Inflation and Its Impact on Investment Decisions.
The global money supply is on the rise once again, bringing with it persistent inflation that may not come as a surprise to many.
Inflation occurs when there is a significant increase in the amount of currency available, surpassing the demand from the private sector.
For investors, one of the worst decisions they can make in this environment of monetary destruction is to invest in sovereign bonds and keep cash.
This government-led erosion of the purchasing power of currency is a strategic move rather than an unintended consequence.
One common question posed by readers is why governments would be interested in reducing the purchasing power of their own currencies.
The answer is quite simple: Inflation serves as an implicit default, signaling the insolvency and lack of credibility of the currency issuer.
Governments can hide their fiscal imbalances through the gradual reduction of the value of their currencies, achieving two main objectives in the process.
Firstly, inflation acts as a hidden transfer of wealth from deposit savers and real wages to the government itself, effectively functioning as a disguised tax.
Furthermore, the government seizes wealth from the private sector, forcing them to use its currency by law and purchase its bonds via regulation.
The entire financial system is built upon the flawed assumption that sovereign bonds represent the lowest-risk asset.
This belief drives banks to accumulate these bonds, leading to a reliance on state intervention and crowding out of the private sector through regulatory mandates.
These policies incentivize the use of little to no capital for financing government entities and public sector projects.
Once we understand that inflation is a deliberate policy choice rather than an accident, it becomes clear why the traditional 60-40 portfolio fails to deliver results.
Currency is essentially debt, and sovereign bonds are no exception.
When governments reach their fiscal limits, the crowding-out effect of the state on credit exacerbates the burden of rising taxation levels on the private sector, favoring the growth of government unfunded liabilities.
Economists often warn about the dangers of excessive debt, but we sometimes overlook the impact of these unfunded liabilities on currency purchasing power.
For example, the United States has an enormous debt of $34 trillion and a public deficit close to $2 trillion per year.
However, these figures are relatively small compared to the looming threat of unfunded liabilities that could severely cripple the economy and erode the value of the currency in the future.
In countries like Spain, unfunded public pension liabilities exceed 500% of GDP, while the average within the European Union is close to 200% of GDP (based on Eurostat data.
These figures only account for unfunded pension liabilities and not other entitlement program liabilities that are not analyzed by Eurostat.
In this context, governments will continue to use the “tax the rich” narrative as a means to increase taxation on the middle class and impose the most regressive tax of all – inflation.
It is no coincidence that central banks worldwide are pushing for the rapid implementation of digital currencies.
Central Bank Digital Currencies serve as a form of surveillance disguised as money, designed to eliminate the limitations of current quantitative easing programs.
Central bankers are becoming increasingly frustrated with their inability to fully control the transmission mechanisms of monetary policy.
By eliminating the banking channel and thus the inflation backstop provided by credit demand, central banks and governments can attempt to remove competition from independent forms of money through coercion and deliberately debase the currency as needed to maintain or expand their presence in the economy.
The gold versus bonds scenario illustrates this perfectly.
In the past five years, gold has risen 89% compared to an increase of 85% for the S&P 500 but only 0.7% for the US aggregate bond index (as of May 17, 2024, according to Bloomberg.
Financial assets are reflecting the reality of currency destruction, as equities and gold experience significant growth while bonds remain stagnant.
This is a clear demonstration of governments utilizing their fiat currencies to mask the credit solvency of issuers.
Given this information, it becomes apparent that gold is not expensive at all; in fact, it is remarkably cheap.
As governments seek ways to address trillions of dollars worth of unfunded liabilities, they will likely have no other choice but to repay these obligations with a valueless currency.
Holding cash poses a significant risk, and investing in government bonds can be reckless; however, rejecting gold would be denying the true nature of money.