Economic Turmoil in the 2nd Half of 2011?

What do we know that will lead towards or away from Economic Turmoil? (See beginning of newsletter here.)

The largest holder of US Debt (after the US Federal Reserve that is) is China.  Just this week they announced that they would be drastically reducing the amount of US Debt which they hold.  So they are a seller (adding to the problems) not a buyer.

The second largest holder of US Debt is Japan.  They’ve got to rebuild after an earthquake and nuclear disaster so it seems much more likely they will be selling instead of buying.

Europe has serious problems and won’t be able to buy anything.  The Middle East has a lot of petrodollars coming in so they should be able to buy some, but not nearly enough!

What about the private sector?

Well, the bond king Bill Gross has recently sold all of his US Debt and even taken a short position because he sees this problem is serious.  If the best and largest bond investor in the world (who are US based and thus most inclined to own US debt) refuses to participate in the Treasury market at these prices, who will step in?

It’s difficult to see.

The obvious answer seems to be that as soon as QE2 ends (and probably before that because the market typically anticipates what’s coming), interest rates will be driven much higher.  At some higher rate, there will be willing buyers.  Just not at this tiny “risk free” rate that the US has enjoyed for generations.

This means two separate factors driving a dagger into the heart of the economy.  The first is that because the Fed is no longer printing so much money, the stock market begins to fall and the economy begins to slow.

The second is that because interest rates are higher economic activity drops.  (Remember that for decades, interest rates have been engineered lower to support the economy).  Thus the economy and markets (real estate, stock, bond, commodity) would all be driven lower as liquidity is sucked out of the market.

So what would happen next?

Ben Bernanke to the rescue of course!!

Bernanke would feel vindicated.  He would finally be able to say, “See, all my money printing was good for the economy.  I will save the day by printing more!”

They won’t call it QE3.  It will have another fancy name.  But the affect will be the same.  And then the end game will be near for the US Dollar.

A depression doesn’t sound fun to anyone, but it’s anathema to a politician or bureaucrat.  However, ask anyone who’s lived through hyperinflation what that is like and you will understand that it’s much much worse.  But unless you’ve lived hyperinflation and live by an unbreakable code to never make those mistakes again (such as Germany does)…. you will always march ever closer to this inevitability under a fiat currency system.  It’s always the easiest answer to a bureaucrat to print and borrow more to pay for all his promises.  Neither the government nor the bankers are God, but we as a people have been suckered into believing that they can be just that for us.  Soon we’ll see how good a job they are at being Him.

So how will all this look exactly?  It’s hard to say.  New events always pop up that slightly change the course.  But we are on a narrowing path in between these two unwanted outcomes and the leaders of the government of Man must choose one of two hard roads.

The road that is painful now (and loses them their job), but could save the whole system after only a few years of pain.

Or the road, that makes things easier today and tomorrow but brings us ever closer to a more terrible fate (but hopefully after I’m out of office says the politician/banker).

To me, the direction and outcome are clear, but we still have to wait to see it all play out.  I hope you are one of the ones who are prepared.

This is the third of a 3 post series.  The entire document that makes up these 3 posts has been slightly modified from the original version which was the April Kingdom Calling Newsletter.  You can sign up to receive newsletters like this here.  Here’s the link to Pt 1 of this letter.  If you’d like to read some prior thoughts on where our economy is headed, check out the series we did on Hyperinflation and the Dollar by following these links: Pt 1, Pt 2, Pt 3, Pt 4, Pt 5, Pt 6, Pt 7, Pt 8, Pt 9, & Pt 10.

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