Today's Money Problem

Restoring consumer confidence is crucial, but using inflation alone will prove a short-term fix...

YOU CAN FOOL ALL of the people some of the time, and some of the people all of the time, notes Julian Phillips of the GoldForecaster.com.

But as you can't fool all of the people all of the time, you can at least discredit the rest who won't be fooled, correct?

Many commentators and analysts are still digesting the outcome of the G-20 meeting in London. Yet if I went to my bank and asked, "May I have another loan? Oh, I know I am terribly over-borrowed already, but could you lend me my entire year's income on top of my present loans?", then they would ask me, "Against what collateral?"

Imagine I then reply "None!"...and try to guess the bank's response. But to top it all I add that "I am your only client and saying no means you'll go bust along with me."

Finally, the banker might crack a smile. But will he hail me as his financial savior, too?

This is what the issue of $1 trillion in US government debt on top of the $12 trillion already issued as guarantees, 'quantitative easing' and the like – already equivalent to the entire production of the US in one year – really represents. Just think of it: Where is the money coming from? What collateral is being given, and on what repayment terms? Isn't the latest round of G-20 stimulus simply another tranche of I.O.U.'s, but this time offered to lift less-developed nations out of a potential depression.

Let's face it, the financial system has broken down and still has not been repaired. Yes, steps are underway to try and restore the system. Yes, the banking system is also being checked to ensure it will be healthy, but something else has not been repaired and remains structurally damaged.

Confidence!

Without this, no matter what mechanics are applied, the repairs won't work. And we are not talking about professionals in finance becoming confident; we are talking about the drivers of the global economies, the consumers. Unless they are confident going forward, they will not spend freely again, but rather save, reduce debt, and remove their vulnerability to suffering a diminished lifestyle from here.

At the moment, repairs to the system are starting at the top not at the bottom. You may reply but homeowners are receiving assistance and seeing a reduction in the threat to their homes. But while this may be true, what we are talking about here is the full restoration of confidence so that the consumer will buy houses again, he will go out and finance cars again, without that sneaky feeling that he could see them foreclosed on or repossessed.

Until that happens don't expect much improvement in the overall national or international economies.

Will the present issues of mountains of money restore confidence? Only with caution, and a retreat into fear can be sparked in just a day or a week. After all, confidence in the banking system has been badly mauled in the last 18 months and presently still stands on the edge of a precipice.

How can the system speed up the process? Through a different kind of fear! With very few choices in the hands of governments and central banks the most obvious way forward is an unpleasant one. But if the consumer is made to believe that his income will rise because of inflation – and that his savings will be further decimated by inflation, too – then he will stop saving and start spending, if only to gain value through the rising prices that his house and perhaps his car will enjoy through inflation. That would be a quicker process, moving at the same speed as inflation.

We don't advocate this path at all, but there has to be a policy of saving what can be saved and letting go of that which cannot be saved, and savers will be the victims as their wealth is erased. (That is unless they switch to precious metal now, Buying Gold or silver to shield themselves from inflation. We do expect to see this happen, but sad to say, most investors just don't know gold and silver.) Until the powers that be accept that the system is structurally faulty and rectify this, the path ahead will not be clear.

Such a course will produce convincing benefits. The consumer would see the burden of debt drop as inflation pushed his income up and that sufficient for him to repay debt quicker. Institutional debt would face the same outcome enabling the system to produce a larger after-tax, cash flow and lowering of debt ratios. Yes, it would be tough on those who live on past savings, unless they hold these in the unprintable precious metals. Unfortunately the dangers are so vivid that this may well be taken as collateral damage, as was the case in the past.

In the Sixties through the Eighties, debt re-scheduling was used in the same way to the point where such bad debt was written off and ceased to be a threat to the banks. A similar path can be followed speeded up by inflation. Toxic assets will have to be "contained" until that process is well underway, emasculating such toxicity. As inflation scythes it way through debt (and the mountains of debt we now see with the lenders of last resort have never been seen before) so confidence, most likely misplaced, will be restored as the threats hanging over the consumer diminish.

Thus the printing of money serves a dual role:

• Restore the system, if only in the short-term;
• Pressure the consumer into spending again.

Remember the target remains the consumer, so that inflation must encourage spending out of both fear and the preservation of value.

However, the entire experience of the last two years will not be erased. The system has broken down and can't be fixed in this way. All the moves to date simply restore the system to a workable one. Genuine confidence, the sort that inspires hope in the future, has gone.

What is most concerning is the way the market is receiving bad news in dribs and drabs. We are aware that another $500 billion in write-downs is on the way and that the process of new liquidity flowing to trouble spots is usually inefficient, so we must expect more shocks to the system. But that takes away a bit more confidence each time and belittles any efforts made to repair the system. Can a resuscitation of confidence take place in this environment?

The consumer driven growth has been found to be wanting. It engendered a "Live now, Pay later" attitude, which has now become "lived once, now paying". And in the current environment the consumer doesn't harbor dreams of wealth beyond his means, he is in survival mode.

How can one get the system right without the traumas that usually attend system reformation? Only if the short-term answers have produced an environment that takes away the traumas at the lowest common denominator of consumer, the blue collar worker level.

In the Great Depression of the 1930s the consumer was revived through infrastructural spending, where he would simply be paid to work, even if that work produced few goods. In China today the government has instituted massive infrastructural projects to keep workers busy and paid. This process must be on-going until confidence is restored, but across the entire world!

One economy from history, millenniums ago, had laws that had debt written off every seven years, with property being returned to it original owners every fifty years. This prevented the building of banking and property empires and spread wealth more evenly through the nation, bringing integration to that society that made it survive and prosper on a broad front. In that economic system there was no mass production, no mass distribution system and no unemployment because of that.

But there is little will to change the current system into anything that produces that sort of result. The focus is now on to get our consumer driven system with its financial empires, restored to what it was. This implies it will remain vulnerable to what it has already experienced.

Consequently, wise investors have to take precautions against the potential damage they may suffer. Leveraged investing with time limits will be seen as what it is, gambling! More and more, investments will be fully paid for up-front and short-term investments relying on short-term results will be seen as unacceptably risky. The prudence of investments in assets that are at the same time assets and cash, such as gold and silver, will come firmly back into fashion and institutional portfolios.

We here at GoldForecaster.com cannot emphasize enough the dangers of the inflation that lies ahead. Gold Investment has yet to have its day.