How this economic disaster ends is something about which many of us speculate. Two extreme endings are likely — a sudden deflationary collapse or a period of very high inflation/hyperinflation which ultimately cripples commerce and resolves itself in a deflationary collapse. In either case, the deflationary collapse is another Great Depression.
It is important to know which route will occur because of what will happen to asset values along the way. A move directly into a Great Depression will depress severely most asset values, especially common stocks, housing and other hard assets. Bonds, cash and fixed incomes may be beneficiaries in the sense that their purchasing power increases.
If the Great Depression is preceded by hyperinflation, just the opposite will happen, at least through the transition stage. Cash, fixed incomes and bonds will be devalued, perhaps even wiped out, if the hyperinflation is severe. Stocks, housing and other assets are likely to benefit until the Great Depression takes hold. Once the Great Depression period begins, the effects on assets will be as described in the paragraph above. However, those who believed they had adequate savings and retirement incomes may enter the Great Depression destitute.
Regardless of which route is taken, most people will lose. Winners will be those prudent and fortunate enough to preserve their purchasing power. Wealth creation is unlikely for most; wealth preservation, in terms of purchasing power, would be an admirable achievement.
Phoenix Capital Research weighs in with their opinion which is that a deflationary collapse lies ahead. They believe we are going directly to the Great Depression because the Federal Reserve has run out of options. Their thinking runs counter to this statement from Bloomberg:
A couple of members indicated that the initiation of additional stimulus could become necessary if the economy lost momentum or if inflation seemed likely to remain below” 2 percent, according to minutes of their March 13 meeting released today in Washington. That contrasts with the assessment at the FOMC’s January meeting in which some Fed officials saw current conditions warranting additional action “before long.”
Even though some members leave the door open for future stimulus, Phoenix believes this unlikely:
The Fed knows that inflation is higher than 2%. It also knows that US growth is faltering. The above announcement is the Fed essentially admitting its hands are tied regarding more easing due to:
- Gas being at $4 and food prices not far from record highs.
- This being an election year and the Fed now politically toxic.
- Growing public outrage over the Fed’s actions (secret loans, etc.) in the past.
Again, we are in a process of slow awakening to the fact that the Fed has not solved the problems that caused 2008. Instead, the Fed has exacerbated these problems (excess leverage) and created new problems in the process (inflation).
From this reasoning Phoenix concludes that central banks are about finished:
In simple terms, the Fed’s hands are tied and the ECB is out of ammo. The End Game for Central Bank intervention is approaching. And it won’t be pretty… First Europe. Then Japan. Then the US.
In terms of the effectiveness of central bank policy with respect to the economy, Phoenix is correct. Additional monetary stimulus has not and will not produce benefits regarding the economy. But that conclusion was true a year or more ago, and it didn’t stop central banks. Nor will it stop them in the near future.
The Federal Reserve was established as a quasi-independent agency and for part of its existence actually functioned relatively separate from political considerations. That certainly has not been the case recently. Since Alan Greenspan ran the Fed (and to lesser degrees before him) the Fed has become increasingly a political institution, serving the needs of the political party in power. As the government took over more and more control of the economy, it became more important that they control the Fed.
From the Fed’s standpoint, they were created by Congress and their charter can be removed by Congress any time it chooses. If the Fed doesn’t cave to political pressures, it will be disbanded in favor of a replacement which directly reports to the President or Congress and does their bidding. Ben Bernanke is fully aware of that and doesn’t intend to lose his lucrative position. Hence he and his predecessor were de facto political servants rather than economic stewards of the banking system.
The issue regarding the Fed and its future actions is less whether they can help the economy and more whether they can help the political class. Printing money provides cover for a bad economy. It drives up asset prices (stock prices) which voters use as one proxy for whether the economy is improving. Does anyone believe that incumbents (even Republicans) want voters more angry than they already are before the next election?
More important than the state of the economy is the fact that the government cannot collect enough tax revenues or borrowings in credit markets to pay for what they spend. If the Fed does not cover this shortfall by buying bonds (the manner in which they “create money”), government cannot pay its bills. When it comes down to stopping social security checks or welfare payments or military pay, does anyone really believe that will happen so long as the Fed has a printing press?
The Fed, just like the government, will do whatever it has to in order to survive as an institution. Survival for both can only be achieved by printing more money. Similar considerations relate to Europe. Without their central bank continuing to print, the European banking system collapses and the Eurozone breaks up. No European politician is willing to allow that to happen, at least not yet.
Obviously printing cannot go on forever, but it can go on and likely will until hyperinflation or something approaching this level of inflation destroys the currency. It is not economics that causes me to predict hyperinflation but politics. After all, inflation everywhere is always a political phenomenon and not an economic one. Without the continued printing of money, the game of government as we know it ends. The Social Welfare States are all bankrupt and dependent upon money creation to continue the charade.
These governments will eventually collapse regardless of what they do. Printing money is a way for them to pretend and extend for a while longer. I do not see politicians throwing in the towel and saying that what we have been doing is running a massive Ponzi scheme before they not exhausted every alternative. For that reason, I believe very high inflation or hyperinflation is in our future before a Great Depression commences.
There is obvious disagreement as to whether inflation or Depression comes first. Indeed, there are some so naive to believe that neither will occur; that the economy will rebound and return to normal. On that last point, I am reasonably certain that it cannot happen. Regarding the sequencing of events, you will have to make up your own mind.
For me, I don’t expect the politicians to do the right thing now or ever. They do what is right for them and not the country. To me, that means watch out for very high inflation ahead.