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The big news Friday was a 200,000 increase in non-farm payrolls. The unemployment rate actually declined in the face of new people entering into the job market, rather than people giving up on finding a job.
While this was welcome news, it was offset by the fact that wages were flat. Subtract consumer inflation, and wages actually fell in real terms. The situation is even worse if you properly weight energy and food inflation, which the Bureau of Labor Statistics doesn't. (We think food and energy inflation matters more than housing prices, since most people only buy a house once every decade or two whereas rising food and gasoline prices are a steady drain on the wallet.)
Nor do we think consumers will feel less pinched for some time. Not only will oil and food prices continue to rise, but we also see more inflationary pressure coming from China. China's five-year plan will see rural and lower-class incomes rise substantially. The country plans to lessen the gap between rich and poor in a big way (even though the inequalities in China are already less than in the U.S.). And China has proven quite good at realizing its plans.
This, of course, is not the way things are supposed to happen. Traditionally, inflation begins with the American worker demanding higher wages. Rising wages create an upward spiral in wages and prices, which we call inflation.
Today, the Chinese worker, not the American worker, is the driving force behind the inflation cycle. It is rising Chinese wages that will make consumer products more expensive in the US. Moreover, the Chinese worker will stay in charge as long as American consumer spending remains low and, consequently, so does U.S. growth. In turn, that will lead to a lower U.S. dollar and even higher inflation.
Our government could do something about this, if it were willing to tolerate inflation. We could try to support the American consumer and build new industries. Yes, we have high debt. And yes, that debt will continue to increase if our government starts investing in industry. On the other hand, debt will not start to shrink in any meaningful way unless tax revenues rise (so the government can eliminate its deficit). Austerity alone won't do it. And the only way for tax revenues to rise is if people in general start earning more money.
We're not trying to be political here. We just recognize that, to succeed, America must not put itself at a disadvantage compared to developing nations like China. We need new industries like alternative energy that will support growth.
Of course, raising salaries and benefits for workers would certainly be inflationary. But we face brutal choices in today's world. There is no perfect solution, but there may be one that involves less pain and sets the stage for the good times to return.
If we continue down the road which seems popular at the moment, that of fiscal discipline, we risk setting off a deflationary outcome in which consumer spending crashes, business starts to contract, and we get another recession.
The alternative is to let inflation out of the bag. The Fed would continue with QE2, followed by QE3, QE4, and however many other QEs it takes to put consumers on a strong footing. Inflation would certainly rise, but that would also let the government pay off its debts with dollars that are worth less. We don't quite know how this cycle would end, but we suspect it would leave the country in a better position to take advantage of the next big opportunity.
Let's look at these two scenarios – deflation and inflation – in a little detail, and consider how you might prosper regardless what happens.
We've had both these 'flations before. Deflation was the theme of the 1930s, while inflation was the theme of the 1970s. Which was worse depends entirely on who you are asking.
From the viewpoint of the average wage earner, the 1970s was the lesser of the two evils. Sure, government spending was high then and commodity prices rose, but the economy still grew. Jobs were available. The system retained enough flexibility by the end of the decade that Fed Chairman Volker was able to slay inflation in the early 1980s. The economy was strong enough to tolerate his engineered recession.
By contrast, wage earners in the 1930s had a terrible time. Unemployment reached devastating levels. The average family struggled to survive. Starvation actually became a serious problem in the U.S.
However, if we switch our viewpoint to that of a typical bank executive, our understanding of these two decades changes greatly. The 1970s were a catastrophe for banks and for the very wealthy, since inflation eroded the value of most financial assets. Stocks, bonds, and cash lost value in real terms. It was also a very bad decade for business, since it drove up costs.
On the other hand, the 1930s were a great time to be rich. Stocks made decent gains. Bonds went on a tear, allowing investors to have their cake and eat it too. Not only were bonds safer than stocks, but they produced bigger returns. Cash also gained value due to deflation.
If you are reading our missives today in the 2010s, our guess is that you are either better off financially than the average person, or you at least hope to be. So you might assume that deflation is the best choice, since it will help your portfolio.
That's not necessarily true. First of all, you can make great returns in an inflationary environment if you buy the right investments (more on this in a second). Secondly, the other problem with the deflation of the 1930s is that it left the government with very little flexibility. Despite all the government spending after 1937, the American economy remained on its knees. The thing that really got it moving again was the effort to wage World War 2. The sacrifices that war required and the massive industrialization that took place led to a boom in prosperity that benefited our country for more than a generation.
Today, we are facing the worst of all worlds. We seem to be favoring policies which will keep the consumer under stress and feed the forces of consumer deflation (ironically, through higher, otherwise inflationary commodity prices).
Our biggest worry is how we will pull ourselves out of this mess in time for the next decade. We have no plans to build any new industries, which is the only way the next generation will get ahead.
By contrast, the Chinese are building like crazy. They are rolling out with alternative energies, including nuclear. (They are promoting the idea of nuclear by saying they can create pebble bed reactors which will be much safer. How true that is, we don't know.)
At any rate, China will not shrink at anything that will promote growth. It knows it has no choice. America, on the other hand, still thinks that growth is inevitable, so it is failing to nurture it properly.
Now for today's other important message: how to make money given all the above.
Whether we get inflation or deflation, you can make money and secure your financial future by owning precious metals. In the 1930s, Homestake Mining, the leading gold miner, rose 8X higher from the market top in 1929 to 1938, proving that gold is a great investment during deflation. Gold did even better in the 1970s, making real gains of around 25% a year. So no matter what scenario we get this decade, you will be much better off in the end if you invest in precious metals.
Sure, precious metals are not the only investments we recommend, nor the only assets that could do well. But they are your safest bet. And the easiest way to buy precious metals is through the ETFs the SPDR Gold Trust (NYSEARCA:GLD) and iShares Silver Trust (NYSEARCA:SLV).
Admittedly, we are a little worried about SLV, simply because silver has been in an exponential uptrend for some time. A little correction would actually be welcome, though it might not come. We won't try to predict how high silver prices could climb this decade, but $100-$140 would not look outrageous, given the fundamentals.
Such a high price might not be good news for SLV. Just as, during the Depression, President Roosevelt made it illegal for citizens to own gold, there may come a time when American investors are barred from owning silver bullion. But just as in the 1930s, silver stocks should continue to do well. With that in mind, stick with well-situated silver miners such as, Silver Standard Resources (NASDAQ:SSRI), Tahoe Resources, and Pan American Silver (NASDAQ:PAAS).
We know some of you were surprised when we dropped Silver Wheaton. Just to be clear, we think this stock will participate in silver's gains. But we think it will trail behind our recommended miners and could be subject to deeper corrections. So we suggest you stick with our other picks.
With gold, you have many more choices. We don't think the government will ban gold ownership again, since gold is not a critical industrial metal. As long as you own GLD, feel free to add good gold shares. The best we know of is NovaGold (NYSEMKT:NG) which is also a great copper play.
Disclosure: Leeb Group, its officers, directors, shareholders, employees and affiliated entities and/or clients of such affiliated entities may currently maintain direct or indirect ownership positions in financial instruments (i.e., stocks, bonds, options, warrants, etc.) of companies or entities whose underlying exposure is in the companies mentioned in this article.