines.

The next depression looms like a dark cloud over America. In April 2007, the Trumpet printed the article “The Coming Storm,” detailing the economic upheaval about to slam into America and warning readers to take action to prepare for the looming crisis. The storm has arrived. The difference with this coming depression is that America may be in a much worse position to face it. During the 1930s, people had savings, America was the world’s biggest lender, and the U.S. was a major producer. Today, all levels of society are saturated with debt, the federal government is the world’s biggest borrower, and America is a nation of superconsumers.

If you have delayed taking the painful but necessary steps to put your financial house in order, you still have a window of opportunity. You can begin by reading “Ending Your Financial Worries,” “The Man Who Couldn’t Afford To Tithe,” and “Get Out Of Credit Card Debt.”

Although America is facing an ugly economic future, and many people will be left financially destitute, the good news is that once all the speculation and fraud has been wiped out, eventually a new global economic system will arise. You can read about this soon-coming time of real prosperity in the booklet The Wonderful World Tomorrow—What It Will Be Like.