State of the Economy 2010 Revisited

[This post is a reprint of a paper I wrote in October of 2010 for my friends. It’s a bit long for blog format. For a pdf of the original format of this paper click here.]

October 26,2010


This paper is a follow-up to a paper I wrote last April titled, “The Precarious State of the US Economy and How to Protect Yourself from a Collapse of the US Dollar.” The original paper outlined the fundamental problems with our economy from the perspective of Austrian Economics. I discussed how the policies that our government and Federal Reserve are following would exacerbate the problems and lead to high inflation.

In this paper I want to highlight some new developments and answer some questions I’ve gotten, primarily about gold and silver. My purpose is not to give investment advice. My purpose is not to depress you before the holidays. My purpose is to alert you to the possibility of a rapidly falling dollar and suggest ways to protect your savings. I hope you’ll do your own research and decide for yourself.

In addition to the resources I recommended before, I would highly recommend watching “The Crash Course” by Chris Martenson. It’s a three hour presentation (broken into short chapters) that will blow your mind and allow you to see the future in a whole new light.

How Has This Advice Fared?

In my original paper I conveyed several predictions about the trends of different investments based on the Austrian economists’ viewpoint on the economy. Those included:

1. I admitted that I had no idea if US stocks would go up (due to Fed money printing) or down (due to fundamental problems with the economy).
2. The value of the dollar would continue its downward trend.
3. Commodities, gold, and especially silver would continue upwards.
4. Emerging stock markets like China, India, Brazil and Russia would out perform the US stock market.

How have those predictions fared in the six months since?

Apr 27, 2010 Oct 26, 2010 % Change
Gold Spot Price 1150 1340 +16.5%
Silver Spot Price 18.15 23.86 +31.5%
Continuous Commodity Index 480 (roughly) 561 +16.9%
S&P 500 Index (US Stocks) 1184 1186 0%
Dollar Index 82.1 77.6 -5.50%
Hang Seng (Chinese Stocks) 21,262 23,601 +11%
VEIEX (Emerging Markets Index) 26.4 29.8 +12.9%

I’m not pointing this out to say “I told you so.” Those trends could pull back or even reverse in the next six months (although I doubt it). The midterm elections or November 3rd Fed meeting could jolt the stock market. I’m just saying that maybe I’m not full of shit. Maybe there are long term macro trends that are predictable and unavoidable. Maybe it’s worth it to read on.

New Developments Since April

I also made some predictions about the economy and about the actions the government and Federal Reserve would take to try to help the economy. Among other things I said:

1. The mortgage crisis is not behind us.
2. The government would continue to borrow and spend to try to stimulate the economy.
3. The Federal Reserve would keep printing money to try to inflate our problems away.
4. The government would continue to increase regulations and taxes
5. None of this stimulus and money printing would help the economy
6. We would start to see high inflation which will crush the poor, the middle class, and the elderly while enriching the bankers and well connected.

How have these predictions panned out? Well, we’re seeing record foreclosures and mortgage defaults including strategic defaults. On top of that we have a new mess called “mortgage gate”. The government has shown no signs of cutting back spending- extending unemployment benefits, continuing the wars (yes we still have 50k “peace keepers” in Iraq), and not even discussing entitlement program reform. The Federal Reserve has kept interest rates near zero causing a “stealth monetization” of the debt and is now talking about a new round of quantitative easing (money printing). The health care bill and FinReg have increased regulations and we are facing increases in all kinds of taxes. Unemployment is still hovering around 10%. Producer prices for all kinds of raw materials are going through the roof and will soon show up in the grocery stores.

Mortgage Gate

As I discussed in April, we’re not out of the woods with mortgage resets as a new wave of mortgages are scheduled to reset in 2011. A recent report showed foreclosures up 29% in the third quarter year over year. In September, foreclosures topped 100,000 for the first time ever. The government tried to prop up the housing market with low interest rates and the new homebuyer tax credit, but that credit simply served to move purchases forward and home sales dried up once the stimulus ended. There has been an increase in strategic defaults where even people who can afford their underwater mortgage have stopped paying. Apparently, the social stigma of defaulting on one’s mortgage all but disappeared when mortgage originators sold off mortgages to Wall Street to slice, dice, traunch, and collateralize in an effort to make a quick buck.

Aside from that, there is a new development, “mortgage gate,” that is potentially a HUGE time bomb that could blow up many of the big banks. It turns out that in their zeal to create mortgage backed securities (MBS) as fast as possible, the bankers took a few shortcuts with the paperwork. They ignored state laws which stated that in order for a mortgage to be transferred to another entity, the mortgage note needed a notarized, “wet ink” signature. The problem was that in order to facilitate the process of creating MBS, the banks created an electronic software system called MERS to track and exchange mortgage notes. Since they weren’t transferred legally, it became muddled as to who actually owns the mortgage note. Once this “chain of title” is broken, the bank cannot foreclose on a borrower if they cannot produce the note. Oops!

