bhc investment: Global Wealth Destruction as Gold Rises, Part III

Thursday, January 15, 2009

Global Wealth Destruction as Gold Rises, Part III

The current U.S. monetary system is one that's based on a fiat currency -- which can be created out of thin air at no cost with an electronic printing press. In charge of that printing press is Mr Helicopter Ben [1], who believes he has learned something from the Great Depression [2]. Consider the following excerpts from the Fed Chairman's 2002 speech about preventing a prolonged period of sustained inflation decline, namely "Deflation: Making Sure 'It' Doesn't Happen Here" [3]:

Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press, that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation...

If there's one thing that Bernanke knows, he knows how important it is for him to keep on cranking up his printing press at full tilt in order to prevent negative inflation and a repeat of the Great Depression, which will the worst of all possible monetary outcomes. Once inflation reaches the negative territory, declines in prices across the board will become self-reinforcing [4], that's how Japan entered its lost decade after the collapse of its credit bubble [5]. The Fed Chairman will do anything and everything, and make sure that will not happen under his watch. Even if that means giving every household in the U.S. a cheque of $100 million, with the creation of new money, of course. It wouldn't matter if the economy is already in a recession, or the banking system is still broken, or pretty much anything else for that matter, inflation WILL follow -- any rules and convention that get in the way will be changed and thrown out of the window! This sort of monetary actions certainly sounded radical in 2002, but today they have become the norm. Let's have a look at what the Fed and U.S. government have done so far:

Lowered interest rates to almost 0%
Provided the now relatively "small" stimulus package in early 2008
Buying up mortgage-backed securities
Buying up asset-backed securities
Buying up agency debts
Doubled the monetary based
Exchanged assets of virtually zero value for Treasuries
Bailed out several huge bankrupt financial institutions
Lent directly into the commercial paper market
Buying toxic assets through the TARP programme
...

We at bhc investment believe the inflation that peaked out in year 2008 before a dramatic decline due to a global deleveraging, in which we saw prices such as Crude Oil, in particular, fell from 147 to 35, did not change the secular outlook for commodities at all. We knew inflation will peak and followed by a temporary correction before U.S. unemployment reaches 8%, as stated in [6]. We had in a number of occasions reduced our holdings in both Natural Gas and Crude Oil before lowering our average cost to around 80 and 7, respectively. However, we acknowledge this deleveraging in commodities is in many times more severe than we had anticipated -- we never thought Crude prices can go below our average cost.

To this end, let me say this for the record: The Fed will not have the b**** to raise interest rates until we see inflation making a comeback, or it will risk pushing the entire U.S. economy over the abyss of another Great Depression. By the time the Fed starts to raise interest rates, it will be a matter of playing catch up with inflation. Mainstream economists who think higher interest rates will tank the commodity market will have a hard time understanding this dynamics until inflation is once again making headline news. The Fed wants inflation so bad it will do anything and everything.

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