Who Will Win the Financial War of the Worlds?

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Maybe we’re wrong. If yesterday illustrated the essence of this market, we are definitely wrong.

Our hypothesis is that the fed’s efforts to inflate will show up more in the gold market than in the stock market. That – and an instinct for self-preservation – is why we’re long gold and short stocks. Stock prices depend, ultimately, on earnings. Gold’s price depends, ultimately, on inflation. The feds can make more cash and credit available… but they can’t wipe away all those bad debts, which are hurting earnings. That is, they can increase the rate of inflation… but not make businesses more prosperous.

We’re witnessing a War of the Worlds – between inflation and deflation. We don’t know which side will win, but we’re betting that while inflation favors gold, deflation has it in for stocks.

But what’s this? Yesterday, the Fed promised inflation – big time. It said it would pump in an extra $200 billion to fight deflation. Europe and Canada said they were in too – for another $45 billion.

Where does all this moolah come from… savings? Don’t make us laugh, dear reader. It comes “out of thin air” as Keynes once said.

And what is the effect of pulling money ‘out of thin air’ and putting it in the money supply? More dollars… more monetary inflation.

According to our hypothesis, investors should see what’s coming a mile away. They should have jumped to buy gold. Instead, they bought stocks. The Dow roared up more than 400 points. Gold barely went up $4.

So go figure. Still, oil hit a new high over $108. And sometimes it takes investors a little while to put 2 and 2 together. So, let’s see what happens tomorrow before we come to a conclusion.

Besides, stocks may have gone up yesterday anyway; a rally was probably overdue. Commodities are at an all time high. Oil too. And more and more evidence comes to us that consumers are feeling squeezed… and forced to cut back on spending – which will further hurt business earnings.

“Surging cost of groceries hits home,” says the Boston Globe.

“Paying at the pump, in a big way,” says the New York Times. “Record fuel prices blow budgets,” adds the USA TODAY.

“401(k)s tapped to save homes,” it continues.

While rising prices pinch family budgets, falling asset prices pinch everyone. Most of the economy seems to be deflating. Housing is going down. Household incomes are going down. We’ll have to wait a few days to find out what direction stocks are going.

The big picture still shows the same scene: America is getting poorer. Its money buys less stuff. Its working people earn less money. Its assets are worth less than they used to be.

“This thing is not about a recession or not a recession… and it’s not about inflation or deflation. It’s about re-pricing the U.S.A., downward. Sell America… sell its money… sell its stocks… sell its property… sell its politics… sell its economy… sell its I.O.Us. Sell it all,” said a friend over the weekend. “It’s clear to me that America’s best days are behind it. The United States has had a disproportionate share of everything for too long – stock market valuations… the world’s savings… the world’s energy… the world’s calories… the world’s military power. That’s what is changing. The world is readjusting… it’s not getting out of balance; it’s getting back in balance. It will be a world where the United States plays less of a role… and takes less of the world’s resources.”

He is probably right. Asia is growing much, much faster than the United States. Wages are going up 10% per year in China… 15% per year in India. Stock markets are booming. GDP growth in many foreign countries has averaged about three times the U.S. rate for the last ten years. Now, with the U.S. economy not growing at all… Asia is racing ahead.

We have no particular quarrel with this. America has enjoyed an extraordinary run of luck. She had cheap energy… history’s most powerful military… and the world’s reserve currency. Now she has the world’s biggest debts… its highest deficits… and the most colossal financial problem ever. In short, it has passed its I.O.Us out all over town and now owes more money to more people than anyone ever did. It now has more financial commitments any nation has ever had (with a financing gap of $60 trillion – not including the cost of the Iraq War… which is expected to be as much as $5 trillion)… and has a competitive disadvantage against much of the rest of the globe. Asians make things cheaper. Europe makes them better.

How did such nice people get themselves into such a mess? Are Americans stupider than other people? Are they lazier? More reckless… more feckless?

Nah… we’re just victims of our own good fortune. We had it too good for too long. A unique set of circumstances allowed Americans to borrow and spend more than anyone ever could before… and so they did.

As an aside, this turn of events for America is where we got the idea for the title of our documentary film, I.O.U.S.A. We are hoping to have an exciting update for you, dear reader, in coming days. Stay tuned. In the meantime, check out the film’s website.

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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