To try to get around this, many of the banks have attempted to fraudulently sign tens of thousands of documents after the fact. But they got busted. As a result, many of the foreclosures that have already taken place may be null and void. On top of that, many new homeowners who purchased foreclosed homes might not actually have legal title to the house they think they own. This giant shit show could take years to sort out and will

require thousands of lawyers, accountants, and government officials doing nothing but trying to make sense of the mess. In the mean time, thousands of homeowners will continue to live rent free in their houses to the consternation of their “sucker” neighbors who are dutifully paying their underwater mortgages.

In another wrinkle of the mortgage mess, purchasers of the original MBS are claiming that roughly 50% of the MBS sold to them were misrepresented by the banks as to the collateral they contained. It was recently announced that PIMCO and the NY Fed were suing Bank of America to have a “putback” of $47bln of worthless MBS. The total cost of these putbacks to all banks is currently estimated to be around $120bln or more.

Nobody knows exactly how this will play out. Some say it’s just a matter of sorting through the paperwork. Others say it’s a several hundred billion dollar problem which will bring down the banks. Raise your hand if you think this is going away any time soon.

Health Care Fallout

Regardless of whether the new health care bill is good for our health, news continues to come out that the bill is making the economy sick. Companies like McDonalds are asking for (and receiving) exemptions for having to cover all of their employees as laid out in the bill. Other companies are dropping their coverage altogether. Many insurance companies have stopped issuing any new insurance policies to children. Premiums are continuing to go up. Business owners are complaining that they can’t hire because they can’t handle the insurance mandates. A recent report from HHS indicated that as many as two-thirds of businesses will have to change their insurance policies to meet government requirements. Businesses will soon have to file 1099 forms for every vender they buy more than $600 worth of goods from over the course of the year. (How that relates to healthcare I’m not exactly sure.) And the expensive parts of the bill don’t kick in until 2014. Stay tuned.

Pending tax increases

This may be considered more of a non-development as congress has failed to define what the income tax rates will be for 2011. The rumor seems to be that they will extend the so-called “Bush tax cuts” for everyone who earns under $250k. This lack of clarity makes it hard to plan for next year. Aside from the income tax, there are several other taxes set to go up in 2011.

If congress fails to act, the estate tax (or death tax) will go from zero in 2010 to 55% on estates worth over $1m. Aside from a huge number of people mysteriously shuffling off this mortal coil on Dec 31st, the estate tax will cause problems for people with family businesses that have assets in fixed plant and equipment like small farmers and manufacturers who may have to fire employees or liquidate assets just to pay the tax.

The capital gains rate is set to go from 15% to 20% and the dividend tax is set to go from 15% to 40%. This will divert even more capital from the U.S. markets.

The healthcare bill includes over a dozen new taxes to be implemented in stages over the next decade to tally an estimated $409bln by 2019.

Taxes are the most transparent and least damaging way for the government to raise revenue (as opposed to borrowing or printing). But while increased taxes may help to close the budget deficit, they will be a drag on the economy as they remove capital from the private sector where it can actually create jobs and growth.

Painting the Picture of a Falling Dollar

In my first paper, I laid out a bunch of statistics about how much trouble our economy is in and suggested some ways to protect oneself. But I think I failed to paint a vivid picture that connects the dots to create a compelling case for action. I’ve had more than one conversation with friends that went something like this:

Friend: Hey, I liked your paper. I passed it on to a friend in finance and he loved it.
Me: I’m glad you liked it. Did you buy some silver?
Friend: No.
Me: Well did you at least look into it or check out some of the references I suggested?
Friend: No.

In the following sections, I want to paint a picture of what high inflation and even hyperinflation would look like and what it could mean to our quality of life as we know it. I believe high inflation for the everyday things we buy, like food and energy, is unavoidable in the coming years. I also believe that hyperinflation and a collapse of the dollar is within the realm of possibility in the next five years. Here’s why.

Deflation vs. Inflation

There is a debate among economists as to whether the biggest risk our economy faces is deflation or inflation. Those on the deflationary side point to the fact that we are in an economic contraction and bank lending is decreasing, thus the overall money supply is contracting. They fear a deflationary spiral where decreasing total wages lead to decreasing prices causing consumers to defer spending and thus weakening the economy even further. Ben Bernanke is firmly in this camp and will do everything he can to prevent deflation.

The deflationist theory has some roots in history, which has shown repeatedly that after an expansionary boom, there is always a deflationary bust. This was evident in the great depression. However, the deflationists are missing one important distinction. They assume a fixed monetary base such as the gold standard that was in place in the 1930s. With a fiat paper money system as we have today, the Fed can always print enough dollars to offset the credit contraction. However, the theory still holds true in one respect- prices will deflate in terms of gold.

