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The Daily Reckoning Weekend Edition Saturday, October 02, 2010 Buenos Aires, Argentina ------------------------------------------------------- Government spending gone wild! And the implications for your wallet, Another installment in the great "Battle of the 'flations" debate, Plus, all the reckoning's from this past week, neatly stacked in a virtual paper box, for your perusal... --- Strategic Short Report Announces... --- Now You Can Beat the Bastards at their Own Game... Hidden Gov't Documents Let You Predict Stock Moves Imagine what you could do with this intelligence... Roger Barnes of Colorado used one of these hidden documents to bank $237,000 in just 6 days... It's all perfectly legal and you can do this too! Click here to watch the new presentation now. ------------------------------------------------------- Joel Bowman, from Buenos Aires, Argentina... With gold on a record-setting streak, and the battered ol' greenback plumbing new, multi-year lows, the debate over the "Battle of the 'flations" has returned with a vengeance. We all know the government's CPI numbers are a junk stat...at best. For those of us living with the cost of food and energy, which the CPI reading conveniently excuses, the eroding purchasing power of the once- mighty US dollar is becoming an increasingly painful concern. So, where to from here? Is the world's largest economy set to slump into a Japanese style, multi-decade period of low-to-no growth; the "lost" decades? Or, will the end to the Great Correction come much faster, in the form of a violent bout of inflation, even hyperinflation? [In any case, is one preferable to the other? Is it really, as Neil Young sang in his classic "My My, Hey Hey (Out of the Blue)" "better to burn out than fade away"? Send your thoughts and/or predictions along here: joel@dailyreckoning.com] In this weekend's special guest essay, Hong Kong-based investment manager, Puru Saxena, returns to offer his thoughts on the matter. Please enjoy... Deflation: Reality or Urban Myth? By Puru Saxena Hong Kong, China The inflation/deflation debate is now the 'topic du jour' and although we have discussed this issue in the past, we want to throw more light on this very important subject. Today, many prominent economists (Nouriel Roubini, David Rosenberg and Paul Krugman) and fund managers (Bill Gross and Jeremy Grantham) are forecasting deflation and according to these folks, a deflationary contraction is now 'baked in the cake'. In fact, these deflationists are extremely worried about the ongoing private-sector debt- deleveraging in the developed world and they are also concerned about the lack of aggregate demand in the industrialised nations. Bearing in mind these two factors, these prominent people believe that deflation is now almost guaranteed and inflation is out of the question. On the other end of the spectrum, and in stark contrast to the deflationist camp, many prominent market participants (Paul Tudor Jones, John Paulson, Jim Rogers, Marc Faber and Peter Schiff) are now warning about high inflation or even hyperinflation. According to these people, the large fiscal deficits and massive debt overhang almost guarantee runaway inflation. It goes without saying that such conflicting views are extremely strange when you consider that all these highly experienced and successful people are reviewing the same economic data! Well, everyone is entitled to their opinion, but as far as we are concerned, deflation is an urban myth and the global economy will have to contend with very high inflation. It is our conjecture that inflation is always a monetary phenomenon and willing policymakers have the ability to create inflation. Now, before we delve any further, we want to make it clear that inflation is an increase in the supply of money and debt. Conversely, deflation is a decrease in the supply of money and debt. Furthermore, it is critical to understand that an increase in the general price level is a consequence of inflation and a decrease in the general price level is a consequence of deflation. Most importantly, despite what you may hear elsewhere, you should keep in mind that a booming economy (operating at maximum capacity) is not a pre-requisite for inflation. Now, if you reside in the deflation camp and believe that inflation cannot occur in a weak economic environment, you need to visit Zimbabwe and meet Mr. Mugabe who will explain how you can create hyper-inflation at a time when a nation is facing an economic depression! Whether you like it or not, Zimbabwe's hyper-inflationary saga clearly shows that despite a huge output gap, surging unemployment and a bankrupt economy, reckless policymakers can succeed in creating massive inflation. Look. We do acknowledge the fact that the economies of the developed world are struggling and they will probably remain weak for several years. We also accept the fact that the aggregate demand in these troubled economies will stay well below the available capacity (output gap). However, contrary to the deflation camp, we totally respect the money-creation abilities of the central banks. Accordingly, we firmly believe that in order to avoid sovereign defaults in the near-term, the Federal Reserve and the European Central Bank will create unprecedented inflation. Already, short-term interest-rates in the US and in Europe are at extremely low levels and real short-term interest-rates are negative. If such a loose monetary policy fails to create