RBS tells clients to prepare for 'monster' money-printing by the Federal Reserve

As recovery starts to stall in the US and Europe with echoes of mid-1931, bond experts are once again dusting off a speech by Ben Bernanke given eight years ago as a freshman governor at the Federal Reserve.

By Ambrose Evans-Pritchard,
The Daily Telegraph
International Business Section
27 Jun 2010
68 Comments

Entitled "Deflation: Making Sure It Doesn’t Happen Here", it is a warfare manual for defeating economic slumps by use of extreme monetary stimulus once interest rates have dropped to zero, and implicitly once governments have spent themselves to near bankruptcy. The speech is best known for its irreverent one-liner: "The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost."

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Bernanke began putting the script into action after the credit system seized up in 2008, purchasing $1.75 trillion of Treasuries, mortgage securities, and agency bonds to shore up the US credit system. He stopped far short of the $5 trillion balance sheet quietly pencilled in by the Fed Board as the upper limit for quantitative easing (QE). Investors basking in Wall Street's V-shaped rally had assumed that this bizarre episode was over. So did the Fed, which has been shutting liquidity spigots one by one. But the latest batch of data is disturbing. The ECRI leading indicator produced by the Economic Cycle Research Institute plummeted yet again last week to -6.9, pointing to contraction in the US by the end of the year. It is dropping faster that at any time in the post-War era. The latest data from the CPB Netherlands Bureau shows that world trade slid 1.7pc in May, with the biggest fall in Asia. The Baltic Dry Index measuring freight rates on bulk goods has dropped 40pc in a month. This is a volatile index that can be distorted by the supply of new ships, but those who watch it as an early warning signal for China and commodities are nervous. Andrew Roberts, credit chief at RBS, is advising clients to read the Bernanke text very closely because the Fed is soon going to have to the pull the lever on "monster" quantitative easing (QE)". "We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable," he said in a note to investors. Roberts said the Fed will shift tack, resorting to the 1940s strategy of capping bond yields around 2pc by force majeure said this is the option "which I personally prefer". A recent paper by the San Francisco Fed argues that interest rates should now be minus 5pc under the bank's "rule of thumb" measure of capacity use and unemployment. The rate is currently minus 2pc when QE is factored in. You could conclude, very crudely, that the Fed must therefore buy another $2 trillion of bonds, and even more if Europe's EMU debacle goes from bad to worse. I suspect that this hints at the Bernanke view, but it is anathema to hardliners at the Kansas, Richmond, Philadephia, and Dallas Feds. Societe Generale's uber-bear Albert Edwards said the Fed and other central banks will be forced to print more money whatever they now say, given the "stinking fiscal mess" across the developed world. "The response to the coming deflationary maelstrom will be additional money printing that will make the recent QE seem insignificant," he said. Despite the apparent rift with Europe, the US is arguably tightening fiscal policy just as hard. Congress has cut off benefits for those unemployed beyond six months, leaving 1.3m without support. California has to slash $19bn in spending this year, as much as Greece, Portugal, Ireland, Hungary, and Romania combined. The states together must cut $112bn to comply with state laws. The Congressional Budget Office said federal stimulus from the Obama package peaked in the first quarter. The effect will turn sharply negative by next year as tax rises automatically kick in, a net swing of 4pc of GDP. This is happening as the US housing market tips into a double-dip. New homes sales crashed 33pc to a record low of 300,000 in May after subsidies expired. It is sobering that zero rates, QE a l'outrance, and an $800bn fiscal blitz should should have delivered so little. Just as it is sobering that Club Med bond purchases by the European Central Bank and the creation of the EU's €750bn rescue "shield" have failed to stabilize Europe's debt markets. Greek default contracts reached an all-time high of 1,125 on Friday even though the €110bn EU-IMF rescue is up and running. Are investors questioning EU solvency itself, or making a judgment on German willingness to back pledges with real money? Clearly we are nearing the end of the "Phoney War", that phase of the global crisis when it seemed as if governments could conjure away the Great Debt. The trauma has merely been displaced from banks, auto makers, and homeowners onto the taxpayer, lifting public debt in the OECD bloc from 70pc of GDP to 100pc by next year. As the Bank for International Settlements warns, sovereign debt crises are nearing "boiling point" in half the world economy. Fiscal largesse had its place last year. It arrested the downward spiral at a crucial moment, but that moment has passed. There is a time to love and a time to hate, a time for war and a time for peace. The Krugman doctrine of perma-deficits is ruinous - and has in fact ruined Japan. The only plausible escape route for the West is a decade of fiscal austerity offset by helicopter drops of printed money, for as long as it takes. Some say that the Fed's QE policies have failed. I profoundly disagree. The US property market - and therefore the banks - would have imploded if the Fed had not pulled down mortgage rates so aggressively, but you can never prove a counter-factual. The case for fresh QE is not to inflate away the debt or default on Chinese creditors by stealth devaluation. It is to prevent deflation. Bernanke warned in that speech eight years ago that "sustained deflation can be highly destructive to a modern economy" because it leads to slow death from a rising real burden of debt. At the time, the broad money supply war growing at 6pc and the Dallas Fed's `trimmed mean' index of core inflation was 2.2pc. We are much nearer the tipping today. The M3 money supply has contracted by 5.5pc over the last year, and the pace is accelerating: the 'trimmed mean' index is now 0.6pc on a six-month basis, the lowest ever. America is one twist shy of a debt-deflation trap. There is no doubt that the Fed has the tools to stop this. "Sufficient injections of money will ultimately always reverse a deflation," said Bernanke. The question is whether he can muster support for such action in the face of massive popular disgust, a Republican Fronde in Congress, and resistance from the liquidationsists at the Kansas, Philadelphia, and Richmond Feds. If he cannot, we are in grave trouble.