Another piece of “evidence” that Paul Krugman and others in the deflationist camp point to is Japan’s lost decade. (Actually it’s about two decades now.) In the 1980s, Japan had a stock market and real estate bubble that burst in 1990. The Japanese government has repeatedly implemented massive stimulus programs and infrastructure projects to try to jumpstart the economy, and still, Japan has slogged through 20 years of anemic GDP growth and deflation. Krugman and others argue that we need to pump even money into our system to avoid the same deflationary fate as Japan.

However, they are overlooking the crucial difference between the Japanese economy and our own. It’s what author Gonzalo Lira in a recent article has dubbed the “Japan is Us” fallacy which conveniently overlooks the balance of payments of the two countries. While Japan has run large trade surpluses with the rest of the world, the U.S. has consistently run huge trade deficits for decades. Japan finances her stimulus by borrowing from her own people while the US is financing her stimulus by selling assets, primarily U.S. Treasuries, to the rest of the world. This distinction makes all the difference as we have been borrowing money we can never pay back except by printing more of it.

The deflationists also point to falling asset prices as a sign of deflation. To be sure, after the housing bubble burst in 2008, we had a massive credit contraction and price deflation. Housing prices fell, stock prices fell, and many retail stores offered big discounts on overstocked goods to induce customers to spend. Our economy needed a period of de-leveraging to liquidate all of the bad debt that had built up over the past decade. The Federal Reserve pointed to this deflation as justification to pump money into the system. If the stock market crashes again or the economy stays stagnant with persistently high unemployment, the Fed will continue to print print print.

However, it seems like the deflation the government feared was short lived and we have already turned the corner towards inflation. According to the Core Consumer Price Index (Core CPI), which the Fed uses to gage inflation, prices are currently rising at a rate of around 1.1% per year which indicates fairly balanced price stability. However, the Core CPI doesn’t include energy and food prices (it’s not like anyone needs those things to live) and is also highly manipulated to make inflation seem lower. What we have is a scenario where some prices are going down while others are rising. While the prices of many so-called “assets” are going down, the prices of the consumables we buy are rising. The chart below shows that the prices of commodities had a sharp deflation after the housing bust, but have since resumed their inflationary run due to a declining dollar and increasing demand in foreign markets.

These increases in commodity prices have begun to work themselves out to the retail stores. As producer prices rise, businesses margins will be squeezed and retailers will be forced to raise their prices, decrease their margins, or shutter their doors completely. Contracting margins means less supply, which leads to higher prices.


Immediately following the bursting of the housing bubble the Fed conjured up $1.7 trillion dollars out of thin air to buy toxic assets from the banks to save the banking system. This process, euphemistically called “quantitative easing”, is Fed-speak for printing money.

In September, the Federal Reserve announce that they were prepared to engage in a second round of quantitative easing, QE II, if the economy didn’t show adequate growth. Ben Bernanke has made it clear that he thinks unemployment is too high, inflation is too low, and the way to fight it is to bring real interest rates down through QE. The Fed is expected to formally announce their plans for QE II at their November 3rd meeting. Estimates are that it will amount to somewhere between $500bln and $1T.

The effects of the expectation of QE II are beginning to be priced into the market. As Peter Schiff pointed out in a recent column:

“Many commentators are celebrating the ‘best September for the Dow and S&P in 71 years,’ rising 7.7% and 8.8% respectively. Well, it was also a pretty great September for soybeans (up 9.5%), rice (up 10%), oil (up 11%), corn (up 12.2%), orange juice (up 13%), cotton (up 17.5%), and sugar (up 19.3%). In fact, the whole CRB is up 8.7%. The Swiss franc is up 4.6%, the euro up 7%, the Aussie dollar up 9%. Gold is at all-time highs, silver at 30-year highs, and copper at 3-year highs.

“In other words, the box of Uncle Ben’s in my kitchen cabinet had a better month than the Dow Jones Industrials. The same could be said for the boxer shorts in my dresser. Could it be that the Dow isn’t rising, but the dollar falling?”

And what if QE II doesn’t work? QE I and the various bailouts and stimulus plans haven’t budged the unemployment numbers. Well then we’ll simply institute QE III, IV and V. As the saying goes- when your only tool is a hammer, every problem looks like a nail. (I wish I came up with that analogy to describe the Fed but I stole it from somewhere.)

Treasuries – The Last Bubble

For those unfamiliar with Treasuries, let me provide a very brief explanation. When the government needs to raise revenue on top of taxes, it borrows money by issuing Treasuries. These Treasuries are debt notes with a specified duration ranging from one month to 30 years in which the government promises to pay back the note, with interest, when the note expires. They sell these notes in periodic auctions where investors bid on the interest rate they are willing to pay for the note which determines the interest rate. The investors can hold the note until maturity or sell the note on the secondary market. If interest rates go down in future auctions, the value of the Treasury notes investors hold goes up. For example, say you buy a 10 year Treasury note yielding 5% per year. If six months later the interest rate on 10 year Treasuries drops to 4% your note becomes more valuable because new buyers would pay more for your 5% note than they would for a newly issued 4% note. Conversely, if the interest rates rise, the “price” of Treasuries falls. And now back to the story…

First came the dot com bubble. The promise of dot com riches had speculators leveraging up to chase after the When the bubble burst there should have been a sharp recession… but the politicians and the Federal Reserve didn’t want that. So instead the Fed drop interest rates below 2% for an extended period of time and the Government enticed people to buy homes with mortgage guarantees and the like.

