Recently reader Bob Kraus wrote another comment to my blog which you can read here.
In essence, Bob is arguing that our policies regarding monetary inflation are to our benefit because we are trading the worthless commodity of paper for the very worthwhile commodity of (among other things) oil. Bob acknowledges that he we have “hosed” the rest of the world by perpetrating this sham but, as he puts it, “what else is new?” Bob also acknowledges that the American economy going forward “is going to be a very painful 3 or 4 years for most Americans.” Despite these acknowledgements, Bob remains a stalwart bull for the US economy because he feels that no other country is as innovative or works as hard as the United States. He feels certain that it will be the United States that innovates the next technology that will replace oil and that our manufacturing will return because the dollar has fallen so essentially the American consumer can not afford to buy imports anymore.
Bob’s thoughts are not uncommon, so I wanted to address them here. Here’s the problem with Bob’s analysis. Currently the US government’s official debt is roughly $9.6 Trillion, but that doesn’t include the liabilities the government just took on with Fannie Mae and Freddie Mac (roughly another $5 Trillion) or the “unfunded” portions of Medicare (roughly $85.6 Trillion). If the US is to make good on its debt then the US is going to have to start seeing savings both on the government level as well as the consumer level, which would be a massive credit contraction over the next couple of decades. Basically we’d be seeing the opposite of what’s been happening over the last two decades where the US has gone deeper into debt. Now given that bull market projections for US stocks earning more going forward are assuming a continuation of the last twenty years, we’d be seeing a much lower level of earnings as the US consumer and government had to drastically rein in their spending. Furthermore, the holder’s of our foreign debt would actually have turn out to not be “hosed” because the dollars the debt would be paid for in a deflationary scenario would actually be worth more than they worth during the inflationary times. That’s assuming that the US actually choses to make good on its debt.
Now what if it doesn’t? What if instead the US choses the easier path of just defaulting on its debt. Well in that case, I don’t see how gold would not be a far superior investment than the stock market. It’s tough to predict what would really happen were the US Dollar to be rendered worthless, but you could expect a great deal of societal chaos and upheaval as well as a flight of foreign capital from our shores. None of these things are particularly bullish for stocks.
Regarding Bob’s longer term view of the US as being the best at innovation or working harder that most other nations, well I’d certainly like to hope so. I’m not nearly as confident as Bob is that the US is going to continue to be the source of all things economically good, but even if this is true, the fundamentals of the United States level of indebtedness are simply against any kind of scenario where stocks become strong investments over the next decade or so.