by David Galland: Government
Last week, the price of gold again broke below its new base at
$1,200, and the U.S. stock market was again under strong pressure,
due to a confluence of fears, most of which point to a deflationary
double-dip. The fears were fanned by disappointment in the just-released
early quarterly results, by the latest CPI reports that show inflation
continuing to moderate, and by yet another poll revealing faltering
The market is also spooked, no doubt, by notes from the latest
Fed Beige Book that make it clear that the Fed is (finally) beginning
to understand the entrenched and endemic nature of this crisis.
While the notes are written in shamanic double-speak, the point
is unambiguous – members of the Fed don’t expect the economy
to get back on track until 2015 or 2016.
"Participants generally anticipated that, in light of the
severity of the economic downturn, it would take some time for
the economy to converge fully to its longer-run path as characterized
by sustainable rates of output growth, unemployment, and inflation
consistent with participants’ interpretation of the Federal Reserve’s
dual objectives; most expected the convergence process to take
no more than five to six years."
The simple reality the Fed is waking up to is that the structural
underpinnings of the economy are damaged beyond any quick or easy
That’s because until the debt is wrung out of the system, either
through default or raging inflation – there’s no chance of
it actually being paid in anything remotely resembling current dollars
– the equivalent of an economic Black Death is going to plague
Each new government initiative, the latest being financial reform,
that doesn’t decisively address the debt, but rather tightens the
dead hands of politicians around GDP, only serves to spread the
wasting disease like so many flea-infested rats running through
And so, each new day will find the carts freshly laden with failed
homeowners, businesses, and banks that have succumbed.
Pundits are fond of saying that things are never really "different
this time around"… yet there is something truly unusual now
going on. See if you can spot the disconnect in the following descriptions
of the current economy.
- Record total debt.
- Record government deficits.
- Record trade deficits.
- Massive additional government
debt financing required to keep the doors open and avoid reneging
on social contracts directly affecting the quality of lives of
millions of people around the globe – the U.S., Japan, and
- Near record-low interest rates.
Anything strike you as out of place?
The current setup with massive debts and low, low interest rates
is like making an uncollateralized loan to an acquaintance at a
very friendly, low interest rate. Then he comes back again for more,
and more, and more. Because you live in a small town, you know he’s
putting the touch on a bunch of other people too. And because you
know his loose-lipped accountant, you also know what his income
is, and even what his total debts are – and it is blatantly
obvious that he won’t be able to repay his debts in a dozen lifetimes.
So would you keep lending him money? And, if you did, would you
do it at the same friendly interest rates?
Not hardly. And therein lies the almost Twilight Zone
caliber disconnect in the world as we know it.
In a conversation yesterday, my dear partner and friend of several
decades, Doug Casey, made just that point – that the situation
today should only exist if the fundamental laws of economics had
been suspended. Interest rates should be going up, but they aren’t
– rather, they are bumping along at the very bottom of the
In my view, this is testimony to the truly extraordinary lengths
– involving trillions of dollars – that the U.S. Treasury
and the Fed have gone to in recent years. But they can only suspend
reality for so long before the fundamentals again rule – and
when that happens, the entire system could literally collapse. Not
to sound dramatic, but it could happen almost overnight.
As frustrating as it may be to all of us, the world is still locked
firmly in the jaws of a powerful bear market. While the bear may
loosen its bite now and again, it’s really only temporary –
to get a better grip.
That being the case, it’s worth remembering the single most important
thing about bear market investing – it’s hard. Or, put another
way, it’s hard to make a decent return without taking extraordinary
As Doug points out, in the current environment, everything –
including commodities – is overvalued. And they are going to
remain that way until they aren’t. Maybe the Fed actually has it
right this time, and the bottom won’t be reached until 2015 or 2016?
I wouldn’t discount it at this point.
But what of the inflation we see as inevitable? And gold, in the
Let me quickly tackle the second question first.
In any debt crisis, the foremost concern of creditors is to get
paid back. Compared to that, returns on investment come in a weak
second. In a sovereign debt crisis, the question of repayment is
complicated by the fact that the debtors control the creation of
the currency units that will ultimately be used for payments.
Individual and institutional holders of U.S. Treasuries, along
with other assets amounting to trillions of U.S. currency units,
can see with their own eyes what’s going on. To continue holding
such large quantities of instruments denominated in these unbacked
currency units – or those labeled "euros" or "yen"
– is to risk being left with a lot of worthless paper as the
governments try to repay debtors by creating the stuff, literally,
out of thin air.
And so these holders diversify their portfolios into alternative,
and far more tangible, assets – gold and silver included. That
is the fuel that has sent gold higher over the last ten years and
that will keep it high – short-term corrections notwithstanding.