This blew up an even bigger housing bubble with which by now we’re all excruciatingly familiar. After the housing bust we were headed for a severe recession and catastrophic failure of many of the large investment banks, but once again that was unacceptable to the politicians… so, to save the well connected bankers, err I mean the banking system, the government and Fed bought up the toxic assets from too big to fail (TBTF) banks, bailed out AIG 100 cents on the dollar and lowered interest rates to near 0% for banks.

This purchase of toxic assets and lowering of the interest rates was supposed to get the banks lending again so that credit could flow through the system and jumpstart the economy; but it hasn’t happened. Many people complain that banks aren’t lending out the money. In fact, they are lending the money. They’re lending it to the Federal Government by buying up U.S. Treasuries. This works great for everybody. The government needs a buyer for its Treasuries to pay for stimulus, wars, entitlements, etc. so they’re happy the banks will oblige. The Fed doesn’t want to appear to be buying too many Treasuries (i.e. printing money) so it’s happy the banks will do it for them. The TBTF banks get to borrow money at 0% and lend it to the government at around 3% for guaranteed profits. Everybody wins! Oh wait, except the ordinary citizens who have to pay back the national debt and find their money losing purchasing power daily.

As a side note, in the first quarter of 2010, four banks- Bank of America, Goldman Sachs, JP Morgan and Citigroup- each had perfect quarters. That is, all four made money on the trading floor every single day for three months thanks to the Fed sponsored carry trade. (And you wondered why they got such big bonuses.) If that doesn’t convince you that the Federal Reserve System is working for the banks and not the people, what will?

So the big banks are buying treasuries (and stocks and commodities) and will continue to do so with free money from the Fed. Who else is buying treasuries? Well, many investors are scared of another stock market crash and are flocking to the “safe” investment of U.S. Treasuries even though they are at record low yields. These investors would rather take a small percentage than risk big losses.

Foreign governments such as China, Japan, and Saudi Arabia are still buying bonds for two main reasons. First, they already own a lot of U.S. bonds so if they stop buying bonds, the dollar would go down and the value of their U.S. dollar holdings would plummet. They’re stuck in a sort of cat and mouse game where no government wants to be seen as dumping Treasuries for fear of other governments following suit which would decimate their dollar holdings. Second, buying U.S. bonds allows foreign governments to keep the value of their own currencies from rising which would hinder exports to the U.S.

Normally, a country would need to have a high savings rate, a strong currency and little debt to enjoy the privilege of borrowing at such low rates. However, Ben Bernanke has made it clear that he will continue to buy Treasuries to keep rates down for an “extended period” to boost the economy. So, investors continue to buy bonds knowing that rates won’t rise because the Fed won’t let them.

But can the Fed really hold down rates in perpetuity? With a national debt near $14T the interest on that debt for 2010 is estimated to be roughly 20% of tax revenues. With the government running perpetual deficits in the $1T range, the percentage of tax revenue that goes towards paying interest on the debt will continue to rise even if interest rates stay at historical lows. As more and more of our tax revenue goes just towards paying the interest on the debt, it will become more and more clear that the U.S. can never pay back the debt. We will have to default, or pay it back with highly devalued dollars.

Thus, as the risk of the US defaulting on its debt goes up, foreign governments and other investors will demand higher and higher interest rates to buy Treasuries. At this point the Fed will have two disastrous choices- let interest rates rise with the market or keep rates low by buying Treasuries at rates below what anyone else will pay for them. Let’s examine those options.

If the Fed lets interest rates rise, several things will happen. Credit will contract killing any shot of an economic recovery. Mortgage rates will rise for anyone with an adjustable rate mortgage leading to more foreclosures in an already devastated market. Many banks will fail. Most importantly, though, the interest our government pays on that $14T debt will skyrocket. A good portion of our national debt is financed with short term Treasury bills that roll over quickly and will be refinanced at a higher and higher rate.

If the Fed buys more treasuries, that equates to printing more money and devaluing the dollar. If, for example your Treasury bond yields 3% a year but the dollar loses 6% of its value a year, your real rate of return is negative. Investors would rather buy real things that they can hang on to instead of watch their purchasing power slowly whither away. Countries like China have already begun slowly pairing down their Treasury holdings and using their excess cash to buy gold, oil, mining companies, and other tangible assets. Soon the only buyer of U.S. Treasuries will be the Fed. That’s when the real money printing begins.

