By Robert Barone of Ancora West AdvisorsNEW YORK ( TheStreet) -- Yesterday's action in the equity markets tells me that risk and volatility have returned. The potential, and, perhaps, inevitable meltdown of the European Union due to the overpromising of entitlements and habitual deficit spending speaks directly to the reasons that volatility has returned to U.S. markets. After all, hasn't the U.S. made similar promises? During the Greek debt crisis, precious metals have moved to the upside toward historic high prices as a flight to safety. My view is, and has been, that the U.S. is not immune from similar dire consequences of its own profligacy. In fact, the country may have already passed the point of no return with regard to solutions. The uncertainty surrounding the long term direction of taxes, fiscal policies and monetary policies in the U.S. makes the flight to safety and to precious metals a rational response. The financial industry generally ignores academic studies and conclusions. But every once in a while, a study based on well documented historical data, reports conclusions so compelling that they cannot be ignored. Reinhart and Rogoff's 2009 book, This Time Is Different: Eight Centuries of Financial Folly made an impression on some business savvy folks regarding the fallacies of the use of debt to resolve a financial crisis. Now comes along another study, this one relatively obscure, by Cecchetti, Mohanty, and Zampolli of the Bank for International Settlements entitled The Future of Public Debt: Prospects and Implications, March, 2010, which concludes that the current and future state of fiscal policies and accumulated liabilities, along with the lack of political will, make future inflation and devaluation the most likely future scenario. Under the following three sets of assumptions about future fiscal policies (which exclude the huge underfunded liabilities in almost all state and local pension plans), the structural deficits now built into the U.S. budgets will move the debt/GDP ratios to levels similar to or worse than those now causing issues in Europe.
Given the spending track record of Congress under both Republican and Democratic leadership since 2001, one should have little confidence that 1) or 2) could be accomplished. And 3) would take political will not seen in our lifetimes. Yet, even if any one of these is accomplished, the authors conclude that the U.S.'s debt/GDP ratio would still reach at least 150%. It thus appears inevitable that the dollar will lose purchasing power (even if it doesn't fall vis a vis other currencies due to those countries' debt/GDP ratios) against hard assets. Finally, history shows that it is politically more palatable for politicians to choose inflation, rather than higher interest rates, as the solution. Increased portfolio allocations to inflation hedges (precious metals), then, would seem to be the rational long-term response. Yesterday, the markets began to recognize this reality. -- Written by Robert Barone in Reno, NV