Today, many prominent economists (Nouriel Roubini, David Rosenberg and Paul Krugman) and fund managers (Bill Gross and Jeremy Grantham) are forecasting deflation and according to these folks, a deflationary contraction is now 'baked in the cake'. In fact, these deflationists are extremely worried about the ongoing private sector debt deleveraging in the developed world and they are also concerned about the lack of aggregate demand in the industrialized nations. Bearing in mind these two factors, these prominent people believe that deflation is now almost guaranteed and inflation is out of the question.
On the other end of the spectrum, and in stark contrast to the deflationist camp, many prominent market participants (Paul Tudor Jones, John Paulson, Jim Rogers, Marc Faber and Peter Schiff) are now warning about high inflation or even hyperinflation. According to these people, the large fiscal deficits and massive debt overhang almost guarantee runaway inflation.
It goes without saying that such conflicting views are extremely strange when you consider that all these highly experienced and successful people are reviewing the same economic data!
However everyone is entitled to their opinion but as far as this article is concerned, deflation is an urban myth and the global economy will have to contend with very high inflation.
It is a widely held belief that inflation is always a monetary phenomenon and willing policymakers have the ability to create inflation. Now, before going any further, I want to make it clear that inflation is an increase in the supply of money and debt. Conversely, deflation is a decrease in the supply of money and debt. Furthermore, it is critical to understand that an increase in the general price level is a consequence of inflation and a decrease in the general price level is a consequence of deflation. Most importantly, despite what you may hear elsewhere, you should keep in mind that a booming economy (operating at maximum capacity) is not a pre-requisite for inflation.
If you reside in the deflation camp and believe that inflation cannot occur in a weak economic environment, you need to visit Zimbabwe and meet Mr. Mugabe who will explain how you can create hyperinflation at a time when a nation is facing an economic depression! Whether you like it or not, Zimbabwe's hyperinflationary saga clearly shows that despite a huge output gap, surging unemployment, and a bankrupt economy, reckless policymakers can succeed in creating massive inflation.
The economies of the developed world are indeed struggling and will probably remain weak for several years; and the aggregate demand in these troubled economies will stay well below the available capacity (output gap).
However, contrary to the deflation camp, don’t underestimate the money creation abilities of the central banks. Accordingly, in order to avoid sovereign defaults in the near term, the Federal Reserve and the European Central Bank will create unprecedented inflation.
Already, short term interest rates in the US and in Europe are at extremely low levels and real short term interest rates are negative. If such a loose monetary policy fails to create inflation, you can bet your bottom dollar that these central banks will unleash even more rounds of Quantitative Easing. Needless to say, such reckless monetary inflation will dilute the existing money supply even further and reduce the purchasing power of money.
Now let’s take a quick look at the private sector.
You may recall that after the credit bubble burst two year ago, commercial bank credit in the US started to contract. After all, this debt repayment by the private sector was a logical response to the crisis and for 17 months, commercial bank credit declined by roughly US $700B. In fact, it was this private sector debt contraction which prompted many economists and investors to enter the deflation camp.
Even though commercial bank credit in the US contracted between October 2008 and March 2010, during that period, America's federal debt went through the roof! Ironically, during the time frame when American households and corporations were tightening their belts, the US Treasury borrowed almost US$2 trillion; thereby stopping deflation in its track. The truth is that at no point during the recession did total debt (private sector plus federal) in the US contract, so deflation did not occur. Now, it is conceivable that the private sector in the US may abruptly start repaying its debt again. However, if such a debt contraction occurs, Mr. Bernanke will create money like there is no tomorrow.
Today, America's total liabilities (including Social Security, Medicare and Medicaid) are around 800% of GDP and federal debt has climbed to be above 90% of GDP. Given the fact that deflation will increase the real value of this debt, you do not have to be a brain surgeon to figure out that before the US government declares bankruptcy, it will desperately try and inflate its way out of trouble. By unleashing another stimulus, Mr. Obama's administration will try and maintain nominal GDP growth, so that nominal incomes and tax receipts are sufficient to service the outstanding debt.
It is interesting to observe that in order to fund its spending binge, so far the US administration has succeeded in borrowing huge amounts of money at low interest rates. It is notable that up until now, demand for US Treasuries has been strong and the US administration has not had much trouble raising money. Perversely, in today's volatile economic environment, US government debt is still viewed as a safe haven. However, every good thing comes to an end and investors' perception could change at short notice. When that happens and the bond market starts to focus on America's ballooning deficits, demand for government debt will dive. At that point, the Federal Reserve will have no option but to create new money so that it can lend it to the US Treasury. In fact, the Federal Reserve has already announced that it will use the proceeds from the sale of its mortgage backed securities to buy US Treasuries. This is only the beginning of an outright asset monetization and this will intensify over the following years.
Throughout history, periods of massive money creation have always been inflationary and this time should be no different. Over the following months, if the economies of the developed world take a turn for the worse, you can be sure that the respective policymakers will respond by creating large amounts of paper money.
Given the inflationary environment we find ourselves in, expect both cash and bonds to lose considerable real value over the following years and the ongoing strength in the government bond market may turn out to be an exceptional selling opportunity. Conversely, expect that precious metals, energy and the stock markets of the fast growing developing markets in Asia will provide stellar returns in this inflationary environment.
I trust this article provides a little more insight into insurmountable demographics, bumbling bureaucrats, and the infamous Greenspan touch. I favor a quote from Steve Forbes … Forbes says that pursuing additional financial education and the resulting increase in our financial literacy will open our eyes to being savvy with our money and using alternative wealth creating strategies; this will be they key to resolving our financial crisis.
To gain the necessary financial education, it is best to pursue association with, access to, and membership in, a wealth creation community. As a result, you will learn about alternative wealth creating strategies and consider investments in non-dollar denominated assets … perhaps emerging markets … perhaps energy assets that are inherently useful like oil rigs, hydropower, or methanol plants … perhaps precious metals, rare earths, water rights, oil, natural gas, potash mines, or gold mines … things hard to build, difficult to replace, and costly to substitute … definitely not financial stocks, definitely not retail stocks, definitely not commercial property.
For those wanting protection of their purchasing power in gold, there are several ways that may be appropriate to obtain this protection. These include direct ownership in minted coins, use of gold exchange traded funds, gold mutual funds, and junior gold stocks. Many are investigating having part of their IRAs in gold, silver, precious metals, and non-dollar denominated currencies.
In addition, for those that truly believe sovereign risk is the greatest risk we all face, it is wise to learn how to implement a multiple flag strategy to diversify this risk or provide protection against higher taxes, capital controls, hyperinflation, civil unrest, erosion of personal liberty, and the rise of a police state. With a multiple flag system, you consider taking preparations like, but not limited to, establishing a foreign bank account, purchasing some real estate overseas, seeking alternate sources of income, dual citizenship, and carrying multiple passports.
I will continue to provide examples of things we need to learn, the secrets of the insiders, as part of being savvy with our money, and introduce alternative wealth creating strategies, in future articles and updates at my blog over the next few weeks.
In addition, a good book to read would be “Bad Money” by Kevin Phillips; it describes Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism.
In closing, be sure to Meet Me at my website, WhoIsMikeFarrell; Read Posts about my Internet Marketing Business at aspenIbiz BlackBox; and Obtain Some Tips About Being No 1 on Google at aspenIbiz My Go-To-Market Partners, my Affiliate website; and Learn How to Live Longer at aspenIbiz My Life’s Advantage Today site.