Clearly this can’t go on forever. And here’s the thing; everybody knows that. No one buying 30 year Treasuries is buying them to hold to maturity. That would be crazy. The only thing worse than holding depreciating dollars is holding a promise to be paid dollars in 30 years. Their plan is to sell them to the bigger fool. This is classic bubble behavior. Soon, we will run out of bigger fools and people will try desperately to dump their bonds.

Collapse of the Dollar

“If something cannot continue forever, it won’t.” – paraphrasing Herbert Stein

“There are only two kinds of paper money – those which are already worthless and those which are going to be worthless.” –source unknown (to me)

“Paper money always returns to its intrinsic value- zero.” -Voltaire

Have I completely jumped the shark? There’s no way our currency can collapse. Really? Why not? Because it hasn’t collapsed yet? America has already had several different monetary systems. Our current system of Federal Reserve Notes (dollars) with no gold backing has been around for less than 40 years. In that time the dollar has lost 81% of its purchasing power according to the CPI numbers and 94% according to the alternate (non-manipulated) CPI numbers calculated by John Williams at shadowstats. To me the question is will we have a long, protracted decline of the dollar that lasts decades or will it be a sharp, chaotic crash.

Throughout history there are thousands of examples of paper currencies that have come and gone. Are you so sure that the paper dollars you hold today will be worth the same tomorrow? In ten years? The U.S. Dollar is nothing more than debt, and its value is based on the perception of the ability of our government to pay back its debts. With perpetual deficits at nearly 10% of GDP and a debt to GDP ratio of over 60% and growing quickly, any hope of our ability to pay back that debt is fading fast. (Actually, according to Boston University economist, Laurence Kotlikoff, the actual debt to GDP ratio is 840% if you include the current value of all of our future obligations.)

For the first time in history, all of the world’s currencies are “fiat” currencies. In other words, paper created by the government with nothing backing it. And lately what we’re seeing is a race to the bottom as many countries are intentionally trying to devalue their currency in an attempt to make their exports more desirable. Unfortunately, this is a race the U.S. can win. How do some mainstream investors and economists feel about this?

– Hassim Taleb, author of The Black Swan, has said he believes the Federal Reserve will not exist in 25 years.

– John Paulson, hedge fund manager and one of the richest people in the world, recently stated that he has 80% of his wealth in gold based assets. 80% in one asset class? He’s crazier than I am; or he sees some compelling reasons to own gold.

– Bill Gross, head of PIMCO, recently called the Fed’s policy a brazen Ponzi scheme and stated that QE II would be the end of the bull market in bonds.

– Mark Faber, international investor, has stated he believes there is a 100% chance of a dollar collapse.

Whether you believe Mark Faber’s 100% number or not, I think it’s reasonable to admit that there is some chance a dollar collapse could happen. How would it happen?

I believe there could be some trigger that pops the bond bubble. It could be mortgage- gate causing Bank of America and many of the other TBTF banks to fail. It could be China, Russia, Japan and Saudi Arabia formally announcing a new trade agreement that doesn’t involve U.S. dollars as they have already been discussing. It could be hedge funds getting scared and bailing out of treasuries. It could be another stock market crash. Any of these would require the Fed to ramp up quantitative easing.

If the dollar keeps going down and Treasury rates stay low due to Q.E., foreigners will eventually stop throwing good money after bad and dump their Treasury holdings. If governments see other nations are getting rid of Treasuries they would follow suit so as not to be left holding the bag of rapidly declining assets. The dollars would instead be used to buy commodities, land, U.S. company shares, anything with tangible value so as not to be stuck holding dollars. All of those dollars that we have exported to the rest of the world over the last century would flood back to our country and the price of everything would skyrocket.

One mistake people make is viewing hyperinflation as simply really high inflation, when in fact, they are different animals. High inflation can happen when an economy is booming, credit is flowing freely, and people feel like the have a lot of money to buy goods. Hyperinflation on the other hand happens when people lose faith in the currency. Instead of a feeling of wealth as the impetus to buy things, the impetus becomes getting rid of the currency as fast as possible before its purchasing power drops further. This happened in Germany in the 1920’s, Argentina in the ‘80s, and Zimbabwe today among many other instances. In almost all cases, hyperinflation happens when a deeply indebted government tries to print its way out of debt by increasing the money supply without a corresponding increase in the production of goods and services. Sound familiar?

What Do Inflation, Stagflation and Hyperinflation Feel Like?

I would argue that we’ve already had high inflation since the 1970’s but it hasn’t been very evident because it has been disguised. We haven’t really had to feel the inflation because we’ve been able to afford more goods each year for several reasons. First, we’ve had huge advances in productivity during that time thanks to computers and the internet. Prices for all goods should have come down dramatically as the same amount of goods could be produced with far less manpower. But if you look at the chart of the CPI below you will see that prices have simply gone up. Wages have gone up as well but not at nearly the same pace and they have flattened out. Second, we have been able t0 export our dollars for real goods from places like China. This has kept prices lower for U.S. citizens than they otherwise would be. Third, more women have entered the workforce which means households can buy more goods than with one wage earner even if wages aren’t keeping up with inflation. Finally, easy credit has caused Americans to save less and borrow more which makes us feel richer and thus not notice inflation.

