The Impact of Bubbles – Week 6

Negative Force – Inflation:

In a discussion of bubbles, one has to understand the significance of the size of the debt of the USA. Under President Obama, USA’s debt went from a nominal value of $10 Trillion to $20 Trillion Dollars in eight years. Our USA annual GDP is approximately $20 Trillion Dollars.

There are estimates that the sum of our unfunded liabilities such as government pensions, Social Security, Medicaid, ObamaCare, and Medicare approach around $85 Trillion. Simply stated, our country has way too much debt and neither political party seems to really care.

In economic history, the problem of too much government debt is resolved in one of two ways:

  1. Complete economic collapse;
  2. or, Inflation.

If the USA experiences 100% inflation (which means that the American Dollar in the future would have half of its value today), our debt would become a lot easier to service. In turn our GDP in nominal Dollars would soar (double) resulting in the ratio between the size of our economy (GDP) and our debt would diminish. It would have the same ratio as existed pre-Obama.

That is why I believe the second of the two alternatives (inflation), is what we will experience.

After World War II the USA had a similar ratio between GDP and debt. Inflation restored the ratios. While there are many dangers associated with inflation, The Fed can more correct inflation by raising interest rates to the point that it slows the economy. The result is called a recession.

For any remaining skeptic, my first new car (Chevy Monte Carlo Sport) cost $4,800 in 1972. My first home cost $38,500 in 1975. Multiply by 5 to get to today’s value. This is 400% inflation.

It is critical to remember that land is the source of all wealth. Every product that we humans consume originates with land. Not all tracts of land are equal in quality and portfolio management requires every investor to hold some cash for liquidity. But historically, long term the best investment is land.