Uncertainty Restores Glitter to an Old Refuge, Gold

By NELSON D. SCHWARTZ
The New York Times
June 13, 2010

It is the resurgent passion of the doomsday crowd, a bet that everything will go wrong. No matter what has you worried, they say, the answer is gold. Inflation, deflation, government borrowing or the plunging euro — you name it — the specter of these concerns has set off a dash to gold, driving the precious metal to new highs and illustrating how fears of economic turmoil have moved from the fringe to the mainstream. And gold bugs, often dismissed as crackpots who hoard gold bars in the basement, are finally having their day. “I just think you’re in a world where a lot of chickens are coming home to roost,” said John Hathaway, manager of the Tocqueville Gold fund. “Gold is an escape hatch.” The most visible new gold enthusiasts range from the Fox News commentator Glenn Beck on the right to the financier George Soros on the left, with even some sober-minded Wall Street types developing a case of gold fever. While their language may differ, they share a fundamental view that the age-old refuge of gold is relevant again, especially as other assets like stocks and national currencies show signs of weakness. Now, individual investors are following their example around the world. The United States Mint is running short of gold coins, and the South African mint increased Krugerrand production by 50 percent late last month, to its highest level in 25 years, on brisk European demand. The debt crisis in Europe and the ensuing drop in the value of the euro are the most recent catalysts for gold’s spike last week to $1,254 an ounce, a record before adjusting for inflation, but the deeper concern is that even in the United States, government borrowing is unsustainable and the day of reckoning is at hand. Sales of American Eagle one-ounce gold coins tripled in May from the month before. If governments print more money to pay off their debts, the logic goes, inflation will destroy the value of the dollar, the euro and other paper currencies — thus enhancing the value of gold. What is more, with tax increases unlikely and with Europe on the brink, the unthinkable — a sovereign debt default or the collapse of the credit system — has suddenly become thinkable. To be sure, gold buyers have always been motivated by fear. What has changed is that some of the most respected investors on Wall Street are now among the fearful. “In recent years, we have gone from one bubble and bailout to the next,” David Einhorn, a New York money manager who was among the first to foretell the failure of Lehman Brothers, said in a speech last month. “Our gold position reflects our concern that our fiscal and monetary policies are not sufficiently geared toward heading off a possible crisis.”

Since ancient times, gold has been deemed intrinsically valuable, holding its worth even as governments fell and currencies collapsed, while seemingly casting a spell on its owners. Still, gold can go down — sometimes sharply. After peaking in 1980 at more than $800 an ounce, gold sank over the next two decades, bottoming out at just over $250 an ounce in 1999. But unlike paper assets that can become worthless, gold always retains at least some value. These days, gold is also something of a political Rorschach test. On conservative talk radio, opposition to the Obama administration’s economic policies and warnings that huge budget deficits will set off runaway inflation have made gold a hot topic of on-air discussion — and lured gold companies as advertisers. Tongue only half in cheek, Glenn Beck advised his audience to consider “Gold, God and Guns,” while laying out three possible scenarios for the economy: recession, depression or collapse. One major advertiser on Mr. Beck’s show is Goldline, a huge California marketer of gold coins and bars that is also a sponsor of programs hosted by other prominent conservative commentators like Laura Ingraham and Mike Huckabee. Mr. Beck has said he “was a client of Goldline long before they were a client of mine,” adding: “I personally don’t buy gold as an investment. I buy it for protection.” Of course, the right hardly has a monopoly on gold. Mr. Soros, a prominent donor to liberal causes and candidates, holds more than $600 million in bullion and gold mining shares. Even as worries about the global economy have intensified, gold has become easier to buy. Although some people still regard bars of gold in a vault as the ultimate insurance policy, exchange-traded funds, or E.T.F.’s, that hold gold have exploded in popularity in recent years. Gold E.T.F.’s, which trade like stocks but track the price of physical gold, account for 1,856 tons of gold, up from less than 500 tons in 2005, according to Credit Suisse. Besides luring individual investors, these funds have also made gold more appealing to hedge funds and other institutions, allowing them to own vast amounts of gold without the burden of having to store it. John A. Paulson, a top New York hedge fund manager who earned billions betting against subprime mortgages, holds $3 billion worth of gold E.T.F.’s, making gold the largest single position in his $35 billion portfolio. Daniel J. Arbess, who manages more than $2 billion in Perella Weinberg’s Xerion fund, is another new gold lover. A few years ago, he said, he would not have taken a second look at gold as an investment. But now Mr. Arbess, a Harvard Law graduate and a generally conservative investor, is very serious about gold. Spiraling deficits in the United States, Japan and Britain are unsustainable, he said, and could eventually hurt confidence in what are called “fiat currencies” — paper money not backed by gold, including the United States dollar. “Indebted countries may soon be forced to choose among three politically difficult alternatives: sharp cuts in expenditures, debt default or printing money to pay off debt,” he said, with the last option the most likely outcome. Gold, he said, is a logical hedge against this risk, because firing up the printing presses ignites inflation. True believers note that gold has risen in each of the last nine years, and that while the Standard & Poor’s 500-stock index is down 13 percent since 2001, gold is now worth nearly five times what it was then. For all its newfound respectability, gold still manages to bring out the inner survivalist in its adherents. Gold bugs like Peter Schiff of the investment firm Euro Pacific Capital in Westport, Conn., envision a black market arising in the United States, with merchants refusing paper money and insisting on gold instead, while Mr. Hathaway, the gold fund manager, says the credit system has entered “the end game.” “People probably still think I’m nuts,” Mr. Hathaway said. “But I’m not talking to myself in an isolation chamber anymore. We’ve got company now.”

Bernanke Puzzled by Gold Rally

The Wall Street Journal
June 9, 2010
Federal Reserve Chairman Ben Bernanke says he’s a bit puzzled by surging gold prices. The 30% rally from a year ago, on top of gains in previous years, might be interpreted as a loud signal from markets that big inflation pressures are building in the U.S. Gold is seen by many investors as a hedge against inflation risk. In this case, it might instead be a risk against risk broadly. Mr. Bernanke notes that the inflation signal isn’t confirmed by movements in other asset classes. Yields on Treasury bonds tend to rise when investors worry about inflation, but those yields have been falling recently. Inflation expectations as measured in Treasury Inflation Protected Securities (TIPS) markets remain low. And other commodity prices are falling. Gold is breaking records, but copper prices are down 17% so far this year. “I don’t fully understand movements in the gold price,” Mr. Bernanke admitted. But he suggested it might be another example of investors fleeing risky assets and flocking to assets that are perceived as less risky, not only Treasury bonds, but also ones like gold.

