Wednesday, May 16, 2012
By Harry S. Dent Jr., Editor, Survive & Prosper
OK, he doesn’t owe me a dollar yet… but he will… at the end of the decade…when I prove him wrong.
Recently, I had the pleasure of being a guest on Porter’s radio program. We covered a lot of topics, most of which we agree about. But then came the big one. Gold. This is where we stood on opposite ends of the spectrum.
Porter sees gold zooming to the moon as the U.S. goes through hyper-inflation. My view is that gold will experience – and has experienced already – a huge bull run as we approach the edge of the crisis that lies ahead. But then gold will slide dramatically once our mountain of debt begins to crumble.
I don’t think we’ll have hyper-inflation. Instead, I see deflation, which will raise the value of the U.S. dollar. Anyone setting themselves up for a huge run in prices, especially in commodities, will be dead wrong and they’ll be left with a handful of assets with diminishing values.
Why Deflation and Not Inflation?
Well, it all hinges on what we, as a society, will allow. I think thatU.S.and world investors will force the Federal Reserve,U.S.banks and theU.S.government back to a more responsible position, especially given the fiasco inJapanand now the euro zone.
Now, I’m not under any illusion that the institutions currently acting so irresponsibly will go quietly! They’ll go kicking and screaming. Politicians will lose power and clout. The Fed will lose its semblance of control. Big banks will lose much of their ability to pay big, fat bonuses.
But the alternative is worse. If they don’t reform, politicians will be run out of town… the Fed will be called on the carpet by new, ideological Congressman… and the executives of big financial institutions will be forced to resign.
What will cause all of this? Actually, it’s more of a “who” than a “what.” And the answer is: all of us, particularly those of us who invest in fixed income and those of us who vote.
As I’ve outlined in my research, the natural course of events, after a huge run up in debt and credit, is for the bubble to burst. This brings with it a reduction in debt and credit. That makes sense.
Unfortunately, to wring credit out of an economy requires pain. Shrinking credit means falling consumption, which leads to falling prices and therefore falling wages. As people earn less their standard of living falls.
The good that comes out of this is a reduction in debts (as credit is paid down or written off) and a fall in prices to more manageable levels. But it takes time. And, as I said, it’s painful.
In the U.S., the federal government has increased its annual deficit and overall debt dramatically in the last few years. It’s been taking on more than $1 trillion a year in new debt since 2008. This is awful because it increases the burdens we, as taxpayers, have to carry… and there have been no productive gains made to show for it!
At the same time, the Federal Reserve has been printing trillions in new dollars out of thin air, desperately trying to force lenders to lend and borrowers to borrow.
So, Has the Fed Stopped Deflation?
If you look at the consumer price index, it would appear it has. Those numbers show that we have inflation.
But, if you look at the largest asset in most people’s portfolios – their home – prices are still falling.
And how about wages? Yep, they’re also still falling.
The truth is, the U.S. government and the Federal Reserve have engineered a very painful situation where they’ve caused our cost of living to rise while failing to push up the prices of our homes or create more, good-paying jobs. This doesn’t even begin to address the outrageous behavior of holding down long-term interest rates, which just adds insult to injury.
But, investors are not stupid. Neither are voters. We recognize that the U.S. government and the Fed have traveled down a dangerous path. That’s why calls for greater fiscal responsibility are growing louder. So are the calls for the Fed to get out of the interest-rate-manipulation business and allow the markets to set the proper rates. This would presumably mean a bump up in interest rates until our own austerity kicks it – which it must – to allow for the deflation of the still exorbitant credit bubble.
Of course, typically the markets would be punishing a country such as ours for engaging in such reckless financial behavior (printing money, huge deficits, etc.). They’d be selling our bonds and currency as fast as they could. But, so far, that hasn’t happened. It’s not because the world loves us, or everyone wants us to succeed. It’s simply because there isn’t much choice.
You see, the other two large buckets of currency and debt on the planet are the euro zone and Japan. Which one of those would you like to have in your wallet? Exactly. If the choice is a yen, a euro or a buck, most people would gladly – and quickly – grab the dollar.
The poor management of the euro and yen has been a tremendous boon to the value of the dollar, which has allowed our federal government and the Fed to experiment (and yes, these were experiments) with Keynesian economic responses like printing and deficits. So we escaped what should have been a falling currency and rising interest rates.
Now, here we stand, at the edge of another fiscal cliff.
Financial markets are spooked by the problems in Europe and the lack of growth in the U.S. Housing is not turning higher. The pool of foreclosed and unsold homes continues to grow.
Unemployment has moved lower, but only because people are leaving the workforce. Wages are stagnant. Benefits are falling.
The policies of the last few years have not worked. It’s time for a different approach. It will happen and it won’t be fun, but at least it will finally be a step in the right direction.
There is No Alternative
The only thing that will cure what ails the U.S., and most of the developed world, is a trip to the debt detox center. We need to kick the habit of simply taking on more debt every time we feel pain.
It will be difficult, but the end result will be an economy that has deflated enough to allow for quality growth and opportunities for the next generation.
The alternative? Turning Japanese. That’s no alternative at all.
Which brings me back to my dollar…
Porter and I could not agree less about the path the U.S. will take. He sees the U.S. continuing to pursue reckless policies, which we, as investors, citizens and voters, simply accept… following the pied piper. This will lead to the eventual ruin of our currency and presumably our financial system, wrecking the wealthiest society in the world. One of the ways to protect yourself, under this scenario, is to own gold, and lots of it.
My view is that investors, citizens and voters will recognize – and in fact have already begun to recognize – that the policies the U.S. government has employed are flawed. They have not solved our issues. They’re only adding to our problems. Taking on debt does not fix a debt problem! It only creates more problems.
As the U.S. curbs its appetite, the amount of credit in our system will shrink. At the same time, other countries will continue to implode. The result will be a rise in the value of the dollar and a fall in the price of commodities in response to both the dollar’s climb and the drop in overall economic activity.
Gold, which is certainly a safe haven, enjoys a good run on the way to calamity. But once the deleveraging begins in earnest, gold will act like all other commodities and as a result gold falls.
Don’t believe me? Trace the value of gold during the fall of 2008 and the spring of 2009. After an incredible run, gold dropped like a rock (no pun intended). Yes, it has recovered, but what will happen in the next phase of the crisis? More deleveraging. More running to the U.S. dollar for safety. More pain for gold.
And I will be one dollar richer.