What If?

Been playing a game of “what if” with some stock brokers, sophisticated investors as well as my son, who’s a pretty knowledgeable financial analyst in a world that doesn’t really seem to value those financial skills right now (they will!). In my March 19^th “To Air is Human” blog, I noted that the Federal Reserve’s $1 trillion increase in money supply (the virtual printing of money) to buy Treasury notes and certain government-guaranteed, mortgage-backed securities, resulted in an immediate and obvious fall of the U.S. dollar against gold and most major currencies. Inflation. Everybody knows that.

And we are going to need to issue more Treasuries to fund an even bigger deficit than even our worst critics imagine. It seems that the Obama administration made its original deficit projections based on expected revenues that would be generated if we “recover” more quickly than other government agencies think we will. The March 20^th NY Times: “The Congressional Budget Office placed a new hurdle in front of President Obama’s agenda on Friday, calculating that the White House’s tax and spending plans would create deficits totaling $2.3 trillion more than the president’s budget projected for the next decade.” That’s $9.3 trillion in total additional deficits over the next decade! A stimulating observation.

Conservative German bankers scowled and joined with French financial gurus who, despite pleas from the Obama administration to the contrary, have already given a pretty strong indication that they really do not favor the kind of deficit-creating stimulus package that America has already passed and other struggling European Union economies (like Greece, Spain, Italy and Ireland) are begging for. This schism threatens to tear the EU apart, but it’s really hard to convince France and Germany that incurring large deficits and risking Hitler-fomenting hyper-inflation is better than a down-and-dirty depression.

France and Germany still remember a decimated post-World War I Germany that literally fell apart from hyper-inflation, generating suffering that gave a demon like Hitler the platform he needed to ascend to power. The feelings are strong and run deep. The resulting World War II was really devastating to these countries… worse than the depression. These Europeans just want more oversight, more regulation – a “never again” scenario – not more government stimulus. We’ll see this divergence between their focus and the American position at the up-coming (April 2^nd) London economic summit of the Group of 20 industrialized and developing nations.

So if Europe doesn’t play the stimulus game, even if the EU falls apart and some of its major banks fall because of all those bad loans to Europe’s subprime equivalent – Eastern Europe, and the U.S. continues to borrow itself silly to effect a “recovery,” by definition the dollar will fall relative to the Euro as well as currencies from other economies that don’t have the same levels of national debt. As prices rise, even skyrocket, we get inflation. If we get inflation too soon, we get a tanking economy with rising prices – stagflation. But if we experience some serious inflation in the distant days of “recovery,” ask yourself a question: who benefits?

Well, if you have millions of houses under water (worth less than their mortgages) but financed with lowered interest rates, inflation probably artificially raises their prices (but not necessarily their value)… maybe enough to make homeowners feel rich again. Takes care of lots of folks who mistakenly thought their homes were their savings account. And higher dollar values for real estate sales, rent, etc. generate additional tax revenues for the government.

If the price of imports increases significantly because it takes more dollars to buy them, Americans will be forced to import less – don’t think China is missing this, by the way – they are focusing on reducing their reliance on exports to the U.S… which includes buying a whole lot less petroleum-based products, like oil! Kind of makes alternative energy more economically viable, an Obama priority even though cheap oil today has side-tracked most Americans’ concern about rising energy prices and made alternative energy too expensive to implement.

U.S. companies that create internationally valuable products or services will find their exports more competitive and their stock price adjusted to the global value of what they produce. If those products/services take more local U.S. dollars to buy, and stock prices rise to reflect that adjustment even though the real value of the companies as compared to their international counterparts is really the same, the stock market shows “appreciation.” And on sale by a U.S. taxpayer, the “appreciated” difference becomes a taxable revenue stream.

Assuming that foreign nations, who bought our Treasuries to support our deficit, still hold dollars in that distant recovery future, we can pay them back at the low fixed interest rates with less valuable dollars… but note China is about to use vast amounts of her currency reserves to buy foreign companies with technology values to her economy. She may not elect to keep those dollars as some of us might wish, and her leadership has been less than subtle in pointing this reality out to the Obama administration.

Okay, we get humongous, double digit interest rates (but interest income is taxable), as we did in the late 1970s/ early 1980s (as the Fed knee jerks to tame inflation – traditionally its biggest nemesis), which makes home-buying more expensive and business growth more difficult to finance. This can create another recession. Folks on fixed incomes can’t afford to live, and U.S. Treasuries are going to be very difficult to sell (absent that humongous interest rate) in that nasty future.

Isn’t playing “what if” fun? If you have some additional thoughts or even if you disagree (it could be “why not” too), hey, throw them into the comment section.

I’m Peter Dekom, and I approve this message.