Rising inflation and growing debts are a combustible mixture
Posted on 01 February 2011 with 4 comments from readers
Two years ago it looked like the world’s financial system was falling apart. Governments nationalized parts of it and printed huge amounts of money to recapitalize the system. This worked miracles for the banking system but many parts of the global economy are still mired deep in recession or something close to it.
However, like all miracle solutions there was a downside to this cure. You never do get out of jail for free. The first problem was that printing money will always eventually produce inflation, with too much money chasing a limited supply of goods.
Fool’s paradise
The second problem is that this bailout process has greatly raised public debt levels. At the moment this debt is not much of a problem because central banks have pushed interest rates down. But this cannot be done indefinitely, so we are living in a fool’s paradise.
And let us be clear about it, anybody proclaiming a recovery now is a fool. It would be terribly foolish to invest on the back of an illusion like the one that has been created at so much expense. For what must come next?
Rising inflation and debt do not mix, indeed they are a highly combustible combination. For as inflation rises this imposes an effective cost on lenders. Eventually you have to reach a tipping point where lenders want compensation for inflation, and that means higher interest rates.
And the last thing you want when you have a big debt is a higher interest rate. This is when the real meltdown in global asset values will occur because only low interest rates are holding values up. It is coming. You cannot debase a currency indefinitely and get away with it. The bond market will react sooner or later.
Bond market crisis
A collapse in the bond markets and currencies is what follows. How far away is this day of reckoning? Far enough it seemed last week in Davos for business leaders to speak more optimistically. But then how many of them anticipated the global financial crisis of two years ago?
Investors who are taking this as a cue to switch from precious metals back into stocks or bonds are leaving themselves open to a repeat performance of the financial crisis, only something far more dramatic and all encompassing this time.
The assets to buy are those that will still be useful after this crisis, and that means real assets – gold, silver, even real estate, oil and industrial commodities – for you will want to own things and not paper currencies. And you should prepare for this crisis while a few fools are convincing themselves that the good times are back. The ArabianMoney newsletter has the right specific investment ideas (sign-up here).
They are not. The real issues need to be solved first by a staggering shake-out. Every debtor who keeps borrowing more and more eventually reaches the limit of his credit. Japan’s credit rating was cut last week, who’s next?
4 Comments posted by readers:
You can be like Brad Pitt in ‘Thelma and Louise’ and have fun for a while inside the rising stock market being pumped up by money creation. Just be ready to get out before the Thunderbird goes off the cliff. I don’t see the cliff this year, but Egypt could turn into a big problem. Who, other than Jim Rogers, saw that one coming? (He predicted it about 10 years ago.)
It could be worse. You could be in Cairns, Queensland, Australia about to get hit with category 4 cyclone Yasi tomorrow night. Normally, we could watch live TV coverage on http://www.itv.com, but a certain former Australian billionaire seems to have the place locked up? Or maybe Australia & New Zealand have some weird Internet TV laws. At least I found a good classic rock radio station in Cairns. I wonder how long they will stay on the air as the cyclone hits.
I saw an interesting statistic about China in the Telegraph the other day. By 2050, something like 40% of the Chinese population will be over 65.
It is hard to type on this Toshiba, listen to the Sony mini earphones (excellent quality), and watch CNBC, at the same time.
The UK may be next for downgrade, if the GDP contracts.
Great commentary, Peter.
It’s fascinating to watch and listen to folks who claim that the western economies are now healthy and growing. What kind of rubbish is that? Absolutely none of the problems have been resolved, although the Obama administration is “taking credit” for financial reform.
In reality, Obama’s financial reform was a farce, since the big N.Y. banks removed all of the “teeth” from the draft legislation, and got every concession they wanted before this trash was signed into law.
So your phrase is quite appropriate at this point in the “global movie.”
… anybody proclaiming a recovery now is a fool.
Who is next? The USA must be pretty close to the edge, with a $14+ trillion debt, which will be rising by $1.5 trillion this year alone. If the Republicans do as they are threatening to do and fail to raise the debt ceiling, the dollar will become inexpensive toilet paper. If they raise the debt ceiling interest rates will inevitably rise up from their crazy low rates and the US will be in big trouble anyway.
The fact that US Treasury bond investors (besides the Fed) have not abstained (i.e., insisted upon higher interest rates) by now indicates to me that normal market forces no longer apply. The big money seems to realize that they ARE the market, and that to demand profit from one aspect of the global financial system implies loses in another. Demanding higher interest rates from Treasuries would not benefit any one. It would invite default (and thus real loses) and unforeseeable and unquantifiable problems across the globe. Therefore, the “Insanity Express” may still have a way to go. No one knows the true limits to these unprecedented and unchartered economic and financial states. We’ll only know them in retrospect. In the meantime, we know that the entire system is man-made and man-governed and so it can possibly continue to an albeit extreme and dysfunctional state for an absurdly long time.
Ed Note: Yes but how would you know when to step off? Most participants in a bubble end up dead, and the insiders are not going to tell you!