What to expect

Robert Smith, The Daily Record Newswire

I was wrong … dead wrong. Obama’s in and stocks are out. The investor class voted with its feet Nov. 7, with the market turning in its worst showing of the year.

Investors quickly shifted gears and focused on the looming “fiscal cliff” and what this means. In a nutshell, taxes are going up while incomes are going down. Households earning more than $250,000 may see their tax rate increase from 35 percent to 39.6 percent. Long-term capital gains may increase from 15 percent to 20 percent, while taxes or dividends and interest income could triple to 43.4 percent.

No wonder investors are antsy. The only real question is: Should I pull the plug now or later? It’s funny that amid all this talk about “revenue enhancement,” I haven’t heard a single thing about spending cuts. I guess this means Americans just want “more free stuff.” However, to quote Margaret Thatcher, the great British prime minister, “The problem with socialism is that eventually you run out of other people’s money.”

What, therefore, can we expect? Will the problems that plague us both politically and economically continue? No one is optimistic about robust economic growth in the near or medium term. In turn, this suggests a continuation of interest rates at or near zero and the continuation of trillion-dollar deficits in an attempt to stimulate the economy.

Furthermore, it’s not just the Fed that’s running wild with the printing press. Nearly every other central bank worthy of mention is printing money as fast as it can. The world is literally awash in cash.

Perhaps this is why the “bond king,” Bill Gross, recently warned PIMCO investors to prepare for a “reflationary” cycle. To hedge against this, the largest fixed-income manager in the world is recommending they buy gold, hard assets and other things whose income stream can be indexed to inflation.

But it’s not just Bill Gross who sees more inflation on the horizon. Peter Warburton, author of the classic “Debt and Delusion,” states that the billionaire investors he consults with are placing 20 percent or more of their wealth into gold. Interestingly enough, this is being done both as an inflation hedge and a hedge against central bank failure. Do you feel like someone just walked over your grave?

The problem is that we are so far adrift from level now in terms of debt and deficits that it may be impossible for us to rediscover a sense of fiscal responsibility. If this proves to be the case, the Fed will have no other choice than to continue flooding the market with dollars and monetize the debt. This is what every other government in history has done.

This scenario also will keep the Fed from raising interest rates when inflation increases. Our end game will be very different from the 1980s, when Reagan appointee Paul Volcker raised rates dramatically to choke off double-digit inflation. He wasn’t hamstrung by servicing the interest on $16 trillion in debt.

When inflation does arrive, it will simply have to run its destructive course, wiping out middle-class savings. The Fed will have no recourse.

However, these things do take time. Money managers and investors should be positioning themselves for another major bout of inflation. This means that any equities should generate substantial cash flow. Income will help offset asset devaluation when stocks sell off.

Also, consider diversification into commodity-based assets or currencies other than the dollar. Real estate assets in prime locations may also profit. Finally, there is gold – the ultimate alternative currency. And don’t forget the wheelbarrows – they can be helpful carting all that cash around.


Robert Smith is president of Peregrine Private Capital Corp. Contact him by calling 503-241-4949 or visiting www.peregrineprivatecapital.com.