An assault of thought on the unthinking

The End of America is Nigh?

 

I consider myself to be a dispositional optimist, meaning the majority of the time I take a hopeful view which usually leads me to expect the best possible outcome from any given situation. In a world that is overwhelmingly negative, pessimistic, and dominated with “if it bleeds it leads” news stories, being an optimist is about as ‘contrarian’ as anyone can get.

The physical and emotional health benefits of having a positive mental attitude are well documented. People who look to the bright side tend to find the silver lining they seek, as a result they are psychologically better adjusted and usually far happier than their pessimistic counterparts. History is also rife with examples of where it pays to be optimistic. Take for instance those that have had an optimistic view of America and have invested their time and treasure accordingly – they have seen marvelous compounded gains over time while those who have been negative about Americas prospects and bet against her have lost a fortune.

I believe in the power of positive thinking, but that presupposes you are actually ‘thinking’. As a sailor I like to take my boat out on the water when the weather is nice, however once at sea pretending the weather will always stay that way foolish. Maintaining a healthy respect for Mother Nature and keeping your passengers safe is the captains most important responsibility.  No doubt it’s important for a captain to keep a positive mental attitude, but It’s delusional to believe that positivity alone will keep the bad weather away and your ship safe.  Positivity should be the catalyst for creative and proactive action, not an excuse for ignorance, apathy, and inaction. If you want your voyage to be successful you must be prepared for the unexpected and recognize the danger storm clouds represent so you can take appropriate steps before it’s too late.

Now I am no monetary scholar or economist, I’m just your typical working guy with an average level of intelligence, but I can clearly see the black clouds gathering on the horizon.

 

Rome is Burning

We have a festering problem that needs to be dealt with before it’s too late.

The U.S. Government gross national debt just surpassed 15 trillion dollars and is growing by a mind boggling 4 billion each day! If you include the federal governments “off balance sheet” deficit, which includes Social Security and Medicare, estimates place our debt at somewhere north of 70 trillion dollars in unfunded liabilities. For the first time since World War II our deficit is over 100% of our gross domestic product, but the difference between then and now, in 1947 our spending was on the war, and shortly after the war was over this deficit was brought back down to manageable levels, today however our deficit is driven by government malfeasance and exacerbated by out of control entitlement programs.

Most of Europe suffers similar problems. Profligate spending and socialist style entitlement programs has them teetering on verge of collapse. China has its own problems with an overheated economy and a real estate market that looks eerily similar to ours in 2006. If you combine Europe, China, and the U.S., global debt has grown over the last nine years from 80 trillion to 210 trillion. The global credit market has grown at an astonishing 12% rate per year for the last nine years, while GDP has barely crept along at 4%.

The current U.S. financial situation is so frail it would take just one falling domino in Europe or China to start a chain reaction that could cause a catastrophic collapse of the entire system, yet the vast majority of people go about their business as if nothing in was wrong in the world. In the meanwhile our government fiddles.

 

America the Dysfunctional

Our once great country has morphed into a dysfunctional democracy. We have a republic that that is not representative of the public. We have something the founding fathers never intended. They intended for us to have our representatives to be real people that come out of the real world with real world experience to provide short-term service and then go back to the cities or small towns from which they came.

Unfortunately, what we have today are career politicians that do not come out of the real world and who have no real world experience. They travel east to Washington DC seeking their own self-interest and become entrenched life-long bureaucrats that don’t understand the real world, nor do they care to represent the real world. These representatives are hired by voters as temporary public servants and given a small but adequate income meant to compensate them for their time while they serve their constituencies.

As soon as the newly elected are sworn into office the corporate lobbyists and special interest groups begin circling like vultures waiting to pounce on their prey. Not long after taking their oath of office the humble pubic servants develop a terminal case of amnesia and quickly forget about the people they promised to serve as well as the constitution they swore to uphold. Soon, back room horse trading and quid pro quo dealing leads to legislation that favors large conglomerates at the expense of small business and the lowly taxpayers. Then after only a few years in office, in a mysterious twist of good fortune, these government paid public employees become fabulously wealthy beyond all comprehension.

