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How this economic disaster ends is something about which many of us speculate. Two extreme endings are likely — a sudden deflationary collapse or a period of very high inflation/hyperinflation which ultimately cripples commerce and resolves itself in a deflationary collapse. In either case, the deflationary collapse is another Great Depression. It is important to know which route will occur because of what will happen to asset values along the way. Words: 1057
So says ”Monty Pelerin” (a pseudonym derived from The Monty Pelerin Society) in edited excerpts from his original article* as posted at www.economicnoise.com.
Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.
Pelerin goes on to say, in part:
A move directly into a Great Depression will:
- severely depress most asset values, especially common stocks, housing and other hard assets
- while bonds, cash and fixed incomes may be beneficiaries in the sense that their purchasing power increases.
If the Great Depression is preceded by hyperinflation, just the opposite will happen, at least through the transition stage:
- cash, fixed incomes and bonds will be devalued, perhaps even wiped out, if the hyperinflation is severe.
- stocks, housing and other assets are likely to benefit until the Great Depression takes hold.
Once the Great Depression period begins, the effects on assets will be as described in the paragraph above. However, those who believed they had adequate savings and retirement incomes may enter the Great Depression destitute.
Regardless of which route above is taken, most people will lose. Winners will be those prudent and fortunate enough to preserve their purchasing power. Wealth creation is unlikely for most; wealth preservation, in terms of purchasing power, would be an admirable achievement.
The Federal Reserve Has Run Out of Options
Phoenix Capital Research weighs in with their opinion which is that a deflationary collapse lies ahead. They believe we are going directly to the Great Depression because the Federal Reserve has run out of options… [saying,] “The Fed has not solved the problems that caused 2008. Instead, the Fed has exacerbated these problems (excess leverage) and created new problems in the process (inflation)….In simple terms, the Fed’s hands are tied and the ECB is out of ammo. The End Game for Central Bank intervention is approaching and it won’t be pretty – first Europe, then Japan and then the U.S..”
In terms of the effectiveness of central bank policy with respect to the economy, Phoenix is correct. Additional monetary stimulus has not, and will not, produce benefits regarding the economy. That conclusion was true a year or more ago, however, and it didn’t stop central banks – nor will it stop them in the near future.
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The Fed Now Succumbs to Political Pressure
The Federal Reserve was established as a quasi-independent agency and for part of its existence actually functioned relatively separate from political considerations. That certainly has not been the case recently. Since Alan Greenspan ran the Fed (and to lesser degrees before him) the Fed has become increasingly a political institution, serving the needs of the political party in power. As the government took over more and more control of the economy, it became more important that they control the Fed.
From the Fed’s standpoint, they were created by Congress and their charter can be removed by Congress any time it chooses. If the Fed doesn’t cave [in] to political pressures, it will be disbanded in favor of a replacement which directly reports to the President or Congress and does their bidding. Ben Bernanke is fully aware of that and doesn’t intend to lose his lucrative position. Hence he and his predecessor were de facto political servants rather than economic stewards of the banking system.
The issue regarding the Fed and its future actions is less whether they can help the economy and more whether they can help the political class [as outlined below].
- Printing money provides cover for a bad economy. It drives up asset prices (stock prices) which voters use as one proxy for whether the economy is improving. Does anyone believe that incumbents (even Republicans) want voters more angry than they already are before the next election?
- The government cannot collect enough tax revenues or borrowings in credit markets to pay for what they spend. If the Fed does not cover this shortfall by buying bonds (the manner in which they “create money”), government cannot pay its bills. When it comes down to stopping social security checks or welfare payments or military pay, does anyone really believe that will happen so long as the Fed has a printing press?
The Fed, just like the government, will do whatever it has to in order to survive as an institution. Survival for both can only be achieved by printing more money…
More Money Printing Will Mean Much, Much Higher Inflation
Obviously printing cannot go on forever, but it can go on – and likely will -until hyperinflation or something approaching this level of inflation destroys the currency. It is not economics that causes me to predict hyperinflation but politics. After all, inflation everywhere is always a political phenomenon and not an economic one. Without the continued printing of money, the game of government as we know it ends…
Printing money is a way for them to “pretend and extend” for a while longer. I do not see politicians throwing in the towel and…[admitting] that what they have been doing is running a massive Ponzi scheme before they…[have] exhausted every alternative. For that reason, I believe very high inflation or hyperinflation is in our future before a Great Depression commences.
Conclusion
There is obvious disagreement as to whether inflation or Depression comes first. Indeed, there are some so naive to believe that neither will occur and that the economy will rebound and return to normal. On that last point, I am reasonably certain that it cannot happen. Regarding the sequencing of events, you will have to make up your own mind.
For me, I don’t expect the politicians to do the right thing now or ever. They do what is right for them and not the country. To me, that means watch out for very high inflation ahead.
*http://www.economicnoise.com/2012/05/07/european-elections-harbinger-of-us-elections/
Editor’s Note: The above article has been has edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.
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