Those who cannot remember the past, are condemned to repeat it.
-- George Santayana
As the U.S. government embarks on creating the most reckless expansion of our country's debt and currency since World War II, a little bit of historical reflection seems appropriate. This "stimulus" as they're calling it is nothing more than a massive giveaway to politically connected interest groups that will do nothing to create any real growth in the economy or lasting job creation.
In fact, it will further destroy growth and jobs by fueling inflation and higher interest rates. The effect of the stimulus can be summarized best by reversing and paraphrasing Winston Churchill's famous statement regarding the Battle of Britain, "Never in the field of human conflict was so much owed by so many to so few."
What does that mean? Put simply, that the stimulus will harm most Americans who have jobs, own businesses, pay taxes, and save money. That's what happens when you create an environment of rising interest rates, higher inflation, declining currency value and enormous future government debt to repay. The recent deficit projection for 2009 is nearly $3 trillion and will probably end up higher than that because of lower tax revenues and higher government expenditures.
The entire U.S. economy's GDP is about a $13 trillion and will probably end up lower than that because it is shrinking. At some point if this continues, we could get close to the government spending more than the entire country is producing. Does anyone really believe that this is sustainable? Of course it isn't, but ignorance is bliss, at least for a little while until reality sets in.
The last time the government pursued spending at these levels relative to GDP was around World War II, but at that time it was necessary in order to win the war. That was a good investment for America because it led to our rise as a dominant world power. Today, there is no such prize to be won. We're just doing this in a desperate attempt to prop up a failed economic system that was based on borrowing, speculating and spending rather than savings, investment, and production. It is far more similar to the
in Germany or various failed regimes from 1969 to 1992 in Argentina. The result is always the same. It is a decimation of the currency, much higher interest rates and much higher inflation. There is no reason to believe that the result will be different this time.
Even worse than the deficit spending on inflationary projects is the monetization of the debt that the
is considering. Monetization of the debt is what happens when a central bank prints money to buy sovereign bonds. With the exception of Japan, which is a very unusual economy with high domestic savings and no need for foreign capital, monetization of the debt has a perfect track record of leading to a severe decline in the value of that nation's currency and much higher domestic inflation or even hyperinflation. (Hyperinflation typically means an inflationary spiral that goes beyond just double digits and approaches annualized rates of 100% or higher.) This has most recently occurred in Zimbabwe.
Of course, the U.S. is not Zimbabwe, and I do not expect hyperinflation in the U.S. Our economy is too big, relative to the rest of the world, for this to happen. What is more likely is that foreign investors will start to bail out of the U.S. before inflation gets to that point, causing a sharp rise in interest rates that would restrain further inflation by draining liquidity from the system.
Unfortunately, this outcome is not really much better. If the economy is in trouble today with low- interest rates and falling prices, think how bad things will get if we have rising prices and high interest rates combined with high unemployment and stagnant growth. Many people in Washington and Wall Street say that doesn't happen, but they are wrong.
It does happen, and it will happen if we keep going down this path of senseless central planning inflationary economics and irresponsible expansionary monetary policy. History and economics don't care how good the rhetoric or the speeches sound coming out of the mouths of skillful politicians. Fancy rhetoric is not any substitute for sound government policy driven by market economics and sound monetary policy driven by the objective of a stable money supply.
What about investing in foreign stocks, bonds and currencies? I don't believe that will offer much protection. The U.S. is so big that as we devalue our currency, other countries will mostly need to follow us and devalue theirs. This will lead to generally high inflation all over the world and a challenging investment environment for financial assets and currencies globally. On a relative basis, financial assets and currencies in countries such as China, Brazil, Australia, Canada, and India should outperform, but they may still lose money. For bond investors, Germany or Switzerland could be a relatively good place to put your money as an investment.
In this environment, investors need to focus on owning hard assets, such as gold and oil, and shorting some long-term Treasuries to balance a large cash position that could be severely damaged by inflation. Stocks will continue to be challenged relative to hard assets, but they are no longer a good short because inflation will ultimately increase the price of everything, including stocks. Specifically, investors should have some capital deployed in
PowerShares DB Gold Double Long ETN
Ultra DJ-AIG Crude Oil ProShares
Ultra Basic Materials ProShares
, which includes in its portfolio
As inflation starts to heat up later this year, investors may want to shift even more cash into investment vehicles such as these. Multifamily rental real estate in supply constrained locations is also a good investment in this environment because rents will ultimately rise with inflation and investors can secure long- term fixed rate financing at low-interest rates from
, or HUD.
The bottom line is that it is too late for America to reverse course. We are headed down the path of inflation and currency debasement, and all investors can do at this point is position themselves to deal with it and minimize the damage. Hopefully, this downward spiral will run its course quickly so that we can get back to focusing on how to create real growth and productivity in this country rather than just how to use rhetoric and politics to bail out or promote certain interest groups at the expense of the rest of the country.
Christopher Grey is a managing partner of Third Wave Partners. He currently has no positions in the stocks mentioned in this article. This article should not be interpreted as personal investment advice or a recommendation to buy or sell any security. Interested readers may contact the writer by e-mailing firstname.lastname@example.org or visiting the company's Web site, www.thirdwavepartners.net.