It’s  sad but true. Will Rodgers had it right when he said, “It’s easy being a comedian when the government is writing the material for you”.

 

A Fool and His Money are Soon Parted

This republic was founded on the principle of opportunity, not entitlement; on savings, not debt, and personal responsibility, not irresponsibility. Today, over half of U.S. citizens’ pay nothing whatsoever in taxes yet they gorge themselves at government trough. The original intent of these government programs was to provide a safety net for those that found themselves temporarily down on their luck or incapable of taking care of themselves –    they were never intended to be hammocks for the lazy.

Under the welfare state we’ve seen entitlement programs explode and now account for over 35% of wages. Over 60% of federal government spending is on obligations that have nothing to do with the original intent of the federal government. We spend one trillion dollars per year to maintain our empire around the world with over 860 military bases in at least 59 foreign countries and territories. And even though we are flat broke, we still send another 48 billion each year overseas to foreign governments in economic assistance and military aid. We spend like drunken sailors and act as if there will be no hangover.

One hundred years ago America borrowed from other countries in order to invest in production to sell products abroad, as a result America became a greatest nation in world and the largest creditor nation in the world. Today, America borrows in order to consume and has become largest debtor nation in the history of the world. America is like a drug addict and foreign lenders are the enablers.

China loans us hundreds of billions each year and we return to them billions in interest payments that they intern reinvest back into their country so that they can keep selling us stuff. We are spending and accumulating debts while China is investing and accumulating assets. China is building a bright future and we are squandering ours. We behave like we are infallible, as if the law of gravity doesn’t apply to us, and we think we are the “greatest”, yet 50% of our debt is owned and financed by foreign lenders – China, Japan, Saudi Arabia, etc. History is very instructive in this regard; no nation has survived let alone thrived as debtor nation. 30 years of fiscally irresponsibility and living far beyond our means has put our republic at grave risk.

 

In the Land of the Blind

Most folks in America don’t give multi-trillion dollar deficits much thought nor consider the consequences of these cataclysmic levels of debt because everything in their life ‘feels’ normal to them. The vast majority of people are too busy running on the gerbil wheel to stop and think about the burning fuse at the end of this ticking time bomb. They are just trying to keep their jobs to put food on the table, and when not at work they are scurrying around like carpenter ants, taxiing kids to and from school, soccer practice, piano lessons, etc. Those who aren’t busy being responsible adults and raising their families are behaving like juvenile delinquents and morons, sleepwalking though life in a semi-comatose state only to waken from their stupor to catch Americas Got Talent, SpongeBob, or one of the Housewives shows on TV. The remaining tiny minority who are engaged and fully awake don’t seem to alarmed about all the deficit hubbub, probably because they’ve heard “the sky is falling” so many times in the past they have become numb to the warnings.

Unbeknownst to the majority, our nation is vulnerable right now and at risk of falling into the ash heap of history. It wouldn’t be the first time it has happened to a great country and you don’t have to go way back to antiquity and the Roman Empire to see that the collapse of a great world power is possible. But we have short memories, especially Americans, who suffer from a collective amnesia when it comes to history.

I find it interesting that it is almost a sacrilege in this country for one to question whether America might someday meet with the same fate as Rome.  People get very defensive when America’s exceptionalism is challenged.  Suggest that we’ve had our century in sun and the next century belongs to someone else and most people become indignant and downright angry.  If you postulate whether a bankrupt nation can still be considered “great” your called anti-American but if you turn a blind eye to the obvious you’re a patriot?  Very curious indeed.

It is an “inconvenient truth” that the country our parents and grandparents fought to preserve is distinctly different from bankrupt country we have today. A person would have to be either blind or hopelessly lost in a state of perpetual nostalgia to not see that America is not the shining beacon on the hill that it once was. I think it’s similarly obtuse to not even consider the possibility that America’s light could someday flame out. I certainly hope we can pull out of this nosedive because It gives me no pleasure to pen these words. I love my country and have a special admiration and appreciation for those that have made the ultimate sacrifice to defend her, but I would be remiss to longingly remember yesterday while conveniently forgetting about the reality of today.

