What if Everything Goes to Shit

This post is pure speculation, it is not a prediction of what I think will happen, but is my attempt to think through a worst case scenario.

If all of the attempts to revive the economy fail and we continue sinking into a deeper depression for the foreseeable future at some point politics will trump economics as the primary concern. The US is blessed with an extremely resilient political system; through civil wars, depressions, world wars and countless other trials our system has continued uninterrupted without so much as a delayed election. Most countries aren't so fortunate. A prolonged depression would have profound geopolitical consequences.

Let's start with Europe: I doubt the Euro would survive a depression. The worse the economy becomes the greater the pressure to devalue the currency will be in hard hit countries such as Spain. Populist pressure will force governments in countries such as Spain, Portugal, Greece, Italy and Ireland to drop the Euro. As the Euro zone retracts, Euro nationalism will emerge as an important force. Pressure to punish the defecting nations will create strong tensions between the remaining Euro countries and the rest of Europe.

In Eastern Europe, the door to further Integration will slam shut. Many countries will look to strengthen ties with Russia as further integration with a crumbling EU will seem less probable and less appealing. Old communist parties will emerge from the dustbin of history on a wave of populist support. In the Balkans tensions between Serbs, Croats and Albanians will return with a vengeance. Without the prospect of EU membership as an inducement to sound moderate policies, extreme nationalists will gain power.

In India, a severe downturn will destroy the moderate Congress led government of Monmohan Singh. My prediction is that the Hindu Nationalist BJP and the Communist party, the second and third largest parties in parliament, will join forces to promote an extremist agenda. Ethnic violence will escalate and tensions with Pakistan will emerge into a full scale war. Millions of members of the emerging middle class will find themselves thrust back into poverty.

The Middle East will get Ugly.

In Latin America, I predict a sharp Backlash against the moderate pro-growth goverments in Brazil, Colombia and Mexico. More countries will align themselves with Hugo Chavez in a defiantly anti-american and anti-capitalist pose. Mexico may feel the worst of it. The government is barely hanging on against the drug cartels today. In a severe depression, it is not hard to imagine the government outright failing.

So how will it all end? Much like the last depression, geopolitics will force the remaining democratic governments to enact the necessary fiscal stimulus. In other words war. If the various drug cartels succeed in toppling the Mexican Government we would be forced to act. America cannot tolerate an anarchistic failed state directly to our South. A full scale land invasion of Mexico combined with increased military spending around the world may be enough to reignite aggregate demand.

If the economy continues to contract at its stunning pace, one way or another fiscal stimulus will have to pull us out. Will it be in the form of productive investment in infrastructure health and education, or will it be in the form of devastating wars in Mexico, the Balkans, the Middle East and South Asia.