Part 2 Inflation
How will investors deal with the surge in inflation that will arrive in 2014 and 2015? Don’t believe the government statistics in the United States and in many other countries around the world. As with unemployment that are deliberately misleading. If the politicians in power don’t like the results they just go ahead and change the way the numbers are calculated.
Many investors believe this is how business is done in just a small number of countries like Argentina, Venezuela, the Congo and Zimbabwe for example. Or that it has mostly occurred in the past as was the case with Germany and Russia.
The truth is it is becoming common practice throughout the world.
Zimbabwe Currency
The government of the United States has changed how it calculates inflation more than 20 times since the late 1970’s. Of course every adjustment made allowed the government to claim a lower rate of inflation than actually existed.
The focus of this article will be on the United States because to this date it is the only world reserve currency. Although it is important to point out that the American dollar is under increasing pressure and in clear danger of losing this status within the next few years.
If one would return to the previous way inflation was calculated (before 1980) Americans have been dealing with price rises from 7 to 8 % annually in recent years. The only exception to this would have been in 2009 where there actually was a short period of deflation.
Misleading Government Statistics
This was due to the sharp downturn in the economy not only in the United States but in many countries around the world. This was the result of the financial crisis of 2008 that began in the United States and was soon spreading to Europe, Asia and Latin America.
The way the American government factors inflation (through the CPI) is to increasingly discount volatile food and energy sectors which are the very ones that first impact consumers overall.
The United States government has an official rate of inflation of 2%. You also have the Federal Reserve stating that more inflation is needed which justifies the continued printing of 65 billion dollars a month and keeping interest rates at historic lows.
The actual result is ever higher prices and a continued destruction of wealth for investors and consumers who are keeping their gains in the form of currency.
Part of the ability of the United States to hide the real inflation rate can be explained through the importation of cheap consumer goods. This reserve status of the dollar has allowed this to continue for years.
Inflation vs Dollar
This reserve status allows many commodities including the all important oil and energy markets to be bought and sold in dollars.
Countries that attempt to change the status quo like Iraq in 2000 asking for Euros instead of dollars in oil transactions or the Libyan government under Gaddafi in 2011 asking for gold in the sale of its oil; soon find themselves in unfortunate international situations.
It has also disallowed producers of goods here in America to pass increasing costs on to the consumer.
Competition therefore remains tight and profit margins razor thin. It also has led to a stagnation in real wage growth. For many companies there is just no money to pay for higher wages.
The game is about to end as the United States will no longer be able to export inflation. The world is awash in dollars and increasingly customers are less likely to want to accumulate dollars as their value continues to decline.
Disposable Cash
The creation of over a trillion plus dollars annually over the last few years has made other countries much more reluctant to hold ever larger reserves of American dollars. This would include the further purchases of American debt as well as the sale of goods and services.
More countries are now interested in exchanging these dollars for other currencies, hard assets and of course commodities.
The increasing world price for commodities will finally force American businesses to raise prices in real terms. This is already beginning to happen and will accelerate in 2014 and 2015.
Consumers will begin to see price hikes in late spring and early summer of 2014. Of course this has already been quite evident in the price for many food items.
As inflation takes hold of the American economy the Federal Reserve will face a difficult choice. In order to “save the dollar” as it were, they will need to increase interest rates. The asset purchases will also then need to cease.
Notice recently how international investors have left the emerging markets and have returned to the United States when the Federal Reserve reduced its asset purchases by 20 billion. It clearly shows how much the changing availability of dollars can impact investors world over.
To attempt to restore confidence all further forms of “printing of money” would need to end as interest rates are allowed to rise.
The result will be a swoon in the stock market as confidence in the American economy is somewhat undermined.
The rise in interest rates will make the cost of debt begin to increase dramatically on individual, business and government liabilities.
This will rapidly squelch any expansion of the American economy real and supposed. The country will fall into a severe recession with rising unemployment.
Then the government of the United States will have a real dilemma. They will no longer be able to service the huge debt accumulated over the past few decades in the old manner of retiring maturing debt through new lost cost loans and money creation.
They will need to raise taxes substantially or drastically cut government spending, preferably both. This will be next to impossible to achieve by politicians when the economy is already in dire straits.
The United States could also default on part or all of the government incurred debt. That is unlikely because that would create an international financial crisis of epic proportions.
So the politicians will look for another alternative.
The remaining option is to inflate the currency. This will allow the cheap repayment of old government debts. It does not necessitate cuts in spending by the government nor does it demand an increase in taxes.
It does however, destroy the value of the American dollar. Investors both domestic and international will need to move their liquid assets into commodities and tangible possessions.
The Loss of Value Due to Inflation
The world price for commodities will rapidly increase, especially those that are purchased as an inflation hedge like gold, silver and other precious metals.
It will finally lead to the ending of the exclusive role the dollar has played since the end of World War II especially since the collapse of the British pound in the 1960’s.
In the United States the huge trade and government deficits will finally need to be addressed once the currency can no longer support the shortfalls in these areas.
Internationally with the collapse of the dollar a new currency order will be the result.