 

This Time its Different

Sir John Templeton, the legendary investor and philanthropist, said the four most dangerous words in investing are: “this time it’s different”. The last 50 yrs has proven Sir John to be absolutely correct. The most successful investors in the world have ignored the naysayers and profited handsomely by his sound advice. Thinking that it is “different this time” has always been a dangerous in investing because it’s almost never different this time. Fanatics who cry, “the end of the world as we know it is nigh”, are disappointed time and again to find the world doesn’t end as they prophesied.

But the reason our deficits in the past did not result in an “end of the world” catastrophic meltdown is because we were able to pay them through economic growth. The problem this time around is our deficits are so huge they simply cannot be overcome with GDP growth. In order for the U.S. to grow its way out of it’s multi-trillion dollar deficit it would require GDP growth to average over 20% per year for the next twenty years. No country in the history of the world has ever seen that kind of GDP growth. We’ve gone way beyond the tipping point this time, the bill is due, and we can’t pay it. It’s a mathematical impossibility for GDP growth to come to our rescue and save us from our excesses. This is not an opinion … this is math. I hate to say it (sorry, Sir John), but unfortunately … it is different this time.

Those that have sounded the alarm about the dangers facing America are met with ridicule, are marginalized, or are flat our ignored. Granted, these nattering nabobs of negativism have been wrong in the past about our countries future, but it’s a funny thing about prognosticators, economists and weathermen; they always seem to be wrong about their forecasts, that is, until the day they are right. It is said that if you cry ‘Wolf’ long enough sooner or later you are going to be right. So, what if this time the big bad wolf really is at our doorstep? What if the doomsayers actually got it right this time?

Sadly, those entrusted with the responsibility of delivering the ship of state and its passengers safely to its port of call have been sound asleep in the wheelhouse, and as a result, they have placed everyone on board this ship in grave peril. Rather than accepting responsibility for their reckless actions and plugging the hole in the hull, they convene super committees, bicker among themselves as to who’s to blame, and squabble over who will fix the problem. These hapless half-wits are rearranged the deck chairs on the Titanic while the ship is sinking! As the water gushes past the bulkheads and rises perilously high, the captain, for some inexplicable reason, decides it might help to roil the passengers with his rancorous rhetoric in a lame attempt to divide the halves from the have-nots. Meanwhile the captain’s minions announce that we have nothing to fear, yet at the same time they dawn their own life jackets and maneuver to secure a seat on the lifeboat for themselves and their friends. The music plays on, and the oblivious passengers go about their day unaware disaster is looming, that is until it becomes obvious that the ship is doomed to sink. At this point, widespread panic ensues as every man woman and child scramble to avoid the rising water in a futile attempt to save themselves, but unfortunately, it’s too late.

 

Where is Ludwig von Mises When We Need Him?

The Austrian School of Economics says if you are swamped in debt and cannot pay your bills then you should go belly up, not get bailed out. In the real world it’s called insolvency and bankruptcy.  Creditors write off the bad debts. Those who took the risks for their own private gain are forced to absorb the losses. Those who made the bets rightly suck the losses. If risk and return are causally linked, then those who made the big bets that went sour should get wiped out. It is the only just, moral, and equitable way to go that makes any sense.  Yes, they get wiped out –that includes high-flying money managers, the politically connected big bank honchos, multimillionaire bond-fund gurus, and everyone else who foolishly bought the debt without investigating the risks. If those who made the bets for their own private gain aren’t forced to absorb the risk, then we don’t live in either capitalism or democracy; we live in a financial-fascist tyranny.

Free markets when they are allowed to work resemble nature. The strong eat the weak and only the fittest survive. While this offends our sensibilities and may seem ugly and cruel, it’s necessary to sustain a perfect balance in nature. There is order in the chaos; it’s only when man interferes with nature’s perfect balance that things go awry. Now I’m not suggesting free markets are perfect, they are far from it, but they are far more perfect than the government bureaucrats that monkey with them.