Bernanke Warns of ‘Unsustainable’ Debt

New York Times, June 9, 2010

WASHINGTON — When it comes to the deficit, Ben S. Bernanke has a story, and he’s sticking to it. Mr. Bernanke, the Federal Reserve chairman, warned on Wednesday that “the federal budget appears to be on an unsustainable path,” but also recognized that an “exceptional increase” in the deficit had been necessary to ease the pain of recession. In nearly two hours of questioning by the House Budget Committee, however, Mr. Bernanke gave potential succor to members of both parties, while refusing to side with either of them. To Republicans, he offered warnings about the fiscal perils of an aging population and the potential threat of soaring long-term interest rates. To Democrats, he made it clear that persistently high unemployment was a drag on growth and said that additional short-term stimulus spending might be needed. All the while, Mr. Bernanke refused to endorse any particular spending cuts or tax increases, or even specify the balance between the two. And he was not subtle about his strategy. “I’m trying to avoid taking sides on this because it’s really up to Congress to make those decisions,” he told Representative Michael K. Simpson, Republican of Idaho. “But we need your expertise on it,” Mr. Simpson pressed. “Well, no,” Mr. Bernanke replied. “Plenty of people have that kind of expertise, including the Congressional Budget Office and others.” With inflation well below the Fed’s unofficial target of about 2 percent, attention has turned to the other side of the central bank’s mandate: maximizing employment. At the same time, the debt crisis roiling Europe has made deficit-cutting a potent topic. Mr. Bernanke suggested that the United States had a while longer — but not much — before it would have to pull in the reins. “This very moment is not the time to radically reduce our spending or raise our taxes, because the economy is still in a recovery mode and needs that support,” Mr. Bernanke told Representative Bob Etheridge, Democrat of North Carolina. In the next breath, however, he added that continuing deficits risked a “potential loss of confidence in the markets.” Representative Paul Ryan of Wisconsin, the top Republican on the committee, focused his opening statement on Europe. “What we are watching in real time is the rough justice of the marketplace and the severe economic turmoil that can be inflicted on profligate countries mired in debt,” he said. But if Mr. Ryan had hoped for similarly dire pronouncements from Mr. Bernanke, he was disappointed. “If markets continue to stabilize, then the effects of the crisis on economic growth in the United States seem likely to be modest,” Mr. Bernanke testified. “Although the recent fall in equity prices and weaker economic prospects in Europe will leave some imprint on the U.S. economy, offsetting factors include declines in interest rates on Treasury bonds and home mortgages, as well as lower prices for oil and some other globally traded commodities.” Representative Jeb Hensarling, Republican of Texas, cited the research of the economist Carmen M. Reinhart, who has found that growth tends to stall in countries where the national debt reaches 90 percent of gross domestic product. The United States is at just about that threshold. “I don’t think there’s anything magic about 90 percent,” Mr. Bernanke said, while noting that in the worst-case projections by the Congressional Budget Office, “debt and interest payments are going to get explosive in 10 or 15 years.” When Representative Jim Jordan, Republican of Ohio, asked Mr. Bernanke to “talk to me about those tax increases that we know are going to happen,” Mr. Bernanke replied: “We have a recovery under way now. So in the very near term, increased taxes, cuts in spending, that are too large would be a negative, would be a drag on the recovery.” But he reiterated that “I’m not going to try to adjudicate for Congress” between tax and spending measures. Mr. Bernanke’s nimbleness in navigating deficit politics reflects his position as the most visible bridge between two administrations, having been appointed by President George W. Bush in 2006 and then reappointed by Mr. Obama to a second four-year term.
Mr. Bernanke has seemed more optimistic, or at least confident, since the crisis peaked in 2008. “As long as we have the confidence of the markets that we will be able to exit from this situation with a sustainable fiscal program, then I think we’ll be O.K.,” he told Mr. Simpson of Idaho.
How long that confidence will last, Mr. Bernanke did not say. Only after several rounds of back-and-forth did he agree with Representative Chet Edwards, Democrat of Texas, that tax cuts do not entirely pay for themselves. And he danced around with Representative Gerald E. Connolly, a Virginia Democrat, on whether the Obama administration’s $787 billion stimulus package last year was “necessary.” Mr. Bernanke would only say it was “useful.” “It must be nice to be an economist,” Mr. Connolly replied.

U.S.’s $13 Trillion Debt Poised to Overtake GDP

By Garfield Reynolds and Wes Goodman

June 4 (Bloomberg) -- President Barack Obama is poised to increase the U.S. debt to a level that exceeds the value of the nation’s annual economic output, a step toward what Bill Gross called a “debt super cycle.” The CHART OF THE DAY tracks U.S. gross domestic product and the government’s total debt, which rose past $13 trillion for the first time this month. The amount owed will surpass GDP in 2012, based on forecasts by the International Monetary Fund. The lower panel shows U.S. annual GDP growth as tracked by the IMF, which projects the world’s largest economy to expand at a slower pace than the 3.2 percent average during the past five decades. “Over the long term, interest rates on government debt will likely have to rise to attract investors,” said Hiroki Shimazu, a market economist in Tokyo at Nikko Cordial Securities Inc., a unit of Japan’s third-largest publicly traded bank. “That will be a big burden on the government and the people.” Gross, who runs the world’s largest mutual fund at Pacific Investment Management Co. in Newport Beach, California, said in his June outlook report that “the debt super cycle trend” suggests U.S. economic growth won’t be enough to support the borrowings “if real interest rates were ever to go up instead of down.” Dan Fuss, who manages the Loomis Sayles Bond Fund, which beat 94 percent of competitors the past year, said last week that he sold all of his Treasury bonds because of prospects interest rates will rise as the U.S. borrows unprecedented amounts. Obama is borrowing record amounts to fund spending programs to help the economy recover from its longest recession since the 1930s. “The incremental borrower of funds in the U.S. capital markets is rapidly becoming the U.S. Treasury,” Boston-based Fuss said. “Do you really want to buy the debt of the biggest issuer?”

To contact the reporters on this story: Garfield Reynolds in Sydney at greynolds1@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net.

Could the US become a "Banana Republic"?

