There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.– Ludwig von Mises
For most of 2009, I've had a friendly disagreement with several colleagues who believe a big deflation will be the end result of the 2008 financial crisis.
I knew they were wrong. I knew inflation would become a problem sooner, rather than later. And in the past several months, I've been proven right.
The mortgage and banking collapse of 2007-2009 saw total collateral values collapse between $5 trillion and $10 trillion. The response from our politicians and central bankers was massive: the largest creation of new money in credit since the Civil War.
The Federal Reserve created roughly $2 trillion in additional credit and loaned it against all kinds of dubious collateral, things like Bear Stearns' mortgage book. (There's a handy and simple guide to estimating the Fed's credit quality. The more acronyms in the lending programs, the worse it gets.)
The Federal government responded with a record annual deficit of at least $1.8 trillion. In the second half of 2008, the outstanding federal debt grew by roughly a 40% annualized pace (24% for the entire year). Thus, in only a few months' time, the roots – the money and credit – underlying our economy expanded at a record pace.
In the second half of last year and the first quarter of 2009, the main question in the world's financial markets was: Can the world's government print enough money, fast enough, to forestall a deflationary collapse?
I knew it was no contest. There is no way for an economy to outrun a printing press. The Fed has the power to create an unlimited amount of money or credit and the power to inject that money into the economy in any way it sees fit.
Let's look at the numbers. Let's assume the total collateral damage of the banking crisis turns out to be $5 trillion. Yes, that's a huge hit – roughly half the output of our economy each year. It's the equivalent of sending every American household a bill for $50,000 – due immediately. However, in less than a year, the Feds have already created nearly $4 trillion in new money and credit. The hole in the system has already been plugged. It only took a few months.
The fight between inflation and deflation is over. Deflation was knocked out in the first round.
The big risk is what happens next. Having turned on the presses to save the day, who will have the political clout and the desire to shut them off? Barack Obama's budget calls for annual deficits in excess of $1 trillion for the next eight years. Thus, by the end of this year, not only will all of the damage from the mortgage collapse ($5 trillion) be replaced by new money and credit, there will be significant inflationary pressures in the economy.
The good news in our economy this year, so soon after such a major collapse, means we will certainly have a massive inflation during 2010 and 2011. There's no such thing as a free ride. Bailing out the banks will carry a heavy price for anyone who doesn't have the resources or the knowledge to escape the dollar.
How can you "escape"? First off, make sure you own plenty of gold bullion. I also recommend owning assets that will run higher in an inflationary environment, like vital transportation and energy assets. Also, own some good farmland. Food and land prices will go higher.
Yes, the news is grim... but if you own gold and strategic assets, you'll survive and prosper in the coming inflation.
This article has been republished from Daily Wealth, a contrarian investment analysis and advice site.
1 comment:
I strongly agree with much of what was discussed in this article. I think that the govt has demonstrated that they are going to continue to throw money at the failed institutions to try to clean up their mess. This will continue to have negative consequences for our currency, as their main remedy for all of these problems is money printing and stimulus, which is essentially debt. And one of the only ways for most people to protect and potentially prosper from this is by investing in those assets that should rise from all the money printing, such as gold and other commodities. Here is a good discussion on a gold mining company, Premier Gold that should benefit from a rise in the gold price. It is unusually well-diversified for an exploration company and does not contain the same risks as many other junior miners that possess a single project.
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