Default and/or Inflation

More and more market observers have focused attention on the financial difficulties currently facing the Fed and the US Treasury. The administration continues deficit spending, and at a certain point it will be necessary to resort either to default, inflation or a combination of the two even if spending is reduced and taxes are raised. The liabilities incurred with Social Security, Medicare and pensions all over the country will lead to bankruptcy rather sooner than later, given the propensity of Congress to finance the military with a total expenditure close to US $ one trillion (1, when everything is included.

Given the role of the US dollar as the main international reserve currency, default on Treasury paper is a measure that the Government will try to avoid in order to prevent massive panic world-wide. Inflation, therefore, is and will be the preferred alternative.

The US dollar has recently strengthened due to the Fed raising interest rates, now at 1.75% to 2.00%, with more rate hikes in the agenda in addition to a liquidity crunch due to QT and the tighter future policies of the ECB and the BoJ. In such an environment the renminbi has declined somewhat in the wake of the incipient trade war promoted by President Trump.

According to official figures, the US has over 8,000 tons of gold, which makes it by far the biggest holder of this precious metal. One has to ask what sort of plan the Chinese and Russians have of basing their currencies on gold, considering the apparently enormous advantage that the US has. One can assume that the Chinese and Russians have a lot more gold than they have officially reported. The PBoC will have already worked out how to enlarge the supply of renminbi in order to make it viable for competing with the US dollar as a global reserve currency. Even so the US will need to increase tax revenues in order to service the debt, and that means that the easiest way to increase income and reduce the real amount of the debt is to foster inflation. But there is a contradiction between a stronger dollar and the need for inflation. Imports will cost less and further exacerbate the trade deficit. Higher interest rates and QT may bring on a recession rather than inflation. So stagflation is a possibility.

In any case the conclusion must be that inflation is the solution, and investors should prepare for such a development. With the stock market set to suffer due to the Trump trade war, now is the time for portfolio adjustment.

Walter Snyder



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