When an outside force (government) interferes with the natural law of cause and effect, disastrous unintended consequences result. When governments bailout out the risk takers by taking money from the strong, competent, and responsible and giving it to the weak, incompetent, and irresponsible (AIG, Freddie Mac, Citigroup, Bank of America, General Motors, etc.), moral hazard is always the result. When government steps in to stop the pain the pain is not eliminated – it’s simply postponed.

 

I’m from the government and I’m here to help

U.S. government used trillions in taxpayer funds to prop up incompetent businesses during the 2008 financial crisis, thus creating the greatest wealth transfer in the history of the world. Let us be clear, they didn’t spend trillions of dollars of their money on their compulsory corporate charity program; they spent trillions of dollars of our money, the taxpayer, who along with our kids, grand kids, and great grand kids, who will be stuck paying for our governments ill-conceived corporate welfare for decades into the future.

The process of sheltering incompetent businesses from the consequences of their bad behavior while preventing them from failing has prevented the recovery from taking place, and in the process expanded the already overstretched bubble. Most talking heads (the majority of whom work on Wall Street) say that our biggest mistake during the 2008 financial crisis was letting Lehman Brothers fail – actually I disagree, in my view that was the only intelligent and responsible thing the government did.

If a business or economic system is nothing but a house of cards then it needs to be allowed to collapse. We should have learned this lesson from Japan which did the very same thing the U.S. Government is doing now, refusing to let anyone fail, as a result they have suffered with 20yrs of malaise and deflation.

Letting the free market work means letting failure get what it deserves. Yes, failure is painful, but postponing the inevitable by propping up derelict companies and inflating the debt bubble with profligate spending will be considerably more painful in the long run. Our phony baloney economy along with all the over leveraged insolvent companies that cannot stand on their own need to be allowed to fail, because that is the only way to stabilize this economy and its only hope for an eventual recovery. Like a woman in childbirth, first pain then joy.

But today, unfortunately, we appear to live in a make believe construct inside the Matrix, where Frankensteinian governments, corrupt self-serving bureaucrats, and PHD monetary scholars at central banks pull all the puppet strings. These apparatchiks do not have a soul and they do know their history. They are not men and women of character and integrity, they are crony capitalists devoid of the political courage and unwilling to risk loosing an election to do the right thing.

Governments bail out the big banks, their campaign contributors, and their friends in high places, all under the pretense of “saving the financial system”, then they shift the losses to the unsuspecting chumps – the taxpayer. To paraphrase Shakespeare, the Federal Reserves unrestrained money printing combined with governments profligate spending, it must follow, as the night the day, thou will see increased taxation. How can we have positive evolution when the people who do the right thing have to bailout and finance the people who did the wrong thing?

What the government doesn’t confiscate in taxes we will end up loosing in purchasing power to hyperinflation (eventually). Nobel prize winning economist Thomas Sargent noted: “There’s a fundamental truth that everyone has to understand: what the government spends, the public will pay for sooner or later, whether in taxes or inflation or both. So yes, that means you and I are going to get stuck with this bill, and our only crime is that we have our fiat money in commercial banks, retirement accounts, and mortgaged homes.

 

The government-funded Ponzi scheme

What I find most objectionable is government’s solution to solving our massive debt problem. They have decided to create more debt! Instead of deflating the bubble they created, our government has gone 180 degrees the other way. These dirty rotten scoundrels have gone on an unprecedented spending spree that is orders of magnitude larger than anything mankind has ever seen. Their misguided plan to create more debt and inflate assets in an ineffectual attempt to stimulate the economy has failed. Not only has it failed to achieve its objective, it has brought us right the to brink.

In an act of criminal foolishness it appears governments plan is ignore its debt problems. It is crystal clear to anyone with eyes to see that not only does the U.S. Government refuse to cut expenses, reform entitlements, and address the debt problems; their intention is to increase spending over the next decade to more than 40 trillion. But the “inside the beltway” propagandists tell us they are cutting expenses. You cannot believe ANYTHING the government tells you! They aren’t cutting anything – they are spending. In a masterstroke of backassward accounting, what the government calls a cut, is merely a minor reduction in the growth of their out of control spending. These “cuts” will not put a dent our deficits; it barely reduces the amount we pay to the Chinese in interest payments on our growing deficits. American politicians will not, under any circumstances willingly confront our underlying debt crisis. While this should not surprise anyone, the sheer dysfunction displayed should serve as a cold shower for those who still harbor any desperate illusions that we can make it out of this mess unscathed.