WASHINGTON (CNN) – A leading fiscal mind on Capitol Hill and a one-time Obama Cabinet pick sounded the alarm Sunday over the projected long-term financial challenges the country faces. “This deficit is driven by us,” New Hampshire Republican Sen. Judd Gregg candidly said Sunday on CNN’s State of the Union when asked about the federal government’s projected $1.42 trillion operating deficit for the 2009 fiscal year. “You talk about systemic risk. The systemic risk today is the Congress of the United States,“ the Ranking Republican on the Senate Budget Committee told CNN Chief National Correspondent John King, “that we’re creating these massive debts which we’re passing on to our children. We’re going to undermine fundamentally the quality of life for our children by doing this.” “Now you can’t blame that on [former President] George [W.] Bush,” Greg said, noting that using the Obama administration’s projections the budget deficit for the next ten years is $1 trillion per year. And Gregg said that during the same ten-year period, public debt as a percentage of gross domestic product would increase from 40 percent - which Gregg called “tolerable but still too high” - up to 80 percent. The figures, Gregg told King, “mean we’re basically on the path to a banana-republic-type of financial situation in this country. And you just can’t do that. You can’t keep running these [federal] programs out [into the future] and not paying for them. And you can’t keep throwing debt on top of debt.” “Standards of living will drop if we keep this up,” Gregg also said.After repeated promises from the White House that the final health care reform bill will be deficit neutral, Gregg said a Democratic plan to avoid otherwise automatic Medicare cuts without having a funding source for the projected expense of $250 billion over the next decade was “gamesmanship.” Asked about criticism leveled Sunday by former Republican-turned-Democrat Sen. Arlen Specter of Pennsylvania that Republicans were being obstructionist in the health care reform debate, Gregg replied, “Well, I suppose he has to call us something now that he’s left the party.” Responding to the Democratic charge that the GOP is “the party of ‘no,’” Gregg pointed to Republican health care reform proposals including his own and another co-sponsored by Republican Sens. Tom Coburn and Sen. Richard Burr, as well as a bipartisan proposal put forward by Sens. Ron Wyden (D-OR) and Robert Bennett (R-UT).” Gregg said the versions of health care reform voted out of the Senate Finance Committee and the Senate Health, Education, Labor and Pensions Committee would amount to “a huge expansion of government.”
“You’re talking about taking the government and increasing it by $1-$2 trillion over the next ten years,” Gregg said. He added that he thought growing government at that rate would have a “very debilitating effect” on the overall economy and the ability of Americans to get health care in the future. At one point earlier this year, Gregg, who is not seeking re-election to his Senate seat in 2010, was President Obama’s choice to head the Commerce Department. But the fiscal hawk removed himself from consideration because of differences with the new administration on several policy issues.

Gold hits record high on 'plan' to ditch dollar

LONDON (AFP) – The price of gold struck an all-time high at 1,038.65 dollars an ounce here on Tuesday as the dollar fell on a reported plan by Gulf states to stop using the greenback for oil trading. Gold reached the level in late afternoon trade on the London Bullion Market, beating the previous record high of 1,032.70 dollars an ounce struck in March, 2008. "Gold prices hit an all-time high as the dollar weakens," said Barclays Capital precious metals analyst Suki Cooper. "The dollar weakness appears to be related to ... (reported) secret talks about oil being priced in a basket of currencies including gold rather than the dollar, which has added to concerns about the future role of the dollar in international financial markets." The dollar's future as the world's top currency was thrown into doubt on Tuesday as a report said Arab states had launched secret moves with China and Russia to stop using the greenback for oil trading. Arab states have launched steps with China, Russia, Japan and France to stop using the dollar for oil trades, British daily The Independent reported on Tuesday, but the report was denied by Kuwait and Qatar and reportedly by other nations. The United Nations meanwhile on Tuesday called for a new global reserve currency to end dollar supremacy, which has allowed the United States the "privilege" of building a huge trade deficit. The Independent's Middle East correspondent Robert Fisk wrote in his paper: "In the most profound financial change in recent Middle East history, Gulf Arabs are planning -- along with China, Russia, Japan and France -- to end dollar dealings for oil." They would instead switch "to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council (GCC), including Saudi Arabia, Abu Dhabi, Kuwait and Qatar," added Fisk. Gold, viewed as a safe-haven investment, has won back favour in recent months as the global economy struggles out of its worst slump in decades. The run-up in gold has been largely driven by weakness in the dollar, which makes dollar-priced commodities cheaper for holders of stronger currencies, boosting demand. Gold also wins support from fears about higher inflation because the metal is widely regarded by investors as a safe store of value. Precious metals consultancy GFMS last month warned that the current upward trend in gold may not be sustainable should global stimulus packages fail to boost flagging demand in the battered world economy and inflation fall as a result. The Group of 20 leaders of emerging and developed nations recently agreed at a summit in Pittsburgh not to roll back massive stimulus measures that helped contain a severe global recession.

White House, CBO debt forecasts challenge Obama

Tue Aug 25, 2009 12:49pm EDT
*White House sees 10-year deficit at $9 trillion
*Grim news for Obama's healthcare push
*Slow recovery seen hurting tax revenues as spending soars (Recasts, adds reaction)
By Alister Bull and Andy Sullivan
WASHINGTON, Aug 25 (Reuters) - The U.S. national debt will nearly double over the next 10 years, government forecasts showed on Tuesday, challenging President Barack Obama's economic and healthcare overhaul agenda. The White House midsession budget forecast and the non-partisan Congressional Budget Office both forecast that government revenues will be crimped by a slow recovery from the worst recession since the 1930s Great Depression, while spending on retirement and medical benefits soars. The White House projected a cumulative $9 trillion deficit between 2010 and 2019, while the CBO took a more optimistic view, pegging the deficit at $7.1 trillion because it assumed higher revenues as tax cuts expire. [ID:nN25198577]
The spending blitz could push the national debt, now more than $11 trillion, to close to $20 trillion. The debt is the sum the government owes, while the deficit is the yearly gap between revenues and spending. "The alarm bells on our nation's fiscal condition have now become a siren," said Senator Mitch McConnell, the Republican leader in the Senate. "If anyone had any doubts that this burden on future generations is unsustainable, they're gone," McConnell said, adding that economic stimulus funds should be diverted to pay down U.S. debt. However, both the White House and CBO estimates anticipate that the deficit, now at its highest level as a percent of economic output since World War Two, will decline relatively swiftly in the next three years as growth resumes and federal bailout programs shrink. White House budget director Peter Orszag said the deficit was too high and cited this as a reason to pass Obama's healthcare overhaul plan, which is in trouble with lawmakers while opinion polls show it losing popular support. "I know that there will be some who say this report proves that we cannot afford health reform. I think that has it backward," Orszag told reporters on a conference call.
"The size of the fiscal gap is precisely why we must enact well-designed and fiscally responsible health reform now. Obama's healthcare plan, his policy priority, has run into opposition from critics who complain its $1 trillion price tag is too high and who worry it will limit consumer choice. The debate is gaining steam as Republicans seek momentum for next year's mid-term elections, where they hope to chip away the dominant position Obama's Democrats enjoy in both the House of Representatives and the Senate.

