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The 'Aftershock Economy'

And according to the authors, the series isn’t over yet; the current lull is just a mid-season break. There are two more bloated bubbles still floating our economy in grotesque cartoon-defiance of gravity. These are the biggest and baddest bubbles of all: the dollar bubble and the enormous U.S. government debt bubble.

As the authors tell us, it is supply and demand that determines the price of the U.S. dollar compared to other currencies. In the decades after World War II, demand for the dollar was strong, and its supply was managed with relative prudence. But beginning in the early 1980s, the U.S. government began to dramatically increase the country’s debt burden. That debt was financed in large part by foreign investment, which flows into the United States in the form of dollar-denominated asset purchases. Now, almost thirty years later, the U.S. government continues to live on credit, and total U.S. debt is expected to reach $20 trillion by 2015.

The trouble for the U.S. economy is that the value of the assets being purchased by foreign investors is now being stabilized -- propped up -- by the cumulative inflow of that same foreign capital.

The collapse of the housing and stock markets forced consumers into a corner, clinging to their jobs and managing their personal debts by cutting back on discretionary spending. The Federal Reserve -- fearing the worst -- escaped the immediate catastrophe by printing money -- $1.7 trillion in 2009 alone.

This sudden increase in the supply of money -- and the inflationary pressure it portends -- functions to decrease the overall value of the U.S. dollar, thus making it less attractive to foreign investors.

“One way to look at this is to think of the United States as a big mutual fund,” the authors write. “When our performance is good, foreign investors throw their money at us, but when performance is not so good, they throw less money at us. And when performance becomes bad enough, they are going to want to take their money and go home.

“Based on our analysis, we foresee foreign investors beginning to significantly lose confidence in their U.S. holdings sometime in 2010 to 2011, and increasing over time, with the likelihood of a mass exit by 2012 to 2014 becoming very high.”

The amount of debt held by investors, which include China and other countries as well as individuals and pension funds, will rise to an estimated $9.1 trillion this year from $7.5 trillion last year.  When the dollar implodes, the U.S. government debt -- now at a staggering $13 trillion and set to exceed GDP by 2012 -- will surely be called-in by its owners.

And with the news that Social Security is now running a deficit this year -- at least five years sooner than economists had expected -- these last two epochal bubbles might burst far sooner than anyone thinks.