Before I get started tonight, take a look at this discussion from CNBC this morning around market manipulation. I was pleasantly surprised that this was discussed in such detail. The market commentators almost talk as if its a foregone conclusion that the Fed is pumping up the markets via the banks.
A hat tip to Itulip for the charts. Now before I get into this let me start off by saying that I am not entirely sold on this thesis. However, hyperinflation is increasingly becoming a formidable threat unless the Fed changes its ways.
Inflation/Deflation is going to come down to one question here folks: How does the Fed react when this debt bubble collapses? The collapse of the debt bubble is the one variable that WILL happen at some point. We simply don't have the money to service the interest payments on the trillions in debt we have built up over the past 25 years.
We will go boom. The question is whats next?
Argentina faced a very similar crisis earlier this decade. Unemployment soared to 20% by 2001 and peaked at 24% in 2002. The government reacted with a large spending plan just like we saw here. The government's debt load eventually began to pressure the currency as its creditors started to doubt whether or not the country had the ability to pay back its debts.
As the deficits grew and grew, eventually the currency violently collapsed and dropped in value by 73% in a matter of months as the world lost confidence in Argentina's Peso:
You would think with 20% unemployment, Argentina would have seen a massive deflationary spiral like we saw during The Great Depression. If the government had approached Argentina's crisis with a proper fiscally sound policy response in the form of increased spending(to a point!) from the government, they most likely would have just seen deflation.
Sadly, the government chose the helicopter route and paid for it dearly as the whole country collapsed.
All bets are off if your turn yourself into a bailout nation and spend more money then you can ever payback. As you can see below, the world seems to have taken a much different approach this go around then we did during the 1930's.
It's eerily similiar to the Argentina's approach:
As you can see above, in the 1930's we increased our spending but only to a point. Ben believes this less agressive reponse by the Fed is where the mistakes were made during The Great Depression. As a result, this go around we have decided to throw money out of helicopters globally in an attempt to flood the system with trillions in liquidity.
As a result, Inflation should become more of a threat this go around because the Fed has been aggressively spending since the start of this crisis. Deflation ruled throughout the 1930's. However, inflation did tick up a bit towards the end as we began to run large deficits.
CPI actually dropped to -4%(deflation) at one point as unemployment soared to 20%. However, once the currency collapsed inflation soared a whopping 120% in just a matter of months! Prices screamed higher as a result because no one believed the Peso was worth the paper it was printed on because the government had spent themselves into default.
Now they say our situation is different over here(Gee..Think I have heard that line before) because the US dollar is the world's currency. As a result, many of the pros think the US dollar could never collapse. I'm sorry folks but I don't know if I buy this.
We are now TRILLIONS in debt. I don't see how we ever possibly pay it back without destroying this country economically. We must stop spending HERE AND NOW in order to have a shot.
The risk that we run by carrying these massive deficits is that the world may begin to lose CONFIDENCE in our dollar. They may decide creating an alternative like a basket of the world's currencies may be best in the long run. We are already seeing signs that the world is losing confidence in our dollar...BRIC summit anyone? Folks, If the world bails, the dollar just might become the new Yen.
Its pretty frightening when you look at the data used to measure our fiscal health. I mean just look at how ridiculous bank borrowing from the Federal Reserve has gotten in the past couple years versus history. This is a fiscal nightmare!:
I don't see how we avoid a bout of inflation with all of this money floating around. My concern is the Fed can't pull this liquidity because the economy will collapse almost immediately as unemployment soars past 10%.
This means the Fed is basically stuck between a rock and a hard place. If they pull liquidity, rates go up and an already deeply damaged economy blows up. If the Fed doesn't pull liquidity and continues to flood the system with money, we run the severe risk of seeing inflation like we've never seen before. We will also run the risk of collapsing our currency which then puts hyperinflation on the table.
This is too tough a call in my opinion. The Fed is basically screwed either way. Inflating out of debts has historically been seen more often then deflation. My common sense side says deflation prevails, but i cannot be more certain until the Fed proves to me that they will pull liquidity and show a willingness to allow things to fail. I have seen no signs of this to date.
As a result, diversification is a MUST here IMO. I can't stress that enough. I am not totally sold on inflation or deflation. Prepare for both. This means owning hard assets to hedge against inflation. Shorting stocks, holding dollars, and paying off your debts is the best way to protect yourself from deflation.
I pray that deflation prevails because I don't think anyone in this country is prepared for inflation. We are a nation of debt slaves that's totally broke. If prices go up as a result of catastrophic inflation, social chaos will be right around the corner.