The red flags contained in the national and global headlines that have come out thus far in 2014 should have spooked investors and economic forecasters. Instead the markets have barely noticed. It seems that the majority opinion on Wall Street and Washington is that we have entered an era of good fortune made possible by the benevolent hand of the Federal Reserve. Ben Bernanke and now Janet Yellen have apparently removed all the economic rough edges that would normally draw blood. As a result of this monetary “baby-proofing,” a strong economy is no longer considered necessary for rising stock and real estate prices.
But unfortunately, everything has a price, even free money. Our current quest to push up asset prices at all costs will come back to bite all Americans squarely in the pocket book. Death and taxes have long been linked by a popular maxim. However, there also exists a similar link between debt and taxes. The debt we are now incurring in order to buttress current stock and real estate will inevitably lead to higher taxes down the road. However, don’t expect the taxes to arrive in their traditional garb. Instead, the stealth tax of inflation will be used to drain Americans of their hard earned purchasing power.
The last few years have proven that there is no line Washington will not cross in order to keep bubbles from popping. Just 10 years ago many of the analysts now crowing about the perfect conditions would have been appalled by policies that have been implemented to create them. The Fed has held interest rates at zero for five consecutive years, it has purchased trillions of dollars of Treasury and mortgage-backed securities, and the Federal government has stimulated the economy through four consecutive trillion-dollar annual deficits. While these moves may once have been looked on as something shocking…now anything goes.
But the new monetary morality has nothing to do with virtue, and everything to do with necessity. It is no accident that the concept of “inflation” has experienced a dramatic makeover during the past few years. Traditionally, mainstream discussion treated inflation as a pestilence best vanquished by a strong economy and prudent bankers. Now it is widely seen as a pre-condition to economic health. Economists are making this bizarre argument not because it makes any sense, but because they have no other choice.
America is trying to borrow its way out of recession. We are creating debt now in order to push up prices and create the illusion of prosperity. To do this you must convince people that inflation is a good thing…even while they instinctively prefer low prices to high. But rising asset prices do little to help the underlying economy. That is why we have been stuck in what some economists are calling a “jobless recovery.” The real reason it's jobless is because it's not a real recovery! So while the current booms in stocks and condominiums have been gifts to financial speculators and the corporate elite, average Americans can only watch from the sidewalks as the parade passes them by. That's why sales of Mercedes and Maseratis are setting record highs while Fords and Chevrolets sit on showroom floors. Rising prices to do not create jobs, increase savings or expand production. Instead all we get is debt, which at some point in the future must be repaid.
As detailed in my special report, when President Obama took office at the end of 2008, the national debt was about $10 trillion. Just five years later it has surpassed a staggering $17.5 trillion. This raw increase is roughly equivalent to all the Federal debt accumulated from the birth of our republic to 2004! The defenders of this debt explosion tell us that the growth eventually sparked by this stimulus will allow the U.S. to repay comfortably. Talk about waiting for Godot. To actually repay, we will have few options. We can cut government spending, raise taxes, borrow, or print. But as we have seen so often in recent years, neither political party has the will to either increase taxes or decrease spending.
So if cutting and taxing are off the table, we can expect borrowing and printing. That is exactly what has been happening. In recent years, the Fed has bought approximately 60% of the debt issued by the Treasury. This has kept the bond market strong and interest rates extremely low. But a country can't buy its own debt with impunity indefinitely. In fact the Fed, by winding down its QE program by the end of 2014, has threatened to bring the party to an end.
Although bond yields remain close to record low territory, thanks to continued QE buying, we have seen vividly in recent years how the markets react negatively to any hint of higher rates. That's why any indication that the Fed will lift rates from zero can be enough to plunge the markets into the red. The biggest market reaction to Yellen's press conference this week came when the Chairwoman seemed to fix early 2015 as the time in which rates could be lifted from zero. That possibility slapped the markets like a frigid polar wind.
Janet Yellen may talk about tightening someday, but she will continue to move the goalposts to avoid actually having to do so. (Or as she did this week, remove the goalposts altogether). As global investors finally realize that the Fed has no credible exit strategy from its zero interest policy, they will fashion their own exit strategy from U.S. obligations. Should this happen, interest rates will spike, the dollar will plunge, and inflation's impact on consumer prices will be far more pronounced than it is today. This is when the inflation tax will take a much larger bite out of our savings and paychecks. The debt that sustains us now will one day be our undoing.
But there are steps investors can take to help mitigate the damage, particularly by moving assets to those areas of the world that are not making the same mistakes that we are. In my new report, I describe many of these markets. Just because the majority of investors seem to be swallowing the snake oil being peddled doesn't mean it's wise to join the party. I urge you to download my report and decide for yourself.
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