The Great Depression Online

Great Depression Online Archive Issue:

Butterfly Economics

Great Depression Online
Long Beach, CA
August 21, 2009

Inside This Issue You Will Discover…

*** The Butterfly Effect
*** The Greenback Effect
*** Butterfly Economics
*** And More

The Butterfly Effect

The world’s a dynamic place.  What’s more, it’s highly sensitive to seemingly insignificant disparities.  Quantum sized discrepancies can perpetuate exponentially until the world no longer resembles itself.

Does the flap of a butterfly’s wings in Brazil set off a tornado in Texas?

That question was the title of a 1972 presentation by Edward Lorenz.  While it may seem a tad hyperbolic, it was rhetorically asked to make the point that, theoretically, it’s possible. 

~~~~~~The Worst is Not Over~~~~~~

Why are the truly big economic catastrophes so “big”?  Put simply, it’s that such a small number of people prepare themselves beforehand.  Think about 2008 and you'll realize it’s true.  What’s more, once you read Bob Prechter’s recent 10-page Elliott Wave Theorist, you’ll see that even fewer people will be ready for the soon-approaching worst leg down of the unfolding depression.  Download it free.


Sometime around 1961, Lorenz was tinkering around with a numerical computer weather prediction model when, as a shortcut, he entered 0.506 instead of 0.506127.  The result, he found, was dramatically different.  And because the input difference was so seemingly insignificant…it was likened that the flap of a butterfly’s wings could change the weather forever.

The butterfly effect is not limited to just the physical world…the social world can be stood up on end for some seemingly insignificant reason too…

If Gavrilo Princip hadn’t shot the Archduke Franz Ferdinand of Austria on June 28, 1914, would there not have been a World War I?  With no World War I, could there have been a World War II?

What a different world we’d be living in if Europe hadn’t destroyed itself twice during the first half of the 20th century.  Would it be a better place?  Perhaps.  We’ll never know.  But we’ll surmise the world geopolitical dynamic would hardly resemble what we know today. 

The Greenback Effect

The butterfly effect also occurs within markets and economies.

On Monday, Warren Buffett – the richest man in the world – had an Op-Ed published in the New York Times.  It was titled The Greenback Effect and is quoted here…

“In nature, every action has consequences, a phenomenon called the butterfly effect.  These consequences, moreover, are not necessarily proportional.  For example, doubling the carbon dioxide we belch into the atmosphere may far more than double the subsequent problems for society.  Realizing this, the world properly worries about greenhouse emissions.

“The butterfly effect reaches into the financial world as well.  Here, the United States is spewing a potentially damaging substance into our economy — greenback emissions.

“The United States economy is now out of the emergency room and appears to be on a slow path to recovery.  But enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects.  For now, most of those effects are invisible and could indeed remain latent for a long time.  Still, their threat may be as ominous as that posed by the financial crisis itself.

“To understand this threat, we need to look at where we stand historically.  If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 percent of gross domestic product.  This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record.  In dollars, that equates to a staggering $1.8 trillion.  Fiscally, we are in uncharted territory.

“An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money.  Let’s look at the prospects for each individually — and in combination.

“The current account deficit — dollars that we force-feed to the rest of the world and that must then be invested — will be $400 billion or so this year.  Assume, in a relatively benign scenario, that all of this is directed by the recipients — China leads the list — to purchases of United States debt.  Never mind that this all-Treasuries allocation is no sure thing: some countries may decide that purchasing American stocks, real estate or entire companies makes more sense than soaking up dollar-denominated bonds. Rumblings to that effect have recently increased.

“Then take the second element of the scenario — borrowing from our own citizens.  Assume that Americans save $500 billion, far above what they’ve saved recently but perhaps consistent with the changing national mood.  Finally, assume that these citizens opt to put all their savings into United States Treasuries (partly through intermediaries like banks).

“Even with these heroic assumptions, the Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing.  Washington’s printing presses will need to work overtime.”

Butterfly Economics

The more there is of something…the less valuable it is.  It’s a simple supply and demand relationship.  Yet as detailed by Buffett, more than half of this years budget shortfall will be funded by money created out of thin air. 

All those extra dollars are bound to have consequences.  Most obviously, they’ll water down the dollar’s value like ice cubes in a warm beer.  In fact, it’s already happening…

The Dollar Index – a measurement of the dollar’s value against a basket of currencies – has fallen 12 percent over the last 5-months. 

It’s a highly dynamic and highly sensitive situation, you see.

China, the world’s largest dollar holder, has over $2 trillion in dollar reserves.  A 12 percent drop in the dollar has resulted in a relative loss of wealth of $240 billion.  Who knows?  Maybe with Washington’s printing press working overtime, they’re getting a little nervous their reserves will be watered down even more. 

Something seemingly insignificant could have a butterfly effect…resulting in a cascade of rash decisions. 

For example, a pension fund in Germany drops some dollars on the market for no reason but to raise some money in anticipation of a wave of new retirees set to come under its payroll by the end of the year.  That same week a Saudi Prince sells some of his petrodollars to buy a fleet of new private jets.

Fearing a global route on the dollar has commenced China hits the panic button…and a tsunami of $2 trillion dollars crashes on the foreign exchange market.  Who would buy them? 

By the time the sun rose in New York…they’d be worthless.


M.N. Gordon
Great Depression Online

P.S.  Bob Prechter, over at Elliot Wave International, is giving away a free download of his Elliot Wave Theorist.  In this issue, Bob gives a warning he’s never had to include in 30 years of publishing – namely, that the doors to financial safety are closing all over the world.  There are but a few opportunities left and little time to take them.  Even as this happens, the terrible irony is that so many people believe the conventional wisdom, which claims “the worst is over.”  It’s not too late, but the doors really are closing shut.  Learn what you need to know now.  It’s not too late.


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