The White House forecasts a record $1.58 trillion deficit in fiscal 2009, matching the numbers of the CBO, while it shows the deficit at $1.5 trillion in 2010, a touch higher than the $1.48 trillion projected by CBO. But both estimates show annual deficits staying above $500 billion every year until 2019, compared with a then-record $459 billion last year. The White House shows the gap averaging 5.1 percent through 2019, compared with 3.2 percent last year.
By 2019, it estimates that the ratio of national debt to gross domestic products will rise to 69 percent from 48 percent in 2009. "The administration has always said that you have to get deficits under 3 percent of GDP to be safe. They now admit that they will not in the next 10 years," said Douglas Holtz-Eakin, a CBO director under Bush and chief economic adviser to Republican Senator John McCain for his 2008 presidential bid. The budget news was overshadowed by Obama's surprise announcement on Tuesday to renominate Ben Bernanke to a second four-year term as Federal Reserve chairman, a move seen as aiming for continuity at the central bank during a tentative stage of recovery. "I'm stunned at how hard they have worked to bury this", Holtz-Eakin said of the White House's budget estimate timing.

DIFFERING ASSUMPTIONS
One reason CBO and OMB can end up with different numbers is technical. The CBO employs a baseline method which only takes into account policies that have already become law. On the other hand, the administration's forecasts can reflect the economic impact of policies it hopes to implement, even if they have not yet been approved by lawmakers. For example, the CBO assumes the there would be no "patch" for the Alternative Minimum Tax, meaning millions more Americans would have to pay higher taxes, even though Congress has agreed to a temporary reprieve every year to prevent this happening. In addition, CBO assumes the tax cuts delivered by former President George W. Bush will expire at the end of 2010. Orszag said that the White House numbers also assumed that some of the Bush tax cuts would be extended. Obama has pledged not to raise taxes on U.S. households earning less than $250,000 a year. (Writing by David Lawder, Editing by Vicki Allen)

Senator warns of hyperinflation rivaling the 1980s

August 25, 2009
Michael O'Brien
The Hill's Blog: Briefing Room
The economy could spiral into hyperinflation not seen since the early 1980s if the Federal Reserve does not tighten its monetary policy soon, Sen. Chuck Grassley (R-Iowa) warned Tuesday. Grassley, speaking about the renomination of Federal Reserve Chairman Ben Bernanke to a second term as head of the Fed, asserted that Bernanke's ability to hold down inflation would be the metric by which the Fed's success would be measured. "We won't know for a year if he's done a good job so far, because he shoveled money out of an airplane to save banks and the financial system," Grassley said in a conference call with Iowa reporters. "But shoveling money out of an airplane to solve problems can be inflationary — in this case, hyperinflationary — if he doesn't start mopping up some of the money that's out there." Grassley, the ranking member of the Senate Finance Committee, said that inflation as a result from government spending on bailouts could result in inflation rivaling rates in 1980, when it hit a peak of 13.5 percent. "The Fed has the ability to put money out, it's got the ability to take money back in, and if they don't do that, we will have hyperinflation worse than we had in 1980 and '81," Grassley said. "And I hope he demonstrates that ability." Grassley argued that while it would be a year until lawmakers will know whether Bernanke has been successful at bringing inflation under control, it would probably be best to keep the chairman on board for a second term as head of the Federal Reserve. "I would suggest that right now, when everybody's nervous about the economy, that you don't change horses in the middle of the stream, and consequently, it would probably be detrimental to not have him reappointed," he said.

