The Next Leg of the Crisis: Unavoidable Catastrophe
From Ahlgren Multiverse
The more I read, the more appalled I become. I am so terrified of what’s coming, but I look around at the general level of ignorance and hubris in the United States today, and I can’t help but thinking, yet again, that we deserve everything we’re going to get. I watch CNBC, FBN, and Bloomberg all day. I see “experts” and “specialists” and “veterans” recycle the same tired messages over, and over, and over. Politicians and economists defend quantitative easing and the Obama administration’s reckless policies. It’s like a nightmare I can’t wake up from.
And then, just when I think I’m going to throw a coffee cup at the television, someone like Jim Rogers or Peter Schiff makes an appearance, and I see a glimmer of hope.
I’ve been a victim of false optimism many times. It’s an easy trap to fall into: you bet on an outcome, and you convince yourself that everything you see points to a positive result — even in the face of changing premises. That, however, is dogmatism; it’s poisonous, and it’s the reason I spend so much time researching the issues facing us. I want clarity, and that requires enduring pointed criticism. But in the last year, the counterarguments haven’t been strong enough to convince me I’m wrong.
Here are some of the thoughts I’ve had this week:
1. Who really believes that wars and natural disasters are good for the economy? When did we become so stupid that we actually started to believe destroying things and killing people are beneficial? It’s like saying burning down your own house will give you prosperity. Or imagine trying to get cancer so you can be healthier? Such notions couldn’t be more ridiculous, and yet this is exactly the type of mindset that socialism and Keynesianism require in order to exist. And – unbelievably — the vast majority of people in the world subscribe to these absurdities.
In response to such thinking, the French economist Frédéric Bastiat created the Parable of the Broken Window – a scenario which demonstrates how preposterous it is to break windows in order to create jobs and encourage the circulation of money.
How can anyone possibly believe such nonsense is actually going to help improve things?
2. Massive Government programs — like Social Security, Medicare, Medicaid, and farm subsidies, just to name a few in the innumerable list of value-destroying components in our economy — are already insolvent. Now the Obama administration wants to implement socialized medicine on a massive scale. It’s the most farcical move, at precisely the wrong moment.
The government shouldn’t be creating more programs; it should be shutting them down! But that’s not what is happening, and we the people are allowing our elected officials to march us directly into insolvency. It’s a simple, exceedingly obvious transaction: politicians offer voters cash, and voters give politicians votes. It is the bane of democracy.
What most voters don’t realize, however, is that the government knows all this, and it will certainly perpetuate these programs the quietest way possible: through inflation — meaning it will print money and maintain easy credit, while increasing pay-outs at a much lower rate. This is just one more reason why I believe large-scale inflationary price-increases are on the way.
3. There has been a lot of talk about the role of mal-investment — in the context of the economic collapse we’re enduring. But nobody’s getting it! When the government creates cheap, or even free money (even though it’s neither “cheap” nor “free”), it encourages people to invest. And because people are investing in things they wouldn’t normally consider, the investments they make are almost certain to be bad. Indeed, in this scenario, everyone in the economy dumps money into assets and services, after which, the prices of these assets and services become artificially expensive. Thus, in this scenario, if you spend money on anything (a home, a car, a computer, tuition, or medical care), it’s impossible not to pay too much — relatively speaking. Artificial demand creates artificial prices.
What results is the classic boom-bust scenario. And what does the government do when the inevitable bust occurs? It prints more “cheap” or “free” money, encouraging yet more mal-investment! And every time the process repeats, it gets more difficult to perpetuate. This cycle has destroyed empires for millennia — including the Roman, British, and Soviet versions thereof. Guess who is next on the list?
Now you’re going to tell me about the low velocity of money – that currency isn’t getting into the economy, because banks aren’t lending. I’m going to reiterate my position on this subject: all that cash and credit is like an ocean pressing against a weak dam, and when it bursts, the tidal wave is going to drive the velocity of money toward the speed of light. The result? Price increases on a scale that developed economies across the globe have never seen. It’s going to be unprecedented. And it’s going to be catastrophic.
4. In 1971, Richard Nixon took the United States off the gold standard. That means the dollar is now fiat – that is to say, it is backed by nothing more tangible than the “full faith and credit” of the United States government. One of the dangers of using fiat money is that the currency is more vulnerable to fluctuations in value. If the U.S. Treasury prints more dollars, the currency will decline in value, relative to everything else.
So, in times like these, if more currency and credit means inevitable price increases — and it does — then by extension, the economy will experience rising interest rates: there is no way to encourage people to buy debt if their rate of return isn’t outpacing inflationary price increases. And since bond prices move inversely to their yields – that is to say, bond prices go up, yields go down, and vice versa – then as inflation drives prices higher, bond yields will rise with them. As such, bond prices will fall.
If the dollar were backed by gold, it would create stability — thereby preventing some of the volatility that might lead to the scenario I just laid out. In 1931, during the depths of the Great Depression, the dollar was pegged to gold, redeemable at a fixed price. And yet in that year — when long-term bond prices were soaring, and their yields reached unprecedented lows (just as they have now) — their prices suddenly turned.
For many months, bond prices subsequently fell, and yields rose. With a relatively stable currency (backed by gold, as the dollar was), this was less prone to happen, so why did it? Yields rose because the Fed and the Treasury were flooding markets with debt and currency (just like they are now). This is, by definition, inflation. And that pushed interest rates higher.
The important thing to note is that, even if a currency is backed by gold, printing vast quantities is still inflationary. It’s like issuing more shares of stock; it’s dilutive, and redemptions only put more pressure on the government’s supply of bullion. But today, the dollar is not backed by gold, so its stability is much more questionable. As governments around the world print more money and sell more debt, there are no mechanisms to stem an upward push in interest rates, as well as yields. Given this context, the Treasury bubble only looks that much more precarious. You might want to think about shorting long-term Treasuries. Or use the double-short ETF, TBT, like I do. It’s a no-brainer.
Related posts:
- Gold is Safer Than Treasuries as a Hedge Against Inflation
- Paul Krugman’s Identity Crisis
- The Real Cause of Inflation
- A Solution for the Financial Crisis, Is America Broke Part III
- The Death of the Dollar
