John Hussman: Timothy Geithner Meets Vladimir Lenin

by: John Hussman

Excerpt from the Hussman Funds' Weekly Market Comment (1/4/10):

“The best way to destroy the capitalist system is to debauch the currency.”

Vladimir Lenin, leader of the 1917 Russian Revolution

Last week, while Congress and the nation were preoccupied with the holidays, the Treasury made a Christmas eve announcement that it would be providing Fannie Mae and Freddie Mac unlimited financial support for the next three years.


What will be a game-changer is if Congress fails to recognize that the Treasury's action is at minimum an evasion, and possibly a usurpation of powers that are enumerated to Congress alone. If Congress does not forcefully defend that prerogative – even if it ultimately ends up voting for exactly the same policy – it will have relinquished the power of fiscal policymaking into the hands of unelected bureaucrats. This is real public money that is being spent to make bad mortgage loans whole. It may not appear to be costly at present, since risk-averse individuals conscious of credit risks, and foreign countries running massive trade surpluses, are still willing to accumulate the Treasury securities being issued, with no apparent impact. But ultimately, those securities will either stand as claims on our future national production, or they will be inflated away. Either the Treasury securities will retain value, so that holders such as China get to use them to acquire our productive assets in the future, while we ultimately tax ourselves in order to pay off that debt, or we must dilute the ability of those Treasuries to claim real goods and services, which is another way of saying we inflate away the debt.


Every dollar of bad mortgage debt that should have been written off is now enshrined as two dollars of government-backed debt. One dollar as the original debt, which will now be made whole, and one dollar of new Treasury securities, which must be issued to make that original debt whole. Accordingly, the holders of both securities will have claims against our national assets and future wealth. A similar two-for-one obligation holds true for bailed-out bank losses.


What we also know is that we can expect far greater issuance of government liabilities due to the coupled effects of bailouts and shortfalls in tax revenues, which will ultimately erode the value of those liabilities. The extent to which it erodes the value of the U.S. dollar relative to other currencies depends on the extent to which other governments match our own in terms of debt issuance and money creation.

What is clearer is that the value of those liabilities is likely to sharply decay over the next decade or so in terms of real goods and services. I continue to view a near doubling of the consumer price index over the coming decade as a reasonable expectation, though again, much of that pressure is likely to occur beginning several years out, due to the continued concern about credit defaults, which tends to mute monetary velocity. Emphatically, slack resources (such as labor and manufacturing capacity) are not a good argument for lack of inflation. It is only an argument that the prices claimed by those slack resources will rise slower than the general price level. I expect that we will tend to be buyers of commodities and hard, non-slack real assets on weakness, but this represents a longer-term view, not a near term forecast.