Obama Raises ‘10 Deficit Outlook 19% to $1.5 Trillion

By Roger Runningen and Brian Faler
Aug. 25 (Bloomberg) -- U.S. unemployment will surge to 10 percent this year and the budget deficit will be $1.5 trillion next year, both higher than previous Obama administration forecasts because of a recession that was deeper and longer than expected, White House budget chief Peter Orszag said. The Office of Management and Budget forecasts a weaker economic recovery than it saw in May, as the gross domestic product shrinks 2.8 percent this year before expanding 2 percent next year, according to the administration’s mid-year economic review issued today. The Congressional Budget Office, in a separate assessment, forecast the economy will grow 2.8 percent next year. Both see the GDP expanding 3.8 percent in 2011. “While the danger of the economy immediately falling into a deep recession has receded, the American economy is still in the midst of a serious economic downturn,” the White House report said. “The long-term deficit outlook remains daunting.” The budget shortfall for 2010 would mark the second straight year of trillion-dollar deficits. Along with the unemployment numbers, the deficit may weigh on President Barack Obama’s drive for his top domestic priority, overhauling the U.S. health care system. “It throws a wrench in health-care reforms,” Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget, said in an interview. “No matter the specific numbers, they’re a constant reminder that we’re in bad, bad shape.”
Spending Caps
House Republican Leader John Boehner of Ohio seized on the numbers to call for the Democrat-controlled Congress to impose “strict annual caps on federal spending.” The health-care overhaul “is just the latest in a long line of expensive Democratic experiments that will add to the deficit, raise taxes on families and small businesses and cost more American jobs,” Boehner said in a statement. The two budget agencies say the shortfall is being driven by the recession as outlays rise for unemployment compensation, food stamps or other programs meant to stabilize the economy rise and tax receipts fall. Administration and congressional budget officials expect the unemployment rate, which was 9.4 percent last month, to keep rising. White House officials said the rate likely will rise to 10 percent by the end of 2009, averaging 9.3 percent for the entire year. It will worsen to a 9.8 percent average in 2010, instead of the 7.9 percent estimate in May. The CBO report also estimates the 2009 jobless rate at 9.3 percent. It puts next year’s average at 10.2 percent.
Deficit Projections
The OMB raised its deficit projection for fiscal 2010, which begins Oct. 1, from the $1.26 trillion forecast in May, reflecting slower economic growth this year and next because of “the severity of the crisis in the U.S. and in our trading partners,” said Christina Romer, White House chief economist, who along with Orszag briefed reporters on the report. The median estimate of 31 economists in a Bloomberg News survey completed Aug. 21 was for a fiscal year 2010 deficit of $1.3 trillion. The outlook for the 2009 fiscal year is slightly better than the previous forecast. The government’s shortfall will peak this year at $1.58 trillion before narrowing over next decade. That is less than the $1.84 trillion projected in May because budget officials were able to delete hundreds of billions of dollars that had been set aside for bank bailouts. Last year’s deficit was $459 billion.
Bailout Money
“The Obama White House deserves some credit for managing the financial situation so that the additional bailout wasn’t necessary,” said Stan Collender, a former budget analyst for the House and Senate budget committees. Orszag said reining in the deficit is a “top priority” of the administration. He said the budget blueprint Obama submits to Congress in February will “include proposals to put the nation back on a fiscally sustainable path.” He declined to give specifics. The OMB added almost $2 trillion to the 10-year deficit from its May forecast, to $9.05 trillion. The nonpartisan CBO lowered its long-range projection to $7.14 trillion. “The market will view this as a very consensus-oriented forecast” and there won’t be any significant reaction, said Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania.
Stimulus
Zandi predicted Congress will pass a second “mini” stimulus bill next year of about $250 billion to aid jobless workers, state governments and home buyers. “The economy will be growing at an uncomfortably slow rate, not enough to bring down unemployment, and of course it’s an election year” for Congress, he said. Orszag defended the trillion-dollar deficits during a recession and said they shouldn’t be used to block the administration’s health-care initiative. Revising the way the nation pays for medical care will help save money, he said. “I know there are going to be some who say this report proves we can’t afford health reform,” Orszag said. “I think that has it backwards,” because savings must be squeezed from the system. Even with economic conditions worse that originally forecast, Romer said “we do expect positive GDP growth by the end of this year” for the fourth quarter, as the economy reaches “a turning point.” “A return to employment growth will take longer,” Romer said, adding that the jobless rate likely will peak in the fourth quarter of this year.
Inflation
Romer said the economic stimulus package probably is adding “between 2 and 3 percentage points” to economic growth in the second quarter of this year, blunting conditions that would have been worse. A report on the effect of the stimulus program is due to Congress next month, she said. Inflation will remain subdued. Projections for the consumer price index show a contraction to 0.7 percent this year, rising to 1.4 percent next year and 1.5 percent in 2011, Romer said. The economic assumptions were compiled by the Council of Economic Advisers, Treasury Department and the Office of Management and Budget. The estimates reflect conditions as of early June.
To contact the reporters on this story: Roger Runningen in Washington at rrunningen@bloomberg.netBrian Faler in Washington at bfaler@bloomberg.net Last Updated: August 25, 2009 13:19 EDT

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The risk of a double-dip recession is rising

By Nouriel Roubini
August 23 2009
T he global economy is starting to bottom out from the worst recession and financial crisis since the Great Depression. In the fourth quarter of 2008 and first quarter of 2009 the rate at which most advanced economies were contracting was similar to the gross domestic product free-fall in the early stage of the Depression. Then, late last year, policymakers who had been behind the curve finally started to use most of the weapons in their arsenal. That effort worked and the free-fall of economic activity eased. There are three open questions now on the outlook.
When will the global recession be over?
What will be the shape of the economic recovery?
Are there risks of a relapse?
On the first question it looks like the global economy will bottom out in the second half of 2009. In many advanced economies (the US, UK, Spain, Italy and other eurozone members) and some emerging market economies (mostly in Europe) the recession will not be formally over before the end of the year, as green shoots are still mixed with weeds. In some other advanced economies (Australia, Germany, France and Japan) and most emerging markets (China, India, Brazil and other parts of Asia and Latin America) the recovery has already started.
On the second issue the debate is between those – most of the economic consensus – who expect a V-shaped recovery with a rapid return to growth and those – like myself – who believe it will be U-shaped, anaemic and below trend for at least a couple of years, after a couple of quarters of rapid growth driven by the restocking of inventories and a recovery of production from near Depression levels. There are several arguments for a weak U-shaped recovery . Employment is still falling sharply in the US and elsewhere – in advanced economies, unemployment will be above 10 per cent by 2010. This is bad news for demand and bank losses, but also for workers’ skills, a key factor behind long-term labour productivity growth. Second, this is a crisis of solvency, not just liquidity, but true deleveraging has not begun yet because the losses of financial institutions have been socialised and put on government balance sheets. This limits the ability of banks to lend, households to spend and companies to invest. Third, in countries running current account deficits, consumers need to cut spending and save much more, yet debt-burdened consumers face a wealth shock from falling home prices and stock markets and shrinking incomes and employment. Fourth, the financial system – despite the policy support – is still severely damaged. Most of the shadow banking system has disappeared, and traditional banks are saddled with trillions of dollars in expected losses on loans and securities while still being seriously undercapitalised. Fifth, weak profitability – owing to high debts and default risks, low growth and persistent deflationary pressures on corporate margins – will constrain companies’ willingness to produce, hire workers and invest. Sixth, the releveraging of the public sector through its build-up of large fiscal deficits risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth. Seventh, the reduction of global imbalances implies that the current account deficits of profligate economies, such as the US, will narrow the surpluses of countries that over-save (China and other emerging markets, Germany and Japan). But if domestic demand does not grow fast enough in surplus countries, this will lead to a weaker recovery in global growth. There are also now two reasons why there is a rising risk of a double-dip W-shaped recession. For a start, there are risks associated with exit strategies from the massive monetary and fiscal easing: policymakers are damned if they do and damned if they don’t. If they take large fiscal deficits seriously and raise taxes, cut spending and mop up excess liquidity soon, they would undermine recovery and tip the economy back into stag-deflation (recession and deflation). But if they maintain large budget deficits, bond market vigilantes will punish policymakers. Then, inflationary expectations will increase, long-term government bond yields would rise and borrowing rates will go up sharply, leading to stagflation. Another reason to fear a double-dip recession is that oil, energy and food prices are now rising faster than economic fundamentals warrant, and could be driven higher by excessive liquidity chasing assets and by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy, as it created negative terms of trade and a disposable income shock for oil importing economies. The global economy could not withstand another contractionary shock if similar speculation drives oil rapidly towards $100 a barrel. In summary, the recovery is likely to be anaemic and below trend in advanced economies and there is a big risk of a double-dip recession.
The writer is professor of economics at the Stern School of Business, NYU