inflation, you can bet your bottom dollar that these central-banks will unleash even more rounds of 'Quantitative Easing'. Needless to say, such reckless monetary-inflation will dilute the existing money-stock even further and reduce the purchasing power of money. Okay, enough about the inflationary bias of the public-sector, let us now move on to the private-sector. As far as the private-sector is concerned, you may recall that after the credit-bubble burst two years ago, commercial-bank credit in the US started to contract. After all, this debt repayment by the private- sector was a logical response to the crisis and for 17 months, commercial-bank credit declined by roughly US$700 billion. In fact, it was this private-sector debt contraction, which prompted many economists and investor to enter the deflation camp. Whilst it is true that the private-sector in the US did experience deflation (contraction in debt) for a brief period of time, it is notable that this 'austerity' did not last very long! Figure 1 shows that US commercial-bank credit bottomed out earlier this year and since then, it has risen by roughly US$400 billion. So, it should be clear to all observers that the private-sector in the US is no longer de- leveraging and this is inflationary. Furthermore, we would like to point out that even though commercial- bank credit in the US contracted between October 2008 and March 2010, during that period, America's federal debt went through the roof! Ironically, during the time-frame when American households and corporations were tightening their belts, the US-Treasury borrowed almost US$2 trillion; thereby stopping deflation in its track. The truth is that at no point during the recession did total debt (private- sector plus federal) in the US contract, so deflation did not occur. Now, it is conceivable that the private-sector in the US may abruptly start repaying its debt again. However, if such a debt-contraction occurs, Mr. Bernanke will create money like there is no tomorrow. Today, America's total liabilities (including social security, Medicare and Medicaid) are around 800% of GDP and federal debt has climbed above 90% of GDP (Figure 2). Given the fact that deflation will increase the real value of this debt, you do not have to be a brain surgeon to figure out that before the US government declares bankruptcy, it will desperately try and inflate its way out of trouble. By unleashing another 'stimulus', Mr. Obama's administration will try and maintain nominal GDP growth, so that nominal incomes and tax receipts are sufficient to service the outstanding debt. It is interesting to observe that in order to fund its spending binge, so far the US administration has succeeded in borrowing huge amounts of money at low interest-rates. It is notable that up until now, demand for US-Treasuries has been strong and the US administration has not had much trouble raising money. Perversely, in today's volatile economic environment, US government debt is still viewed as a safe haven. However, every good thing comes to an end and investors' perception could change at short-notice. When that happens and the bond market starts to focus on America's ballooning deficits, demand for government-debt will dive. At that point, the Federal Reserve will have no option but to create new money so that it can lend it to the US Treasury. In fact, the Federal Reserve has already announced that it will use the proceeds from the sale of its mortgage-backed securities to buy US Treasuries. In our view, this is only the beginning and outright asset-monetisation will intensify over the following years. Throughout history, periods of massive money-creation have always been inflationary and this time should be no different. Over the following months, if the economies of the developed world take a turn for the worse, you can be sure that the respective policymakers will respond by creating copious amounts of paper money. If you still believe that deflation will prevail, perhaps you should review the table below, which highlights the inflation rates in various countries. It is noteworthy that the inflation rate depicted here for each nation is in fact the Consumer Price Index (CPI), which significantly understates the price increases within an economy. Let there be no doubt that the majority of government agencies make seasonal and hedonistic adjustments to bring down the level of the CPI. Regardless, you can see that despite such 'feel good' adjustments to bring down the reported 'inflation' rate, every nation (except Japan) is currently experiencing 'inflation.' Bearing in mind this compelling data, we are left wondering how anybody can get hoodwinked by the deflation hype!? Perhaps, the deflationists know something the rest of us do not, but at this point, hard data does not support the deflation thesis. Given the inflationary environment we find ourselves in, we do not like cash or fixed-income securities. In our view, both cash and bonds will lose considerable real value over the following years and the ongoing strength in the government bond-market may turn out to be an exceptional selling opportunity. Conversely, we maintain our view that precious metals, energy and the stock markets of the fast growing developing markets in Asia will provide stellar returns in this inflationary environment. Regards, Puru Saxena, for The Daily Reckoning Joel's Note: Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription here. Puru is also the founder of Puru Saxena Wealth