The U.S. has four choices in the coming decades for how to deal with the government’s extraordinary debt burden:
- Default on its debt;
- Inflate it away;
- Impose sufficient austerity to slowly pay it down.
- Muddle through economy
We are no more in a normal business cycle and that’s why it becomes important for us to evaluate all these 3 options carefully to choose the right mix of assets allocation in coming years.
Option 1 is unnecessary and politically unacceptable till the time US is a democracy. Democratic govt with right checks and balances on power rarely defaults. If this option is chosen then this is outright bearish US Dollar and can lead to hyperinflation.
Option 2 is the easiest option and can be deployed and is successfully deployed by US previously whenever the debt burden has become large. This will be done by keeping ( artificially suppressing) interest rates below inflation for an extended period of time. This can lead to higher inflation and possibly hyper stagflation but not hyperinflation. This is negative for US dollar but not as much as option 1
Option 3. I don’t think this option is possibility in today’s political environment but having said that if this option is chosen then the only beneficiary is US Dollar and it is extremely negative for EVERY asset on planet except US Treasuries. In this environment US bond yields will decidedly go negative.
Option 4. In this option policy makers get worried about putting too much stimulus and withdraw the easy money at the first sign of inflation. This will lead to periods of strong growth and period of very weak growth. This is the worst environment for investing and in this environment keeping an open mind and becoming opportunistic will be helpful as compared to buy/hold investing. This environment will alter between mild deflation and controlled inflation. This will keep US dollar generally bid as debt/GDP continues to pile up.
In my view we are transitioning from option 4 to option 2
Ritesh, do you mean to suggest we are transitioning from 4 to 2 or vice-versa? As I would think we are in 2 already (with the amount of money thrown at the situation and the price action in gold etc)
I think we are just transitioning from 4 to 2 and what we have seen till now is just the appetizer
That is, assuming the printing will cause consumer price inflation. What if inflation remains stubbornly low as is the case with Western Europe and Japan?
Will attempting option 4 be the only viable one left?
why is it different this time is because politicians have got control of money supply and they are not going to leave it. still if i am wrong and debt overhang is too much then we just go to deflation which is positive for US dollar and US treasuries