"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.' There has never been any attempt to abandon the credit expansion. Indeed any crisis was simply an excuse to open the monetary spigots. This, then, is the beginning of the total catastrophe of the American dollar, indeed the entire world monetary and financial structure."
The more I read, the more appalled I become. I am so terrified of what's coming, but I look around at the general level of ignorance and hubris in the United States today, and I can’t help but thinking, yet again, that we deserve everything we’re going to get. I watch CNBC, FBN, and Bloomberg all day. I see "experts" and "specialists" and "veterans" recycle the same tired messages over, and over, and over. Politicians and economists defend quantitative easing and the Obama administration’s reckless policies. It’s like a nightmare I can’t wake up from.
I've been a victim of false optimism many times. It's an easy trap to fall into: you bet on an outcome, and you convince yourself that everything you see points to a positive result -- even in the face of changing premises. That, however, is dogmatism; it's poisonous, and it's the reason I spend so much time researching the issues facing us. I want clarity, and that requires enduring pointed criticism. But in the last year, the counterarguments haven’t been strong enough to convince me I’m wrong.
Here are some of the thoughts I’ve had this week:
1. Who really believes that wars and natural disasters are good for the economy? When did we become so stupid that we actually started to believe destroying things and killing people are beneficial? It's like saying burning down your own house will give you prosperity. Or imagine trying to get cancer so you can be healthier? Such notions couldn’t be more ridiculous, and yet this is exactly the type of mindset that socialism and Keynesianism require in order to exist. And – unbelievably -- the vast majority of people in the world subscribe to these absurdities.
In response to such thinking, the French economist Frédéric Bastiat created the Parable of the Broken Window – a scenario which demonstrates how preposterous it is to break windows in order to create jobs and encourage the circulation of money.
How can anyone possibly believe such nonsense is actually going to help improve things?
2. Massive Government programs -- like Social Security, Medicare, Medicaid, and farm subsidies, just to name a few in the innumerable list of value-destroying components in our economy -- are already insolvent. Now the Obama administration wants to implement socialized medicine on a massive scale. It’s the most farcical move, at precisely the wrong moment.
The government shouldn’t be creating more programs; it should be shutting them down! But that’s not what is happening, and we the people are allowing our elected officials to march us directly into insolvency. It’s a simple, exceedingly obvious transaction: politicians offer voters cash, and voters give politicians votes. It is the bane of democracy.
What most voters don't realize, however, is that the government knows all this, and it will certainly perpetuate these programs the quietest way possible: through inflation -- meaning it will print money and maintain easy credit, while increasing pay-outs at a much lower rate. This is just one more reason why I believe large-scale inflationary price-increases are on the way.
3. There has been a lot of talk about the role of mal-investment -- in the context of the economic collapse we’re enduring. But nobody’s getting it! When the government creates cheap, or even free money (even though it's neither "cheap" nor "free"), it encourages people to invest. And because people are investing in things they wouldn't normally consider, the investments they make are almost certain to be bad. Indeed, in this scenario, everyone in the economy dumps money into assets and services, after which, the prices of these assets and services become artificially expensive. Thus, in this scenario, if you spend money on anything (a home, a car, a computer, tuition, or medical care), it's impossible not to pay too much -- relatively speaking. Artificial demand creates artificial prices.
What results is the classic boom-bust scenario. And what does the government do when the inevitable bust occurs? It prints more "cheap" or "free" money, encouraging yet more mal-investment! And every time the process repeats, it gets more difficult to perpetuate. This cycle has destroyed empires for millennia -- including the Roman, British, and Soviet versions thereof. Guess who is next on the list?
Now you’re going to tell me about the low velocity of money – that currency isn’t getting into the economy, because banks aren’t lending. I’m going to reiterate my position on this subject: all that cash and credit is like an ocean pressing against a weak dam, and when it bursts, the tidal wave is going to drive the velocity of money toward the speed of light. The result? Price increases on a scale that developed economies across the globe have never seen. It’s going to be unprecedented. And it’s going to be catastrophic.
4. In 1971, Richard Nixon took the United States off the gold standard. That means the dollar is now fiat -- that is to say, it is backed by nothing more tangible than the "full faith and credit" of the United States government. One of the dangers of using fiat money is that the currency is more vulnerable to fluctuations in value. If the U.S. Treasury prints more dollars, the currency will decline in value, relative to everything else.
So, in times like these, if more currency and credit means inevitable price increases -- and it does -- then by extension, the economy will experience rising interest rates: there is no way to encourage people to buy debt if their rate of return isn’t outpacing inflationary price increases. And since bond prices move inversely to their yields – that is to say, bond prices go up, yields go down, and vice versa – then as inflation drives prices higher, bond yields will rise with them. As such, bond prices will fall.