Thirty years of reckless spending, deception, and manipulation has turned our financial system into a government-funded Ponzi scheme. And one thing is for sure, all Ponzi schemes eventually implode, and when they do they do so quickly. Ask anyone who had money with Bernard Madoff – he successfully perpetuated his fraud for over thirty years with barely a hint of impropriety, and for thirty years investors actually profited from his scam, but when confidence in the market was lost, his enterprise imploded quickly, and nobody, not even the most sophisticated investors had time to get their money out.

Schemes like the one the government has perpetuated for the last thirty years is based on the same principle: lies, deceptions, and the confidence game. When the curtain is pulled back, the ugly truth is exposed, confidence is lost, and the financial house of cards comes tumbling down.

Ernest Hemingway, when asked how a bankruptcy happens, he replied, “Slowly, then all at once.”

Our paper currencies are not backed by the gold standard, they are backed by PHD’d money-men at the FED and hollow promises by our career politicians. Our banks are empty vessels that have leveraged and lent out our deposits and barely keep any cash on the books. Most western nations are completely insolvent, and everyone is exposed to everyone else.

Everything can ‘feel’ normal so long as that trust and confidence remains intact, but as soon as people lose confidence in the system, things collapse very, very quickly. The late German economist, Rudi Dornbusch said, “The loss of confidence takes longer than you think it should and happens faster than you thought it could”.

 

Lies, Damned Lies, and Statistics.

Of course the government establishment will aggressively and vehemently deny all facts about a coming economic collapse in order to avoid widespread panic. Earlier this year Ben Bernanke went on 60 minutes (the first time ever for a Federal Reserve chairman) to tell us that “everything is okay and our economy is recoverng”. Timothy Giehtner (Treasury Secretary) just announced that the “we have a strong dollar and a strong dollar policy” … but we know exactly the opposite is the case. Benjamin Disraeli, the British Prime Minster, said, “there are three kinds of lies: lies, damned lies, and statistics”.

Our government is incapable of telling the truth. If the general public knew that the U.S. was on the verge of collapse or about to loose it’s standing as the world’s reserve currency there would be widespread panic. This would lead to a run on the banking system, a seizing up of our economic system, and a collapse of the stock market. It is a certainty that the public will not be given “a heads up” from the federal government that we are at the precipice. You and I will be the last to know.

When it comes to the economy, we have nothing like a tsunami or earthquake early warning system to prepare the population in advance of an economic disaster. We will not hear sirens or warning bells so we have a chance to head to higher ground and save ourselves. Actually, we have exactly the opposite of an early warning system in the U.S.; what we have more closely resembles a Ministry of Propaganda whose mission appears to be to shove us into the path of an oncoming freight train. The earth is shaking yet our government leaders go on TV and tell us the “water is fine” and they encourage us to head to beach!

I just can’t help but laugh when I think of the quote by Lily Tomlin when she said,  “No matter how cynical I get, it is impossible to keep up. Yup, I think that pretty much sums up my sentiments exactly.

 

Up, Down, Sideways …who knows?

I wouldn’t venture a guess as to what will happen in the short term, nor can can be absolutely certain what will happen in the long run. Bertrand Russell said, “Not to be absolutely certain is, I think, one of the essential things in rationality”. I consider myself to be a rational person; as such I have to admit my crystal ball has been on the fritz so I can only take a guess, just like everyone else, as to what the future holds, but I think there is a 98.3 % (laughing) statistical probability that this story will eventually end very, very badly.

That said, even though governments around the world are defaulting and central banks are flooding the market with monopoly money, the stock market may still rally from here. The real estate market may recover in the short run. The economy might rebound and double dip recession fears may abate. Euphoria and optimism may return in spades and everyone might start singing “happy days are here again”.

