Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 11th October 2009.
It is very likely that two ultra-long-term trends reversed direction over the past two years, the first being the expansion of private-sector credit in the US and the second being the contraction of the US savings rate. The trend reversals are, of course, inter-related, in that the new trends towards less debt and more savings are being driven by economic hardship in the present and the revelation that the economic future will not be as rosy as previously thought.
As discussed at length in many TSI commentaries, the problems that have emerged over the past two years were not created over the past two years. They were, instead, the natural and inevitable consequences of the monetary inflation that occurred during the first half of the decade. To put it another way, the problems arose during the inflation-fueled boom, but only became visible to most people after the amount of new money entering the economy became insufficient to sustain the boom. Illusions have since been shattered and people have been forced to come to terms with a very different financial future to the one they were counting on just two years ago.
The increasing desire to save and the reduced desire to take-on debt should have led to a period of deflation, but governments and central banks decided that deflation would not be permitted. They decided, instead, to prevent the natural corrective process from running its course and to tackle the problems caused by the combination of monetary inflation and government meddling with even more monetary inflation and government meddling. It is idiocy on a phenomenal scale, but it is not surprising. Since establishing the TSI web site 10 years ago we have consistently maintained that after the private sector credit expansion came to an end, the public sector would 'step up to the plate' and create, via government borrowing/spending and central bank monetisation, whatever amount of new money was needed to perpetuate the inflation. Unfortunately, it looks like we are going to be proven right.
Monetary inflation causes problems regardless of whether the new money is being borrowed into existence by private operators or by the government, but the problems will potentially become apparent to the average observer earlier if the government does the bulk of the borrowing. This is because government borrowing, and the associated spending/investing, will rarely be motivated by economic merit, meaning that the effects of monetary inflation stemming from government borrowing are less likely to be masked by productivity improvements than would be the case if the private sector were borrowing most of the new money into existence. In simple terms, government-driven monetary inflation is more likely to boost the general price level -- creating what most peoplethink of as "inflation" -- than the private-sector-driven variety.
So, we should reasonably expect more monetary inflation over the years ahead and for this extra money to have a greater effect on the cost of living than the money added to the economy during the 1990s and the first seven years of the 2000s. At the same time, it is likely that the desire to save will continue to grow. In fact, the more the government and the central bank intervene in an effort to stimulate the public's borrowing and spending, the greater the desire to save will likely become. This is because the interventions will create uncertainty and deplete existing savings. We therefore appear to be heading towards a situation where the public wants to increase its savings while the government makes it crystal clear that anyone who saves in terms of the official currency will be punished.
This is where the "law of unintended consequences", a law that seems to involve itself with almost all of the government's plans to 'help' the economy, shifts to centre-stage. People now have a rational and irrepressible desire to increase their savings, but the government is promising to depreciate the official currency and has demonstrated that it is capable of fulfilling this promise. People are therefore prompted to save in terms of something else, the most obvious "something else" being gold. In other words, one of the consequences of policies designed to discourage saving won't actually be less saving; it will be less saving in terms of the official currency and more saving in terms of gold, leading to a much higher gold value in currency terms and relative to most other commodities.
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