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June 15, 2009

The Government Bubble
by Steve Saville

Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 7th June 2009.

It is clear that a concerted effort is being made to replace the ruptured private-sector debt bubble with a government debt bubble, although the effort is generally not labeled as such. Moreover, the dramatic increase in government debt that we are seeing is really just a symptom of expanding government. In the case of the US, for example, GW Bush presided over a rapid expansion of government power and the trend has accelerated under Obama.

As an aside, although President Obama is sometimes referred to as the new FDR he is probably more like President Herbert Hoover than President FD Roosevelt. We say this because Hoover -- despite the way he is often portrayed -- was a strong believer in the ideology of central planning, whereas Roosevelt didn't believe in anything except the need for him and his party to maintain political power. Both Hoover and Roosevelt were totally clueless about economics, but whereas FDR never expended any mental energy contemplating the long-term economic implications of any policy -- his sole consideration being a policy's vote-winning potential -- Hoover genuinely believed that a government-managed economy would be more efficient than a free-market economy if only the government applied the practices that worked well in the field of project engineering.

Getting back on topic, we can explain why the current trend will lead to poor economic performance and the severe curtailment of individual freedom, and, therefore, why it should be stopped. However, when planning our investments and our lives we must acknowledge the reality that the government's growth spurt will almost certainly not end anytime soon, because there is very little resistance to it. That is, we must act based on the way things are, as opposed to the way they should be, and part of today's reality is an inexorable trend towards a bigger and more intrusive government.

Something to bear in mind when considering the investment implications of the current trend is that governments always play favourites. To be more specific, the governments of today are giant re-distribution machines in that they take money and resources from some individuals, corporations and economic sectors, and give them to other individuals, corporations and economic sectors. The overall economy either grows at a reduced pace or shrinks as a result of this re-distribution, and in the long run almost everyone loses; but over shorter timeframes there will be winners as well as losers. The winners will be chosen by those in power based on perceived vote-gaining potential (the Roosevelt approach) or the misguided belief that the economy can be improved via the government-mandated transfer of resources from A to B (the Hoover approach), although we expect that the biggest winner of all will not be chosen by the government, but will, instead, arise due to the unintended consequences of the wealth re-distribution. We expect gold to be the biggest winner.

Other big winners are likely to be companies involved in alternative energy and companies that benefit from increased spending on infrastructure, but in general the stocks of non-gold companies will have substantial downside risk until after the broad stock market becomes attractively valued.

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Steve Saville
Hong Kong

Regular financial market forecasts and analyses are provided at our web site: http://www.speculative-investor.com/new/index.html. One-month free trial available.