As governments and central banks from around the globe lock arms in a coordinated response they may actually succeed (again) at covering up and hiding our festering problem from view for a while longer, thus extend the lifespan of the bubble. This bubble might continue expanding unabated for months, or even years, who knows? You can’t tell by looking at a bubble when it’s reaches its maximum elasticity and is about to explode. You only know it’s stretched too far in hindsight,  AFTER it’s blown.

No reasonable person can predict with any degree of certainty WHEN a bubble will blow, but reasonable people can speculate on HOW. The overwhelming majority of economists are unanimous in their consensus that our massive debt burden and governments response will bring very high levels of inflation. I’m not so sure.

 

Popular Delusions and the Madness of Crowds

Most financial experts agree that inflation is coming, as such, they recommend buying gold, which makes perfect sense when you think about it. It’s so obvious everybody and their mother seem to believe now’s the time to buy gold. Late night infomercials are capitalizing on the enthusiasm by showing us how to buy sell and trade gold. Today, gold and inflation are the topics du jour around the water cooler, and waitresses, cab drivers…everyone is buying gold.

The gold rush is on with the precious metal trading at $1800 an ounce, up from $250 an ounce just ten years ago, and with major Western nations defaulting on their debts there are plenty of good reasons to buy an asset that doesn’t depend on the solvency of an ETF, bank, or government. Right?

If history repeats itself, and it usually does, then there is good reason to be a little leery about all this exuberance. I recall not long ago the dizzying dot-com days between 1995-2000 where “ordinary people” were day-trading Internet stocks and making a killing. And how can we forget the heady days when real estate was skyrocketing and was a slam dunk moneymaking proposition. People much smarter than I made compelling arguments explaining why these investments were bulletproof and headed straight to the moon. Well, we all know how those stories ended, don’t we?

Inflation certainly seems to be the logical byproduct from running the printing presses 24/7 and flooding the markets with liquidity. When currencies are getting debased they usually go down and gold makes sense as a safe haven. But currencies are all relative, and in a world that is hemorrhaging, convulsing, and deleveraging, the currency that goes down the least in comparison to its rivals will be the winner. As counter-intuitive as it may sound, the U.S. Dollar just might just be the cleanest dirty shirt in the laundry basket, and if this turns out to be true, then the price of gold will likely fall.

Conventional wisdom makes me queasy so naturally I get skeptical whenever the majority is united in certainty and enthusiasm about anything. I don’t doubt we’ll see inflation in our future, I think it’s inevitable at some point, and I don’t doubt gold will be a good long term investment, but what I doubt is the consensus opinion on how this next financial crisis is going to unfold. I just don’t think things are going to play out the way everyone expects, and my contrarian instincts tell me that we are going to get the unexpected.

 

Expect the Unexpected

The majority of economists believe inflation or hyperinflation is in our near future. I disagree with this hypothesis.

The two historical periods I believe are relevant are the U.S. during the Great Depression and the Japanese experience over the last twenty years. In Japan, nominal GDP remained flat for 20 years even though total debt as a percentage of GDP went from 50% to 200%. The economic story was similar in the U.S. in the Depression. After falling dramatically, nominal GNP came back up at the end of the 1930s to where it was in 1929, so there was no growth for the entire period. If not for the war, that would have lasted for a longer time. After 20 years in which most developed countries have seen leverage going to record levels, I think there are many, many years of de-leveraging to go. Governments have tried to step in to mitigate the pain of that process, but if there was a simple and pain free solution it would have been implemented by now. You can already see attention in Europe turning to cutting spending and raising taxes. I expect we will see the same in the U.S. in the coming years. With a multi-trillion dollar deficit and near-0% interest rates, the government and the Fed has no bullets left.

My conclusion is that a crisis of confidence will cause the economy de-lever. We are in store for along period of economic tribulation similar to the 20 year long malaise Japan has experienced or that of the Great Depression in the U.S.. I do not think the next phase of economic pain is going to bring rising prices and 1970’s style inflation.

The reason deflation and depression is not on our national consciousness is because very few of us have ever experienced it. Most people living today weren’t alive in the 1930’s during the last time we experienced deflation. They’ve never experienced it, so they naturally don’t fear it, and unconsciously believe it cannot happen. This is called the “normalcy bias” – when otherwise intelligent people believe it can’t happen because it never happened before. This is a dangerous mindset to have.