Unfortunately, with the exception of technology continuing to improve our quality of life, the factors that have hidden inflation have been exhausted. Families have tapped out their credit, we don’t have a new class of workers entering the workforce (unless the soldiers come home), and foreign countries are becoming more and more loathe to accept our dollars. As the Federal Reserve creates more money, the prices on goods will continue to rise and families will be able to buy less and less stuff.

Stagflation is the combination of high inflation with a stagnant or declining economy. We had this in the 1970’s as we suffered the hangover from our welfare and warfare policies of the 60s. I believe that’s where we are headed for the next several years. Imagine high unemployment and flat wages yet the price of milk goes to $10 a gallon, ground beef costs $10 a pound, and gas costs $15 a gallon. The unemployed and people on fixed incomes like many of the elderly would be scraping by just to put food on the table. Even those with jobs will need to give up many of the little luxuries they enjoy as more and more of their paycheck goes to paying utilities, food and basic clothing. The government might impose price controls on necessities as they did in the ‘70s which would lead to shortages and long lines for goods. Crime will go up and many more people will be living in poverty.

Hyperinflation is a whole new level of shit show. Anyone who has lent money such as bond holders or mortgage originators will be completely wiped out. Anyone who has saved in cash can see all of their savings disappear in a matter of weeks or days, no matter how much they start with. People will cash their paychecks as soon as they get them and immediately go out to buy whatever tangible good they can get their hands on. There will be panic in the streets, crime, riots, and perhaps marshal law. The best way to try to get a feel for it is to read about the other episodes of hyperinflation such as Weimar Republic Germany. At that time people were carrying bundles of money in wheelbarrows to buy bread. According to Mike Maloney at, at the height of the inflation you could purchase an entire city block in Berlin for 25 ounces of gold.

Hyperinflation can sneak up on you because it usually starts fairly mildly but increases at a rapidly accelerating pace. If you think you can just wait and if hyperinflation starts to happen you will just get out of the dollar… think again. By that time, it will already be too late. I’m not saying hyperinflation is definite or even probable, but I am saying you should be prepared just in case.


I believe we are living in extraordinary times that will see some major changes in this decade. I think it’s important that we all do our own investigation into how the world really works. Even if you think the worst case scenario is unlikely, I hope you will consider actions you can take to prepare yourself just in case. Think of it as you would fire insurance. While the chance of your house burning down may be very unlikely, the outcome would be severe.

Besides, what’s the worst that can happen if you follow my advice? Maybe five years from now you have some gold and silver coins that are less valuable than when you bought them. Maybe you missed out on some fun you could have had while you were dutifully paying down your credit card debt. Maybe you missed out on some gains in the stock market. Maybe you feel a little silly for having a weeks worth of emergency food and water taking up space in your cupboard. Wow. Now that does sound awful.

How you prepare will depend on your individual circumstances. If you are living paycheck to paycheck with high debt as many Americans are, you may need to proactively slash your expenditures and build up a rainy day fund. (Please be sure to read question 3 below.) If you have built up sufficient savings you may want to put at least some of those savings into safe haven assets like gold and silver. The point is that there are many actions you can take to mitigate risks depending on your personal situation.

I was going to write a more detailed conclusion but I believe Chris Martenson pretty much said it better than I could in the last chapter of his Crash Course video titled, “Chapter 20: What Should I do?” As I mentioned before, I would highly recommend watching the whole presentation but if you only have 20 minutes to spare on figuring out how to navigate today’s crazy world, then watch this chapter.

Well that’s enough of the completely depressing and morbid forecasts. It’s time for the silver lining (pun intended). Even if the worst happens and our currency collapses, America has strong roots and can rebound stronger than ever. Like a high colonic cleanse that evacuates the impacted fecal matter that has been gumming up the bowls of our eco-political system, a collapse of our Federal Reserve system will allow us to start with a clean slate. Those who have prepared and educated themselves can help lead us to a sustainable system of sound money and steady prosperity.

And buy some silver coins already.


I received many questions and comments after my first paper mostly about gold and silver that I want to address.

1. Is gold in a bubble?

Gold has gone up every year for the past 10 years. It’s up over 430% in the past 10 years. Surely it’s in a bubble by now right? Well, think about other recent bubbles.

During the dotcom bubble, internet companies were sprouting up like wildfires. Companies with no revenue stream and a cute sock puppet were getting millions of dollars in financing as long as they had a dotcom website. As Peter Schiff pointed out, at one point, Yahoo! stock was worth more than the entire stock market of New Zealand.

