Consequences

“The man that sets out to carry a cat by it’s tail learns something that will always be useful and which will never grow dim or doubtful.”

– Mark Twain

Here we go again

Over the past year or so, when the Federal Reserve – lead by Chairman Ben Bernanke talked about withdrawing stimulus we kept saying we didn’t believe him. Why would we or anybody else? Bernanke, along with his predecessor Alan Greenspan, are Kenesyian money-printers of the first degree. Their typical response to economic problems has been to throw newly printed money at them. And the U.S. with it’s stubbornly high unemployment, ever-growing massive debt, and anemic recovery after $trillions in government “stimulus” already – has some serious economic problems. As expected, right on queue, the Fed has announced that it will buy $600 billion of U.S. Treasuries through June, 2011.1 All with money newly printed out of thin air.

Savers Bear the Brunt of Fed Policy

As Fed money-printing increases the supply of dollars, it continues to dilute the value of dollars already in existence. The same dollars Americans’ hard-earned savings are denominated in. And as Fed purchases create an artificial market for US Government debt – they also it keep the interest rates on Treasuries artificially low.

Think about it. If China and the rest of the world really wanted to buy US Treasuries – they’d be lining up to buy large amounts of them. But at current interest rates they are not. They might be interested if rates were higher – but increased borrowing costs are not what the US Government wants. Instead, via the Fed printing press, the Government can sell it’s debt (Treasuries) at ridiculously low interest rates – basically to itself. Not only do Americans get to experience the purchasing power of their dollars becoming more and more diluted – the resulting low rates Treasuries, CD’s, and other traditionally conservative investments pay, make it harder for investors to keep pace with rising prices. The Fed can talk about low “inflation” ’til the cows come home – but one walk through any supermarket tells us where prices are heading. In our opinion – that is up.

Are we Greece?

What’s the difference between the U.S. and Greece? Besides having great weather, beaches and food, ancient history, and being the cradle of Western philosophy and the Olympics – the one glaring thing the Greeks don’t have that the US does – is a money-printing press. In the old days, when the Greek government over-spent on social benefits it could not afford, they just printed more Drachmas. But under the EU and Euro, the Greeks don’t have a printing-press. And the Germans who work their tails off (and make cars which actually work, last, and are fun to drive) – don’t like to pay for Greek financial mismanagement (not to mention pre-age 60 retirement). So after a grudging bailout by the EU – the Greeks are now forced to enact austerity measures (many of which have met with public protest) requiring them to cut spending in an attempt to get their fiscal act together.

In the US – we do have a printing-press via the Fed. And as the US government continues to rack up larger and larger deficits and national debt – it just continues to print to pay for it. We don’t think this can go on forever without serious economic and monetary consequences.

Velocity

By the true definition of the term “inflation” (increasing money supply) the US already has very high inflation. We believe two key things to watch for are “inflation expectations” and “velocity.” Right now there is a lot of money sitting on the sidelines due to monetary inflation. If it becomes generally accepted opinion that Dollar debasement is accelerating, this can result in high inflation expectations among investors. This is when monetary velocity may accelerate dramatically. At this moment, investors sitting on conservative, low yielding investments like cash, bonds, and CD’s may come a realization. That realization could be that they need to own things which have a better likelihood of holding (or increasing) their value in such an environment. We don’t believe cash, bonds, or CD’s would be very popular in such an environment.

The Election

We don’t think the recent election results will have a tremendous affect. To us both parties are responsible for the current mess. The Republicans and Democrats are quite good at demagoguing to their constituents. But when push comes to shove it’s our opinion neither party has shown the ability or the resolve to do what’s necessary (and politically unpopular in many cases) to get the United States’ fiscal house in order.

We believe the majority of the members in each party will stare into the abyss and courageously say – “print!” And it’s our opinion there will be consequences indeed.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time — now, more than ever — we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of economic circumstances. Others may feel free to contact us to lean more.

Sincerely

Stephan R. Ernharth, JD, AIFA
Vice President
Ernharth Group
www.ernharth.com

Please note that nothing in this communication is intended to encourage investors to engage in any specific investment strategy.

Please note that nothing in this communication is intended to imply projected performance or guaranteed returns of any type. Indexes are unmanaged measures of market conditions. It is not possible to invest directly into an index. Past performance is not a guarantee of future results. Economic conditions experienced in years past are not those of today and should only be looked upon historically. Special attention should also be paid to the historic volatility of commodities and precious metals. Certain statements contained within are forward-looking statements including, but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties.

Securities and advisory services offered through NATIONAL PLANNING CORPORATION (NPC), Member FINRA/SIPC, a Registered Investment Adviser. Ernharth Group and NPC are separate and unrelated companies.

1. Bloomberg, “Fed to Buy Extra $600 Billion of Treasuries to Boost Growth” November 3. 2010