It is, however, when the inflation from all the money creation
starts to appear that we’ll begin to see the shift into gold begin
in earnest, and the price will really take off. When might that
occur? Rather than trying to answer that question myself, I’ll refer
you to the latest, excellent edition of, Conversations
with Casey, in which Louis James interviews Casey
Report co-editor Terry Coxon on the outlook for inflation.
Here’s an excerpt…
Coxon: …the operations that began
in late 2008 have about doubled the monetary base. It was very
roughly a trillion dollars. Nothing like that had ever happened
before. Most of the new cash went to buy troubled assets from
commercial banks. The first goal was to prevent the commercial
banks from collapsing. If the Federal Reserve had done nothing
else, the result would have been a doubling of the money supply
within a few months, and we would have had South American-style
L: So they changed the rules so they
could create a huge amount of money to keep the banks open, while
trying to avoid hyperinflation.
Coxon: Yes. The money supply grew by
about 20%, which, I suppose, they thought would be enough. To
keep it from growing any further, they started paying interest
on excess reserves, effectively sequestering those excess reserves.
L: That’s a lot of sequestered cash.
But the U.S. government has done more than directing or allowing
the Fed to buy toxic paper. There’s Cash for Clunkers and all
sorts of other insane ideas coming out of Washington, with Congress
seemingly willing to spend "whatever it takes" to get
Boobus americanus to imagine he’s rich enough to start
And yet, the average Joe in the street doesn’t see inflation.
Life hasn’t really gotten any cheaper, but gas is still way below
its previous $5 high-water mark. Joe is worried about losing his
job and cutting his expenses, which is price-deflationary. Why
isn’t he seeing more inflation?
Coxon: Joe isn’t seeing inflation because,
so far, the Federal Reserve has not allowed the money supply to
grow enough to trigger inflation. You’re mixing apples and oranges
when you talk about Congress and the Federal Reserve. All of the
runaway deficit spending is not, in and of itself, inflationary.
The government spending borrowed money does not increase the money
supply – it doesn’t change the amount of cash people have.
L: Ah. You’re saying that out-of-control
government spending isn’t inflationary, but sets the stage for
future inflation, when money has to be created to pay the government’s
Coxon: What it does is create a political
motive and economic need for inflation. These huge deficits may
have slowed the recession that began in 2008, but to keep the
recession from worsening, the Federal Reserve will have to prevent
interest rates from rising for months or years to come. And to
do that, it will have to start printing money to buy up debt instruments
whenever the economy starts recovering, to keep interest rates
down to levels that will not choke off the recovery.
L: So more money creation will be necessary
to keep interest rates low, but at some point, the foreigners
holding dollars, believing it to be a sound currency, will have
to get worried about all this dilution of the dollar – and
that would tend to force interest rates up, as it will take more
and more to convince those people to keep buying T-bills and such.
Coxon: The world outside the U.S. has become like a giant
capacitor for U.S. inflation. The charge that’s building up is
the accumulation of dollars and dollar-denominated assets in the
hands of foreigners. When the outside world wakes up to the threat
of inflation in the U.S., they will start unloading U.S. dollars,
which will suppress the dollar’s value in foreign exchange markets,
which will make prices of imports (including oil) go up, and that
will be a separate vector feeding price inflation in the U.S.
For now, the key is to get through this period in the best possible
shape. That means watching your debt, keeping well cashed up, buying
gold on dips, and, when you venture into investment markets, it’s
never been more important to understand what you are investing in
There’s no need to chase anything – which means you have the
luxury of building your portfolio over time, on exactly the terms
While it may sound contradictory, I think this is also a good time
to learn more about speculating. In the simplest terms, a speculator
risks just 10% of their portfolio in the hopes of receiving a 100%
return. By comparison, most investors put 100% of their portfolio
at risk in the hopes of getting a 10% return (actually, these days,
most people would be happy with just 5%).
In the case of the speculator, 90% of their portfolio can be largely
kept in cash and gold. So, who’s more at risk – the investor
or the speculator?
And where are the best speculations found today? Personally, I
like energy, and I very much like bottom fishing in the junior gold
sector. That’s because there are some terrific micro-cap Canadian
junior exploration and mining companies (which you can buy using
your U.S. discount broker) sitting on large known deposits
– but their share prices periodically fall back based on nothing
more than investor emotion. That’s called a buying opportunity.
(For our best bets in this sector, check out a risk-free 3-month
trial to the International Speculator – it’s no coincidence
that every single stock Senior Editor Louis James picked in 2009
has turned out to be a winner. Details
is the managing editor of Casey