Our record levels of leverage and debt will eventually rupture our over inflated bubble.  When the bubble bursts there will rush of air whistling by us as massive deleveraging and a forced liquidations take place in all asset classes. Real estate, cars, boats, clothing, and food … everything falls, including gold. I think we will experience a violent period of deveraging followed by a decades long period of Japanese style deflation.

Deflation equals falling prices, which is far worse than inflation. Deflation will cause massive deleveraging and a forced liquidation in all asset classes. Assets worldwide will get marked down and this will drive all prices down causing a corrosive effect on people’s wealth. During deflationary times people stop spending which causes a collapse in demand. Those who have bank-financed assets (like home mortgages) are faced with a rising debt burden because you end up repaying an amount far in excess of the falling value of the asset. During deflation people save more, don’t borrow, and cut consumer spending, and this will hit the U.S. especially hard because 80% of our economy is based of consumer spending. When consumers don’t spend, companies’ profits shrink, and when companies earn less this always leads to layoffs and higher unemployment, which exacerbates and prolongs the terrible economy.

Governments greatest fear is not inflation, it’s deflation, and they will do almost anything to prevent this from happening. Central banks respond to even the smallest hints of deflation by lowering interest rates to encourage people to spend, but with rates at near-0% today they have very little leverage right now to manipulate the economy.

Once deflation takes hold governments interventions and monetary policies are less effective because people can’t be “stimulated” to borrow money to buy a depreciating asset. So governments would rather cause hyperinflation by debasing our currencies and decimating the purchasing power of our dollars (as the FED is doing right now) than to see deflation raise its ugly head, but at this point Government may have little ability to control where our economy goes next.

After 30 years of partying like rock stars and spending like there’s tomorrow, the tomorrow we all hoped would never come is here today … and the bill is due.

As terrifying as deflation scenario is, the political risk that would likely accompany deflation is even more frightening.  When economies shrink and widespread deleveraging takes place, tax revenues fall precipitously. Bankrupt governments already on life-support become increasingly desperate and aggressive as they scavenge for revenue. Under the pretense that they must “save the economy” they will devise new and creative ways of generating new tax revenues. This means that there is a high risk that any monetary asset you hold domestically could be a target of confiscation through increased taxation or even seizure. In addition, capital controls would likely be implemented, which would limit or eliminate your ability to protect your money by sending it abroad. If enacted, your capital would be trapped inside the U.S. at the mercy of whatever taxing and regulating schemes the government might concoct. Although you might be able to leave the country, your assets might not be able to leave with you.

Right about now I know what Harry Truman felt like, when he said, “I never did give them hell. I just told the truth, and they thought it was hell.”

Yeah, happy days!

 

Battening Down the Hatches

As dark as those clouds on the horizon appear to be I still remain positive, not so much about America’s long-term prospects,  but rather, my ability to weather the storm should good ole ship USA capsize and sink.

I’m not smart enough nor am I dumb enough to predict the timing the storm, but in looking at the gathering clouds it seems evident a storm is on it’s way,  and when that day of reckoning comes there will be very little warning.

I spent my young teen years as a Boy Scout and I recall reciting the “be prepared” mantra. Always good advice.  Now that doesn’t mean I’m preparing for armageddon -  I’m not digging a bomb shelter, buying guns and ammo, or stocking up on canned food (although I think there are worse ideas) because planning for the end times is a little extreme.

By my way of thinking we have three options: We can prepare for inflation, prepare for deflation, or we can stick our heads in the sand and do nothing. The “head in the sand” approach might sound compelling, especially after reading the exposition above, but the risk of inaction may be far greater than the risk of action. Doing somthing and moving forward is better than being immobilized and doing nothing. Sir Winston Churchill said, “If you are going through hell, keep going.” I don’t know about you, but should things go all to hell I want to take proactive and positive actions right now to protect me and mine.