Federal deficit higher in July, $1.27T this year

Record federal deficit climbs higher, $180.7 billion in July, $1.27 trillion so far this year
By Martin Crutsinger, AP Economics Writer
On Wednesday August 12, 2009, 3:07 pm EDT
WASHINGTON (AP) -- The federal deficit climbed higher into record territory in July, hitting $1.27 trillion with two months remaining in the budget year. The Treasury Department said Wednesday that the July deficit totaled $180.7 billion, slightly more than the $177.5 billion economists had expected. The Obama administration is projecting that when the current budget year ends on Sept. 30, the imbalance will total $1.84 trillion, more than four times last year's record-high. The soaring deficits have raised worries among foreign owners of U.S. Treasury securities including the Chinese, the largest holder of such debt. Massive amounts of government spending to combat the recession and stabilize the U.S. financial system have pushed the deficit higher. The cost of wars in Iraq and Afghanistan, along with depleted government tax revenues, also are major factors. The July deficit reflected government spending of $332.2 billion, a record amount for any month and up from outlays of $263.3 billion in July 2008. Of that increase, about $25 billion reflected the fact that Aug. 1 was a Saturday this year, requiring many government benefit checks to be sent out earlier and counted as spending in July. Government receipts totaled $151.5 billion, down 5.6 percent from a year ago. It marked the 15th consecutive month that government receipts have been lower than the same month in the prior year, illustrating how deep the recession has cut into tax receipts. Through the first 10 months of the budget year, receipts total $1.74 trillion, down 16.9 percent from the same period in 2008. Outlays totaled $3 trillion over the past 10 months, up 21.1 percent from the same period in 2008. The resulting deficit of $1.27 trillion compares to an imbalance of $388.6 billion during the year-ago period. The deficit for all of 2008 was $454.8 billion, the current record holder in dollar terms. President Barack Obama's economic team sought to reassure the Chinese during high-level talks last month that the administration is committed to reducing the deficits once the current economic and financial crises have been resolved. So far, interest rates have remained low as the Federal Reserve has kept the federal funds rate, a key short-term interest rate at a record low near zero in an effort to jump-start the economy. At the end of a two-day meeting Wednesday, Fed officials repeated their view that the weak economy was likely to "to warrant exceptionally low levels of the federal funds rate for an extended period." The concern, however, is that rates could begin rising despite the Fed's efforts if foreigners suddenly lose confidence in the government's ability to manage its debt burden. In bond markets, prices fell Wednesday after a fairly weak auction of $23 billion in 10-year Treasury notes. The Treasury Department is auctioning a record $75 billion in debt this week. The yield on the benchmark 10-year Treasury note, which moves opposite its price, rose to 3.75 percent from 3.70 percent ahead of the auction results and 3.67 percent late Tuesday. Bond prices jumped Tuesday as stocks fell. Investors will track demand because a drop in buyers could force the government to increase its payout. The resulting rise in rates would raise borrowing costs for the government as well as consumers and businesses, and could end up slowing the economy. The total public debt now stands at $11.6 trillion. Interest payments on the debt cost $452 billion last year, the largest federal spending category after Medicare-Medicaid, Social Security and defense.

U.S. Inflation to Approach Zimbabwe Level, Faber Says

By Chen Shiyin and Bernard Lo

May 27 (Bloomberg) -- The U.S. economy will enter “hyperinflation” approaching the levels in Zimbabwe because the Federal Reserve will be reluctant to raise interest rates, investor Marc Faber said. Prices may increase at rates “close to” Zimbabwe’s gains, Faber said in an interview with Bloomberg Television in Hong Kong. Zimbabwe’s inflation rate reached 231 million percent in July, the last annual rate published by the statistics office. “I am 100 percent sure that the U.S. will go into hyperinflation,” Faber said. “The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”

Federal Reserve Bank of Philadelphia President Charles Plosser said on May 21 inflation may rise to 2.5 percent in 2011. That exceeds the central bank officials’ long-run preferred range of 1.7 percent to 2 percent and contrasts with the concerns of some officials and economists that the economic slump may provoke a broad decline in prices. “There are some concerns of a risk from inflation from all the liquidity injected into the banking system but it’s not an immediate threat right now given all the excess capacity in the U.S. economy,” said David Cohen, head of Asian economic forecasting at Action Economics in Singapore. “I have a little more confidence that the Fed has an exit strategy for draining all the liquidity at the appropriate time.” Action Economics is predicting inflation of minus 0.4 percent in the U.S. this year, with prices increasing by 1.8 percent and 2 percent in 2010 and 2011, respectively, Cohen said.

Near Zero

The U.S.’s main interest rate may need to stay near zero for several years given the recession’s depth and forecasts that unemployment will reach 9 percent or higher, Glenn Rudebusch, associate director of research at the Federal Reserve Bank of San Francisco, said yesterday.
Members of the rate-setting Federal Open Market Committee have held the federal funds rate, the overnight lending rate between banks, in a range of zero to 0.25 percent since December to revive lending and end the worst recession in 50 years. The global economy won’t return to the “prosperity” of 2006 and 2007 even as it rebounds from a recession, Faber said. Equities in the U.S. won’t fall to new lows, helped by increased money supply, he said. Still, global stocks are “rather overbought” and are “not cheap,” Faber added. Faber still favors Asian stocks relative to U.S. government bonds and said Japanese equities may outperform many other markets over a five-year period. “Of all the regions in the world, Asia is still the most attractive by far,” he said.