Management, his Hong Kong based firm, which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs. ------------------------------------------------------- Looking for Real, Tangible Assets to Protect Your Wealth? Look no Further... Mayer's Special Situations Announces: American experts call this unconventional new natural gas recovery program... "The Biggest Resource Breakthrough Since the 'Beaumont Miracle' of 1901" But only one of these cutting-edge companies offers you the "secret wealth advantage" I reveal right here. ------------------------------------------------------- ALSO THIS WEEK in The Daily Reckoning... Opt Out of Social Security By Ian Mathias Baltimore, Maryland Given the deplorable fiscal condition of the Social Security Trust Fund, some forward-looking Americans are asking, "Why can't I just opt out?" Even middle-aged members of the Baby Boom generation are wondering if there will be any Social Security left for them when the time comes...and if they wouldn't be better off abandoning the government's mandatory retirement plan. So can you opt out? In a word, yes. Flip-Flops-On-The-Ground Research By Chris Mayer Florianopolis, Brazil Our topic today is fertilizer. In Sao Paulo last week, I gave a short presentation to a group of readers about a few attractive Brazilian investment themes. I talked about the expanding middle class, which is driving the need for new housing. I talked about Brazil's dominant position in the global meat trade. I also talked about the case for hard coking coal (also known as met coal)...and about fertilizer. Brazil, like most emerging markets, needs much more fertilizer than it produces for itself. What's Really in the Social Security Trust Fund? By Ian Mathias Baltimore, Maryland The Social Security Trust Fund is, in fact, worth roughly $2.6 trillion. The status quo is safe at the moment. But as you hinted, there isn't a single US dollar in that fund...and anyone who thinks the money they've been sending the government to pay for retirement is neatly stacked in a giant vault - some super-sized swimming pool of money - has the wrong idea. Indeed, your government-sponsored retirement fund has all been spent already. Didn't you get your receipt? Fragging Your Own Money By Bill Bonner Baltimore, Maryland "Monetary warfare!" says The Financial Times. In North America, the US is pointing its heavy guns at China... the US Congress has proposed a bill naming China as a 'currency manipulator.' How, exactly, is China manipulating the renminbi? It is holding steadfast to the dollar! This, says US Speaker of the House, Nancy Pelosi, "translates into a significant subsidy, artificially making US products more expensive, and jeopardizing efforts to create and preserve manufacturing jobs in America." ------------------------------------------------------- With over 40,000 copies now in print, read your free online review copy of the brand new breakthrough financial report from Gold, Silver, and Energy expert Byron King... The Curse of the Incas: Gold's Untold Story and the Shocking New Role It Could Play in Your Financial Survival A 476-year old mistake could soon cost you your retirement. How so? To understand, you have to let me share a little-told story. It starts like this...(Cont. Here) ------------------------------------------------------- The Weekly Endnote: "One of my mates recently bought a property over in the States...somewhere cold, I think, maybe Michigan. Anyway, as you know, the Aussie dollar has rallied pretty strongly against the greenback of late and, with prices having held up relatively well here so far [compared to those in the United States], many Aussies are seeing opportunities to scoop up good deals over there." Your editor was enjoying his weekly "What's going on in your hemisphere?"conversation with his father. "They reckon they've picked the bottom of the market then, huh?" we inquired. "I don't know," father replied. "I don't think they really know, either. The point, though, is that the US looks to be on sale, one way or another. At least, that's the perception. The currency is cheap, historically speaking, and assets there have had the hell beaten out of them. I don't know if that's going to continue...or for how long, but some people are beginning to think there are good bargains to be had." "What are your thoughts on the matter?" "Well, I tend to favor local knowledge. Maybe the US property market is on sale...maybe not. What do I know? But I prefer to maintain a portfolio here, where I know the neighborhoods, where I can check on them every now and then to make sure things are going along smoothly. If a pipe busts, I don't want some guy on the other side of the world reading me three quotes to get the thing fixed, each more expensive than the last. I want to be able to go 'round and check it out myself. "Besides, that guy who bought his place in, I think it was Michigan...well, now he has a place in Michigan. I'm sure the people there are nice but, well, if the market really does crash, if things get really bad, you might have to live in the place for a while. For my money, I'd rather be riding it out on a sunny beach than in the thick of a Detroit winter. Again, that's just me." Enjoy your weekend... Cheers, Joel Bowman Managing Editor The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com The Daily Reckoning - Special Reports: Gold: The Truth About Gold Fiat Currency: Using the Past to See into the Future Have You Heard of the OTHER Government Backed "Pension Program?"