At the peak of the real estate bubble everyone wanted to buy a house because it could only go up. People were buying houses to flip them. In his book, The Big Short, Michael Lewis chronicles strippers in Las Vegas who owned five houses with no money down on their mortgage. That’s what a bubble looks like.

Compare the dot com bubble and the real estate bubble to gold. How many people do you know that own physical gold or silver? Are people buying gold so they can hold on to it for a bit and then flip it for a higher price? Are people borrowing money with zero down as they did in the real estate boom to buy a bunch of gold? Is there a lot of leverage jacking up the price of gold?

In fact, the opposite is true. The average person on the street is selling gold jewelry to get some extra cash. In 1900, Americans held 20% of their savings in gold. Today it’s more like 2%. People that own gold are hanging on to it because the reason they own it is for protection against a falling dollar. Almost no one is borrowing money to buy gold and if they are, they’re limited to about 5 times leverage which is the equivalent of putting down 20% for a mortgage. Also, gold mining stocks, which are a leveraged play on gold, would be going through the roof if there was a bubble. Instead they have been lagging the physical metal.

I believe gold will become a bubble; a huge bubble. But we’re nowhere near the top and I’m happy to ride that wave. Most “gold bugs” don’t buy gold just to have it. They believe that precious metals go through macro cycles in which they cycle from undervalued to overvalued relative to other asset classes. When they decide gold is near the top of that cycle, they will trade in their gold for more “useful” assets like stocks or real-estate.

To hear a great discussion on bubbles, check out Peter Schiff’s speech, “Why the Meltdown Should Have Surprised No One”.

2. Why should I buy gold at an all time high? Didn’t I miss it?

Yes, gold is at an all time high and silver is at a 30 year high in nominal terms. When you take inflation into account the all time high for gold is around $2215 and the all time high for silver is around $138. In other words, silver would have to go up over five times to match its inflation adjusted all time high. Could they go down? Of course. Nothing goes in a straight line but the long term trend is up as long as we continue deficit spending and money printing.

Also keep in mind that when G & S reached their highs in 1980 there was no multi-trillion dollar derivatives bubble, there was no concern about our government printing too much money, there were no trillion dollar bank bailouts, and there were no “paper” gold and silver markets such as Exchange Traded Funds (ETFs). Also, the only people participating in the gold rush were Americans and Western Europeans. This time, the whole world has the resources to join the party.

If G & S keep going up they will keep making all time highs. So when should you get in? Most metals investors recommend getting in a chunk at a time to dollar cost average. That way if the price goes down you can buy more at the lower price. If it goes up you at least know you already got some at a lower price. If gold or silver goes down count your

blessings because it means you can buy more ounces for your buck. In short, you can’t time the market so just buy some now and periodically add to your holdings.

3. I’d love to buy some silver or foreign stocks but I’ve got a mortgage and kids and we can barely buy food much less silver. Or, I just got laid off so I can’t afford to buy silver.

This is a huge red flag. You are precisely the person I am writing this paper for. First of all, you’re not alone. A recent study by said the number of American workers living paycheck to paycheck has risen from 43% in 2007 to 77% in 2010. The bad news is that if money is tight now, it’s only going to get tighter. I’m sorry. What you need to do is empower yourself. Get ahead of the curve and save now and pay off debts. One in seven Americans is living in poverty and that number is growing. The scary thing is that many of those people had good jobs a year or two ago and went from a comfortable middle class life to wondering why they need food stamps. 60 minutes recently had a segment called “99 Weeks: When Unemployment Benefits Run Out” which I would recommend watching. It’s amazing to see how quickly even smart people with good jobs and masters degrees can be swallowed up by their debts and expenses when they lose their jobs.

The bottom line is, if you aren’t saving 10-20% of your paycheck (or unemployment benefits), if you don’t have a rainy day fund, if you have a high level of bad debt, then you’re living above your means. Just because your neighbors live on borrowed money doesn’t make it right or even normal. Our grandparents ate lard, cut their own hair and went to a picture show once a month for entertainment so they could save for the future. OK, maybe that’s a slight exaggeration but the point is, no matter how strapped you are you can always cut back. You can move in with a roommate, cancel your cable, eat beans and rice, clip coupons, and use cloth diapers instead of disposables. If you have major debt issues like many Americans I would suggest talking to a debt expert to negotiate, consolidate, and work down your non-productive, high interest rate debt.

If you act proactively by voluntarily living below your means now, you can avoid a situation where you are forced to live well below your means if your job disappears. Talk to you family, make a commitment and make a plan.

4. Isn’t gold just a useless metal that only has value because people think it has value? Aren’t stocks a better investment?

You could also ask why paper money has value. In actuality anything can be used as money (shells, cigarettes, salt) but the best money has several characteristics: it’s scarce, it’s divisible into standard units, it’s a store of wealth, etc. For 6000 years gold has served as money for these reasons and more. To make more gold, people have to exert effort to search for it, dig it up and process it. Like other assets gold can go through cycles where it is more or less valuable compared to other assets.

