Hyper-stagflation© - This newly minted term is fixed wages due to lack of pricing power resulting from globalization combined with the devaluation of the dollar combined with rising consumption costs and higher borrowing costs. This is the economic version of the bogie-man in the basement that your parents always warned you about.
The missing link between where we are today, what we must go through and where we will be is the delta between 2010 and 2011 US Budget actual and estimates.
Estimates are for a deficit of $1.3T in 2010 rest entirely upon 2010 being a recovery year and an improvement in GDP. If this does not happen, and it does not look as if it will, budget gaps will widen, the dollar will be pressured and borrowing will become more costly. As borrowing costs increase, so will the budget gap widen further.
The Federal Reserve will become the lender of last resort.
However, until this happens, the economy will feel “normally sluggish” for a few months. Markets will be choppy. Some days it will feel like a recovery and others not so much. New and unexpectedly high unemployment will persist and the costs of increasing employment artificially with government jobs will further balloon the deficit. New stimulus plans will add additional burden. January 1, 2011, taxes will revert to pre-Bush cuts and the economy will now face a dramatic drop in disposable income that will accelerate this cycle.
The result will be less private sector jobs, health care costs pushed onto government, state and local governments relying upon federal bailouts and we will have passed our “Peak Lifestyle©” with declining disposable incomes, fewer private sector jobs, dramatically increasing debt at all levels of government and fewer tools for the FED and the Treasury to use. Any future social benefits from the government will be in dollars will declining purchasing power.
We have already reached unsustainable debt levels at all levels of government and these debts will increase at an increasing rate. After all, we don’t want rioting in the streets do we?
The governments must now figure out what benefits to cut and to whom to cause the least likelihood of rioting in the streets. Any guess as to whether benefits for older or younger Americans will be cut? And guess as to whether healthy or not so healthy American’s benefits will be cut? It is all about who will react most violently and who are the most productive. Just as Zeke Emmanuel (more on him later but look him up now…no, really, right now…and look at his “life cycle curve”). Let’s hope that you are not very young, very old, unproductive or sick.
The key is to look to assets not directly linked to the dollar…the Australian, Canadian and Swiss currencies, gold, silver, etc. Be cautious of the Australian Dollar as they are directly linked to the prosperity of China and China is just now facing their own massive banking crisis with vast amounts of bad real estate loans yet unreserved for. Canada is linked to the US and may face their own problems. The Swiss economy is fragile. There are not many sure bets out there over the long term except for gold but there will be great values if you have quick reactions and don’t listen to the drumbeat of the perma-bulls on TV and radio and from our own government and the entirely independent Federal Reserve. Remember, they are selling PMA – Positive Mental Attitude – not reality.
Of great importance is that you must focus upon purchasing power and wealth preservation. If everything goes down but you go down less, you win. Paper is still paper and US paper is still the most at risk. Going to cash (including non-TIP treasuries) is your first instinct for safety (as you have always been taught). But this will be a trap mid-term. Going to non-US related cash and cash equivalents (including the ultimate currency, gold) will be essential.
One thing you cannot do is to pull out of all investments and stay in US cash. Cash will decrease in purchasing power and we want to preserve purchasing power. That requires that you stay invested but you must improve your investment strategy and the speed with which you adopt and proactively act. Speed is critical in this worldwide game of investment musical chairs. To win, you must be right and fast and you must look further into the future and ignore the noise around you. You must act on conviction and not on whim.
The wild card is world conflict. If it is regional, the US dollar and treasuries will see an improvement but will ultimately succumb. The likely area of conflict is the Middle East. The Korean Peninsula is a second possibility but the key is whether or not it is a nuclear exchange. A nuclear exchange and all bets are off. Non-nuclear and it is manageable.
Assuming conflict will not escalate, the tealeaves are cast for the US on its current path and with the current administration. State, regional and local governments are bankrupt, tax burdens will increase and jobs and investment will suffer. Unions will be rescued and national healthcare for all is just about here but no one has thought through to the end game. That endgame will be here sooner than you might think.
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