Gloom, Doom

Faber, the publisher of the Gloom, Boom & Doom report, said on April 7 stocks could fall as much as 10 percent before resuming gains. The Standard & Poor’s 500 Index has since climbed 9 percent. Faber, who said he’s adding to his gold investments, advised buying the precious metal at the start of its eight-year rally, when it traded for less than $300 an ounce. The metal topped $1,000 last year and traded at $949.85 an ounce at 12:50 p.m. Hong Kong time. He also told investors to bail out of U.S. stocks a week before the so-called Black Monday crash in 1987, according to his Web site.
To contact the reporter on this story: Chen Shiyin in Singapore at schen37@bloomberg.net; Bernard Lo in Hong Kong at blo2@bloombeg.net Last Updated: May 27, 2009 00:54 EDT

Obama Says U.S. Long-Term Debt Load ‘Unsustainable’

By Roger Runningen and Hans Nichols

May 14 (Bloomberg) -- President Barack Obama, calling current deficit spending “unsustainable,” warned of skyrocketing interest rates for consumers if the U.S. continues to finance government by borrowing from other countries. “We can’t keep on just borrowing from China,” Obama said at a town-hall meeting in Rio Rancho, New Mexico, outside Albuquerque. “We have to pay interest on that debt, and that means we are mortgaging our children’s future with more and more debt.” Holders of U.S. debt will eventually “get tired” of buying it, causing interest rates on everything from auto loans to home mortgages to increase, Obama said. “It will have a dampening effect on our economy.”

Earlier this week, the Obama administration revised its own budget estimates and raised the projected deficit for this year to a record $1.84 trillion, up 5 percent from the February estimate. The revision for the 2010 fiscal year estimated the deficit at $1.26 trillion, up 7.4 percent from the February figure. The White House Office of Management and Budget also projected next year’s budget will end up at $3.59 trillion, compared with the $3.55 trillion it estimated previously. Two weeks ago, the president proposed $17 billion in budget cuts, with plans to eliminate or reduce 121 federal programs. Republicans ridiculed the amount, saying that it represented one-half of 1 percent of the entire budget. They noted that Obama is seeking an $81 billion increase in other spending.

Entitlement Programs

In his New Mexico appearance, the president pledged to work with Congress to shore up entitlement programs such as Social Security and Medicare. He also said he was confident that the House and Senate would pass health-care overhaul bills by August. “Most of what is driving us into debt is health care, so we have to drive down costs,” he said. Obama prodded Congress to pass restrictions on credit-card issuers, saying consumers need “strong and reliable” protection from unfair practices and hidden fees. “It’s time for reform that’s built on transparency, accountability, and mutual responsibility, values fundamental to the new foundation we seek to build for our economy,” the president said. Obama called on Congress to send to him by May 25 a bill that would clamp down on what he says are sudden rate increases, unfair penalties and hidden fees. He also wants the measure to strengthen monitoring of credit-card companies.

House Bill

The U.S. House of Representatives passed the credit-card bill last month after adding a provision requiring banks to apply consumers’ payments to balances with the highest interest rates first. The bill also imposes limits on card interest rates and fees. The Senate continued debating its version of the bill today. It would require credit-card companies to give 45 days’ notice before increasing an interest rate. It would prohibit retroactive rate increases on existing balances unless a consumer was 60 days late with a payment. The president said Americans have been hooked on their credit cards and share some blame for the current system. “We have been complicit in these problems,” he said. “We have to change how we operate. These practices have only grown worse in the midst of this recession.” The American Bankers Association, which represents card issuers, has warned lawmakers and the Obama administration against taking punitive action or setting requirements that are too stringent. Doing so, the lobby group says, would limit consumer credit and worsen a credit crunch. Obama said that restrictions “shouldn’t diminish consumers’ access to credit.”

Uncollectible Debt

Uncollectible credit-card debt rose to 8.82 percent in February, the most in the 20 years that Moody’s Investors Service Inc. has kept records. Lawmakers have said they’re under increasing pressure from constituents to respond to rising interest rates and abrupt changes to consumers’ accounts. Obama held a White House meeting last month with executives from the credit-card industry, including representatives from Bank of America Corp. and American Express Co. Afterward, he told reporters that credit-card issuers should be prohibited from imposing “unfair” rate increases on consumers and should offer the public credit terms that are easier to understand. “The days of any time, any increase, anything goes -- rate hike, late fees -- that must end,” Obama said today at Rio Rancho High School. We’re going to require clarity and transparency from now on.” He also said the steps he has taken to stimulate the economy and start the debate on overhauling the health-care system are beginning to take effect.

‘Beginning to Turn’

“We’ve got a long way to go before we put this recession behind us,” Obama said. “But we do know that the gears of our economy, our economic engine, are slowly beginning to turn.” Taking questions from the audience, Obama repeated his stance that he wants legislation to overhaul the health-care system finished before the end of the year, saying it is vital to the economy. Health-care costs are driving up the nation’s debt and burdening entitlement programs such as Medicare, the government- run insurance program for those 65 and older and the disabled. The programs’ trustees reported May 13 that the Social Security trust fund will run out of assets in 2037, four years sooner than forecast, and Medicare’s hospital fund will run dry by 2017, two years earlier than predicted a year ago.

MONEY & BREAD!

by Puru Saxena
Editor, Money Matters
March 20, 2009

The cat is out of the bag. The Federal Reserve is waging an all-out inflationary war on the economic contraction. Two days ago, Mr. Bernanke announced that the Federal Reserve would buy US$300 billion worth of US Treasuries and another US$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 of 0–0.25% 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 monetising debt is inflationary and confirmation that the Federal Reserve wants to debase the US Dollar. It is worth noting that the total debt in the US now exceeds US$60 trillion and its economy is around US$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 US$100,000 from their friends roughly 50 years ago. Back then, US$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, US$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:

a. Default or bankruptcy
b. Monetary inflation

Given the fact that the US is still the world’s largest economy, owns the world’s reserve currency and 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 a slice of bread!

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. Remember, monetary inflation 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, 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 GBP150 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 that 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.

Over the past couple of days, in the aftermath of the latest announcement by the Federal Reserve, we have seen significant strength in precious metals, crude oil and grains. Conversely, we have seen a huge decline in the US Dollar. If the Federal Reserve continues on this inflationary path, we can expect a resumption of the commodities bull-market and renewed weakness in the US Dollar.

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. Now, I am aware that my bullish stance may lead to ridicule from some of my readers, but I would like to point out that new bull-markets are always born during abject pessimism and scepticism. 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, 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 and long-term investors may want to wait for the usual summer correction before adding to their positions in physical gold and silver.