Stocks are valuable because a company can bring in a revenue stream to its owners (shareholders). The price of the stock can go up or down based on what people anticipate the future profits of the company to be. If companies are hit with higher taxes, regulations and health care costs, and if consumers don’t have the money to spend, the future value of stocks does not look good. If you invested in Apple Computer ten years ago (and only Apple) you’d have grown your money 10 times. (If you invested in Enron or you’d have nothing) If you invested in gold you’d have a 5 times gain. If you invested in the broader stock market you would be slightly down.

If your concern is that gold doesn’t have any real value because it’s not used for anything you could always invest in Silver (or other commodities). Silver is used in circuit boards, air purifiers, cameras, and more. The industrial use of silver has outpaced mining production for the past 20 years. In fact, I think silver will do better than gold and will be the best, safest investment you can make for the next several years.

5. How do I buy gold and silver?

There are several ways to buy gold and silver. You can buy coins or bars, you can buy an ETF (exchange traded fund) that holds gold or silver, or you can buy gold mining companies. Below are the plusses and minuses of each. This is just an introduction so do some research before buying precious metals. I would recommend Mike Maloney’s book, Guide to Investing in Gold and Silver.

Buying coins or bars:

I believe that everyone should own some physical gold and silver. The first thing to buy is silver coins. They’re cheap, fun to hold in your hand, and if the shit hits the fan you can buy stuff with them. You can also buy gold coins or gold and silver bars. There are several online retailers that sell gold and silver at a slight markup from spot price. I like Monex as a broker but do some research to compare prices and service before choosing a broker. You can either take delivery of your metals and bury them in the back yard or pay a small fee to store them in a vault. Make sure that if you get vault storage that your gold is allocated and the company cannot lend out your gold to others.

– Upside: There’s no counter party risk. It’s a private investment outside of the matrix. It’s an asset you can hold in your hands and potentially use as money. – Downside: It could get lost or stolen or buried in an earthquake. It’s heavy.

Gold and Silver ETFs:

The gold and silver ETFs trade like stocks and claim to back all of their shares with physical gold and silver. This is an easy way to buy gold. You can simply buy shares of ticker symbols GLD or SLV and sell at any time. However, there are rumors in the gold circles that these ETFs don’t actually possess all of the gold or silver they claim to have. It’s possible that they are lending out their metal to bankers who are shorting the gold/silver market. Some believe that these shorts are leveraged up to 100:1 and that is suppressing the spot price of the metals. For this reason I would stay away from the physical ETFs.

– Upside: Easy to trade like stocks. – Downside: Counter party risk. That is, the ETFs might not actually own all of the gold they say they own.

Gold and Silver mining companies:

Owning mining companies is a good way to leverage the rising price of precious metals. If gold and silver go up, the mining companies will (in theory) rise at a faster rate as their profits are leveraged to metals prices. However, it’s important to remember that these are companies competing against one another and it’s important to pick good companies. Also, mining companies do correlate with the general stock market to a degree so if the market goes down, mining stocks could go down in sympathy. If you don’t have the means to evaluate individual stocks you can buy an ETF of mining companies like GDX.

– Upside: Leveraged to the price of gold. Undervalued mining companies could see huge returns if the gold price goes up. – Downside: You need to pick good companies. If they fail, they could go down just as any stock. Also, if the price of gold goes down they will be hit harder.

6. How do I buy foreign stocks?

There are several ways to gain access to foreign markets. You can buy stocks of American companies that do a lot of business oversees. A more direct way is to buy Exchange Traded Funds (ETFs) that track the stock market of foreign countries. Some of these include ticker symbols CHN (China fund), IFN (India fund), EWA (Australia). Or you can buy a mutual fund that tracks several countries at once such as the emerging market fund VEIEX. For direct access to specific companies you can use a brokerage firm that specializes in foreign stocks. I like Peter Schiff’s firm Euro Pacific Capital.

7. How do I invest in commodities?

Many commodity experts like Jim Rodgers are more bullish on soft commodities like wheat, rice, cotton, oil than they are on precious metals. They cite growing populations, rising production costs, water and land use issues, etc. to show that food and other necessities will increase in price. I haven’t experimented with buying commodity futures so I can’t give much advice there although that is the most direct way to invest in commodities. Another way would be to invest in companies that produce these commodities. There are some commodity ETFs that are supposed to track commodity prices but I have found that their performance comes nowhere near the performance of the actual commodities. For instance, this year, while many commodities are up 30%, 40%, 50%, the ETF GCC is only up 13% and GSG is actually down 3%.

I hope this has been helpful. If you have any other questions let me know and I’ll try to answer them.

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One Response to State of the Economy 2010 Revisited

  1. Pingback: The Top 10 Reasons Silver Will Soar. | Liberty Insight

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