Inflation is the consensus view. Deflation is contrarian view. If you doubt the consensus and are inclined to expect the unexpected,  then here are some things you may consider doing:

 

1). Save Money: During deflation, good old-fashioned cash is your best friend. When assets are getting marked down and everything is going on sale, those with cash on hand will be able to scoop up some great bargains. You will have some dry powder on hand to invest in depressed real estate, selected stocks at fire sale prices, and gold and commodities as they rebound. Cash is king … especially in the midst of a global meltdown.

 

2). Get Debt Free: Getting out of debt is a good idea regardless of what is happening in the economy, but paying off your debts is a critical move to make when there is deflation. Debt is particularly corrosive and punitive in a deflationary environment because when values and prices are falling you don’t want to be stuck blowing your valuable dollars on interest payments and bank installments on stuff you bought yesterday that is falling in value today. You get bupkus, zero, zip, nada, nothing for the money you spend on interest, and if you are paying interest on assets that are depreciating in value, you are going to be in a real world of hurt.

 

2). Sell your Assets: Cars, real estate, stocks…everything, even gold and commodities will go down as the world de-levers. Selling assets and going to cash doesn’t make sense in an inflationary environment because your cash becomes worth less, but it does in a deflationary environment. Some might want to hold on and wait until the direction of the economy comes clear, however by the time it’s obvious to everyone, the gig will be up and it will be too late do anything. On the flip side, the problem with selling now is assets prices might rise from here and you could miss the move up if you sell too early. Timing the market is tricky business and has always been a fool’s game. If one were to err on the side of caution, then protecting against downside loss would be better than hanging on in the hope of seeing some upside gain. If you were convinced the world was headed for a melt down and prices would eventually follow, then going to cash would be one way to protect yourself. Every family’s circumstances are unique so it is impractical to apply a “one size shoe” strategy to everyone’s situation, but for some people this might be a very good time to convert your assets to cash, stay liquid, downsize your lifestyle, and rent for a while.

 

3). Diversify your Income: Starting a your own side business or figuring out some other way to create another source of income can’t hurt. This is smart idea in the best of times, but in a depressed economic environment when companies are getting lean and slashing jobs, you don’t want to be left without a chair when the music stops. If you sign the back of the paycheck and your only source of income is your 9-5 gig, you are vulnerable.

 

4). Diversify geographically: Get some of your money outside the U.S.. I’m not advocating tax evasion, I’m talking about tax planning. It’s important not only diversify among asset classes but also to diversify where you hold those assets. Having some of your funds elsewhere (including owning real estate overseas) can provide a good hedge should the greenback crash or if U.S. goes to hell in a hand basket. If the U.S. Government attempts to confiscate your hard earned capital through increased taxation (which is inevitable), you will have some of your funds beyond the reach of those sticky fingered politicians back in Washington DC. If the U.S. Government decides to implement capital controls in the future, waiting to diversify outside of the U.S. will become far more difficult.

 

5). Invest for Deflation: This is not for the faint of heart because it entails risking some of your capital during a time when it’s important that you preserve it, but If you are sophisticated investor and have a high tolerance for risk, there are many creative ways to hedge and even profit in a deflationary environment.

 

Disclaimer

It should go without saying the ideas and opinions herein should not be should be considered a recommendation to buy or sell any stock or security. Nothing contained herein constitutes financial, legal, or tax advice, so before you open a Swiss bank account, bet the ranch on shorting the S&P or sell the family home, I strongly recommend that you consult with your financial adviser or tax professional. I assume no responsibility should your wife decide to leave you on account of you wanting to relocate to an underground bunker in Dead Horse North Dakota (If you currently live in Dead Horse I’m very sorry  -  you are already in a deep depression). If you are inclined to rely solely on the findings in this article for all your financial decisions, I ask that you please select the ‘unsubscribe button’ and go back to watching The Desperate Housewives. In the event you choose to go back to watching The Desperate Housewives you should consider yourself warned: Long term exposure to this show may result in headaches, nausea, vomiting, dizziness, hammertoe, head lice, cardiac arrhythmia, hemorrhoids, a darkened soul, diminished IQ, weight gain, lower back pain, and no life.    J