If the dollar were backed by gold, it would create stability -- thereby preventing some of the volatility that might lead to the scenario I just laid out. In 1931, during the depths of the Great Depression, the dollar was pegged to gold, redeemable at a fixed price. And yet in that year -- when long-term bond prices were soaring, and their yields reached unprecedented lows (just as they have now) -- their prices suddenly turned.
For many months, bond prices subsequently fell, and yields rose. With a relatively stable currency (backed by gold, as the dollar was), this was less prone to happen, so why did it? Yields rose because the Fed and the Treasury were flooding markets with debt and currency (just like they are now). This is, by definition, inflation. And that pushed interest rates higher.
The important thing to note is that, even if a currency is backed by gold, printing vast quantities is still inflationary. It's like issuing more shares of stock; it’s dilutive, and redemptions only put more pressure on the government's supply of bullion. But today, the dollar is not backed by gold, so its stability is much more questionable. As governments around the world print more money and sell more debt, there are no mechanisms to stem an upward push in interest rates, as well as yields. Given this context, the Treasury bubble only looks that much more precarious. You might want to think about shorting long-term Treasuries. Or use the double-short ETF, TBT, like I do. It's a no-brainer.
5. I wrote an article not long ago about the true definition of inflation. I also mentioned it above, and I want to expound upon it again here: most people believe inflation is defined as rising prices, but that is incorrect. Inflation, by definition, is an increase in the supply of currency and credit; any subsequent rise in prices result from inflation. Likewise, the definition of deflation is a decrease in the supply of currency and credit, and any subsequent decrease in prices result from deflation.
This distinction may seem subtle, and perhaps even tediously academic, but it's also very important. The government and the media are trying to make you believe that we are in a deflationary environment, and that simply is not true. The government is printing prodigious sums of currency right now, and that, as I pointed out, is inflationary.
I won't try to deny that many asset classes are falling, or have been falling for some time. But these prices aren't falling because of deflation. No, rather they are falling in spite of inflation. As I've said so many times, the U.S. has an unprecedented amount of debt, and the destruction of prices we're seeing right now has been a result of massive deleveraging -- that is, people and institutions selling assets in order to raise cash. In the meantime, the Fed is printing currency on a scale never seen.
So enjoy falling prices now, because they aren't going to last. We are in an inflationary hurricane; rising prices are coming -- and when they do, they will come hard and fast. Add to that an unemployment rate we haven’t seen in decades, and you begin to see how much we’re facing. And just when the government should be cutting spending and limiting printing and credit, it is doing just the opposite.
In anticipation of imminent inflationary price increases, as I said earlier, I think shorting long-term U.S. Treasuries (TBT) is a no-lose play at this point; no matter what happens, their prices are going to collapse, and their yields are going much higher. I also still believe many commodities can outpace inevitable price explosions, like agriculture (DBA), metals (DBP), as well as gold, silver, and platinum. I'm also still bullish on oil (UCO). Here's a technical analysis video of oil that convinces me the recent correction is short term:
In several articles, I’ve mentioned that I believe stocks will go higher in the near- and longer-term, but I don’t think they’ll outpace inflationary price increases. I believe the current economic crisis has now permanently diverged from the crisis in the 1930s, in that all asset-classes are soon going to turn abruptly. What will make this environment much more dangerous than previous economic catastrophes is that people will wrongly see increasing asset prices as a good indicator that conditions are improving. But conditions, for the most part, won’t be improving, because increases in the prices of most assets – including the stock market – won’t outpace collapsing global currencies.
A lot of analysis lately has optimistically and fatuously pointed to a bullish stock market. I have been a value investor and a portfolio manager for almost twenty years, but I have no faith in stocks right now, and I think they should be avoided. Here's a technical analysis video of the S&P 500 that bears out a lot of my fear:
Here’s another thing to remember: when the Dow Jones Industrial Average first crossed 10,000, gold was at about $250 an ounce. Today (ten years later), the Dow is hovering in a trading range between 10,000 and 10,500, and gold is over $1100 an ounce. What does this mean? Well, precious metals have always been the most accurate harbingers of coming inflationary price increases. I think this interesting piece of information speaks for itself.
I’m going to leave you with this thought: the world is in a lot of trouble right now, and most people don’t even know it. You may be surprised to hear me say this, but our greatest enemies aren’t inflation and unemployment. No, the most alarming issues before us are ignorance and apathy. So as you read this think about something… are you scared?
If you’re not, you may want to return to the beginning of this article and read it again.
Disclosures: Paco is long TBT, UCO, and gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.