Bet Your Bottom Dollar

Will the US try to inflate its way out of trouble...?

SO THE CAT IS OUT OF THE BAG, writes Puru Saxena, Hong Kong wealth manager and author of the Money Matters letter.

The Federal Reserve is waging an all-out inflationary war on the economic contraction.

Last week, Ben Bernanke announced that the Federal Reserve would buy $300 billion worth of US Treasuries and another $700 billion worth of government-agency mortgage debt. In order to finance these purchases, the Federal Reserve would simply create this money out of thin air.

It is worth noting that the Federal Reserve has already dropped the Fed Funds Rate to a historically low range below 0.25% and now it is desperately trying to use other unconventional methods (Quantitative Easing) to stimulate the economy. In my view, this latest development of the Federal Reserve monetizing debt is inflationary and confirms that the Federal Reserve wants to debase the US Dollar.

It is also worth noting that the total debt in the US now exceeds $60 trillion and its economy is around $14 trillion. So the US is already bankrupt, and the only way it can ever hope to repay this gigantic sum is through monetary inflation and debasement.

Allow me to explain.

Suppose your grandparents borrowed $100,000 from their friends roughly 50 years ago. Back then, $100,000 was a lot of money and the chances of your grandparents ever repaying this loan were slim at best. However, thanks to monetary inflation and the debasement of the US Dollar, today $100,000 isn't a very large sum of money and your grandparents would find it much easier to repay their debt.

Turning to the present situation, the US owes its creditors a gigantic amount of money and a debt so large that it can never hope of repaying it in today's dollars. So, the US has two options:

• Default or bankruptcy;
• Monetary inflation.

Given the fact that the US is still the world's largest economy, that it owns the world's reserve currency and that it has a democratically elected government, I think we can pretty much rule out the possibility of sovereign default.

Therefore, you can bet your bottom dollar that the US will try its best to inflate its way out of trouble.

Remember, politicians borrow money when it buys them a loaf of bread and they repay it when the same money is worth only one slice. And it is my firm belief that over the years ahead, the US and all other debt-laden nations in the West will engage in massive money-creation in order to debase their currencies and dilute the purchasing power of paper money.

Monetary inflation of this kind is a debtor's best friend, as it makes the debt easier to service and repay. On the other hand, monetary inflation goes against the interests of savers and creditors. Given the fact that most of the developed nations are up to their eyeballs in debt – while the great economic powerhouses of this century so far are net savers – you don't have to be a genius to figure out that monetary inflation is our future.

At present, the global economy is dealing with deflationary forces due to credit contraction in the private-sector. However, even now, total credit in the US is expanding due to rampant borrowing by the US government. So I don't expect deflation to take hold; rather, I anticipate accelerating inflation which has always led to rising asset and consumer prices.

It is worth noting that apart from the Federal Reserve, other nations have also started monetising their debt. Recently, the Bank of England announced that it plans to buy £150 billion worth of its government debt by creating money out of thin air. Needless to say, such a move is inflationary and terrible for the health of the British currency.

Now that we have established why monetary inflation is our future, let us examine which currencies and assets will maintain their purchasing power.

If history is any guide, nations which engage in monetary inflation always diminish the purchasing power of their currency. So, in the years ahead, we can expect currencies in the West to depreciate in terms of purchasing power but the trouble is that none of the fundamentally sound nations want a strong currency either! As the world engages in competitive currency devaluations, I expect all the currencies in the world to lose significant purchasing power against hard assets. Therefore, in the years ahead, precious metals and other commodities with intrinsic value should appreciate considerably. Even the values of fundamentally sound businesses with clean balance-sheets should sky-rocket as a result of inflation.

Contrary to popular opinion, I am of the view that most commodities and stock markets have seen the lows for the entire bear-market and we may be in the early stages of a new cyclical bull-market which could last for a few years. Yes, I am aware that my bullish stance may lead to ridicule from some readers, but I would like to point out that new bull-markets are always born during abject pessimism and skepticism.

Even if some asset prices break to fresh lows in the near-term, I suspect such a move will prove to be a 'head fake' and prices will soon rebound. So if you have a 4 - 5 year investment horizon, now may be a good time to convert some of your temporarily powerful cash into hard assets (precious metals such as Gold Bullion, energy and industrial metals), related producing-companies and sound businesses in the fast-growing Asian economies.

At the current levels, the energy complex looks extremely attractive and should prove to be a fantastic long-term investment. After years of extensive research, I am convinced that the world's oil production is peaking and we are likely to see much higher energy prices in the future. So, investors may want to add to their positions in upstream oil/gas companies and the energy service stocks.

Finally, it looks as though the precious metals complex is becoming over-heated for the short-term. Long-term investors may want to wait for the usual summer correction before adding to their positions in physical Gold Investment and silver.