Transfer of Wealth

After decades of excess credit and over-consumption, the developed world is finally being forced to deal with private-sector deleveraging. However, the governments seem to have other plans and they’ve decided to fight these deflationary forces tooth and nail. Their solution – even more credit and consumption!

Rather than accept a painful adjustment period, policymakers are desperately trying to revive the party. And in the process, they are making the situation much worse. All over the world, governments are spending trillions of dollars in order to clean up the mess. Unfortunately, the stark reality is that these governments have no money. So, in most instances, these glorious state-sponsored spending programs are being financed by borrowing and money printing.

Most people seem to forget that these fiscal spending programs aren’t creating any real wealth and are simply transferring wealth from the savers to the debtors. Essentially, governments are taking money from the solvent and re-distributing these funds amongst the insolvent.

Needless to say, by bailing out the incompetent and buying their toxic assets, the governments are cleaning up the private-sector balance sheets but at a huge cost. In the process of saving a few ‘too big to fail’ corporations and their bondholders, policymakers are greatly increasing the risk of sovereign defaults. In a nutshell, policymakers are erroneously transferring private-sector risk to the state.

So far in the ongoing credit crisis, we haven’t really seen many sovereign bankruptcies but I suspect they will follow. And you can bet your bottom dollar that policymakers will not hesitate to use the printing presses if it results in escaping sovereign default. As a result of the world’s banking system being a multiple of world GDP, the sad truth is that politicians don’t have very many options.

What we’ve witnessed over the past few months is that governments around the world have decided to maintain the stability of their banking systems in order to preserve the trust of their populace. Basically, policymakers have opted to save the banks even if it means putting entire nations at a great risk. And the most likely outcome is that the politicians will continue on this inflationary road to nowhere.

In my opinion, as the private sector continues to pay back debt, the use of the printing press won’t result in immediate inflation. However, over the medium-term, all these needless bailouts are going to create a massive inflation problem.

Amidst all this economic uncertainty and rampant money printing, confidence in governments will plummet and people will turn to ‘old fashioned’ stores of value – those assets which represented money long before pieces of paper backed by empty promises became fashionable. Indeed, the investment community has already begun moving towards precious metals and I expect this trend to continue.

It is interesting to note that only 160,000 tons of gold has ever been mined from the face of this planet and at US$950 per ounce, it is worth US$4.9 trillion. Now, consider that the total amount of paper money in circulation (currencies, savings, deposits, money-markets and CDs) is worth US$60 trillion or approximately twelve times the value of the gold in existence. Now, there is no doubt in my mind that as world governments debase their currencies, many people will begin to question the viability of paper money as a store of value and they will turn to gold, silver and platinum. Even if a small fraction of paper money rushes towards the small gold and silver markets, what do you think will happen to their prices? No question, precious metals’ prices will explode!

Accordingly, I sincerely recommend that investors allocate at least 10% of their wealth to physical bullion. Over the next few days, it is likely that precious metals will correct and this may be the final opportunity to buy gold and silver at these levels. Those looking for extra leverage should invest money in the precious metals mining stocks. So far in the precious metals bull market, we’ve had massive rallies every two years. If this trend remains intact, after the usual summer correction, we should see an explosive move until spring next year.


Puru Saxena
for The Daily Reckoning

The Daily Reckoning