With out of control spending to the tune of $1+ trillion deficits and a health care bill equaling that amount, it is no wonder that countries around the world are questioning our ability to make good on our debts without some form of restructuring. We are moving perilously close to a point where our country is going to have to make some serious decisions on how to proceed going forward. My fear is that our country has forgotten what inflation looks like and is in serious danger of repeating the mistakes of the 1930s and 1970s.
For a short history lesson, let us look back to 1933, shortly after FDR took office. President Roosevelt passed a bill which made it illegal to own gold coins or bullion for private usage. The reasoning behind this bill was that at the time, our country was on the gold standard, where each dollar was convertible into a fixed amount of gold (and later on silver). If the government could take gold out of circulation and then devalue the amount of gold that each dollar could be converted into, it would inflate the monetary supply and stimulate economic activity. The outrage of this is that we robbed Peter to pay Paul; yes we stimulated the economy, but almost overnight we eliminated 20-30% of the purchasing power of each dollar. In today speak, imagine if your checking account tonight said you had $2000 in it and the next day you only had $1500. Magnify this to include the whole country, and you can imagine the kind of outrage that we would have today.
However, with the massive deficits, bloated bureaucracy, and tax regime we have in place today, we are moving towards a point where the inflation question will be crossed. Two years ago, it was incorrectly stated that TARP would spark off massive inflation. While we did infuse $700 billion into the monetary system, this was also done with a quick exit strategy, saved our country from massive runs on the banks, and has been mostly paid back due to the restrictive terms of the loans. On the other hand, a similar stimulus package was passed the following year, but this bill was filled full of pork and trash such as funding for the National Endowment for the Arts. We are borrowing money for programs that will never pay a return to the taxpayer. Originally, the $700 billion was sold as an infrastructure and public works bill. Had we put all $700 billion into public works, then surely down the line the bill would pay for itself. But to send $700 billion to organizations that put out moral filth such as the NEA is just a crime. To steal money from the hard working Americans like this is wrong and unconstitutional.
We will have four major options for handling our current financial mess. The first option, and most unlikely, is a flat out default on our debt. This would freeze up our access to the capital markets, and would be devastating to the functioning of our economy. Option two is to cut a deal with China or other major debt holders on some sort of a debt forgiveness program. A possibility is that we would allow our debt to be renegotiated in exchange for lifting our defense guarantees for Taiwan. This type of deal would never be able to clear both houses of Congress, and I feel that even if it could, our moral conscience would not let us consider this possibility. Option three is to put in place massive tax hikes. While this may raise more money in the short run, we run the danger of the taxes becoming a permanent drag on future growth and economic competitiveness.
Which leads us to the final option: Inflation. I feel that we are in grave danger of employing this option in the relatively near future. With neither party able to get their agenda through Congress in the next two years, it is unlikely we will see the budget cuts needed to put our country back in economic health. I feel that if inflation is pursued, we will not see the same gold seizures as those that occurred in the 1930s; this would require an immense amount of police state power that could trigger a civil war. Most likely, we will just let the printing presses run, as our dollar is not tied to any sort of fixed commodity. While I do not suggest a running out to the coin shops, I would encourage investors to keep the risk of inflation in mind, and consider assets that do not lose their value due to governmental devaluation.