« The Effect of Deposit Insurance (or Lack Thereof) on Gold and Silver as Money | Main | Decline in the BRICS Dependency on the Dollar and its Interesting Effect on Gold »

The Fork In The Road

We are in a bus going 90 mph on a narrow road which forks on January 1, 2013.  The current itinerary has us taking the road toward fiscal responsibility and recession.  But I am in the camp that the drivers of the bus will suddenly (and at the very last minute) veer off course  and onto the road of money printing and hyperinflation.  Either way, the scenery isn't going to be pretty.

On January 1, 2013, the current plan is for the following tax increases and austerity measures to go into effect (these measures do not require a vote, they just are):

1)  The expiration of the Bush tax cuts (hit to investors)

2) The additional tax on investment income to fund Obamacare (hit to investors)

3) The expiration of the payroll tax reduction and unemployment benefit extension (hit to workers)

4) The implementation of the across-the-board spending cuts brought about by last summer's debt ceiling/super-committee debacle (hit to government employees)

Of course, the anticipation of measures 1 & 2 will only serve to derail an already rocky recovery fueled exclusively by stock market equity gains.  All those investors who (thanks to Jim Cramer et al) have been piling into the "safety" of dividend-paying stocks will just as suddenly start piling out as they realize that not only will their dividend income no longer qualify for capital gains treatment but be subject to medicare tax as well!

Measure 3 will result in workers making $50,000 having $1,000 less per year to spend at a time where every penny counts.

Measure 4 will result in increased unemployment in the public sector and a reduction in governmental contribution to GDP

Well, it'd be worth it, wouldn't it?  To put us on the path to fiscal solvency?  The problem is, it won't  Taken as a whole, these measures wouldn't even cut our current annual deficit of $1.4 trillion by 20%.  We would still need to borrow over a trillion a year!  So why do it?  Because it might (and I say might) reassure our creditors that we are serious about dealing with our issues and lull them into continuing to hold/buy our bonds (at least for a while).

So why do I think the drivers of the bus will chose the other path instead, and why do I think the other path is hyperinflationary?

The petri dishes that are Japan and Europe have proven up what happens to countries who elect to get off the growth gravy train.  Debt doesn't really go down, but debt to GDP skyrockets and you end up in a worse place than if you hadn't instituted austerity measures in the first place.  It become hyperinflationary because when the jig is up and the world becomes convinced that you are taking the money printing path they refuse to buy your debt instruments at any price.

QE1, QE2, and QE2.5 (Operation Twist) have laid the groundwork for hyperinflation.  By buying up long-date treasuries and selling short-dated treasuries, Bernanke has insured that foreigners and the public mostly own very short-term paper.  In point of fact, the average maturity of US treasuries is less than four years.  Because so much paper is short term, it would require a huge amount of money printing to buy up all of the new and rolling debt coming out over the next four years.  I also believe that QE3 will be the tipping point in which the world becomes completely convinced that quantitative easing in the US has become structural (ie. QE will be henceforth be required to infinity and beyond)

There is lots and lots of hot money sitting on the sidelines waiting to see which way this game plays out, the reason being that the strategies for each path are 180 degrees apart.  If we go the route of austerity, the last thing a person should want to hold are hard assets (you'll be able to pick them up cheaper later on).  If we go the route of hyperinflation then hard assets are the best investments to be holding (and you'd better be holding before TSHTF because you won't be able to buy them during).

So how will you know what to do before everybody else does?  Other than buying PMs on the understanding that any pullback will only be temporary,  I believe we may get an indicator of what the drivers are thinking this summer when the debt ceiling limit gets increased.  If the government only raises the debt ceiling by enough to get through the election (say $500 billion) then austerity is still on the table.  But if the debt ceiling is raised to $20 trillion or more (even removed altogether) then you can bet that 11th hour deals are in the works to extend the Bush tax cuts (good for investors) in exchange for  extended benefits and postponement of austerity (good for workers) as was done on 1/1/2011, thus setting the stage for structural QE.


TrackBack URL for this entry:

Post a comment

(If you haven't left a comment here before, you may need to be approved by the site owner before your comment will appear. Until then, it won't appear on the entry. Thanks for waiting.)