Lear Capital – November 20, 2012 – David M. Engstrom with Kim Bacic – Now that the election is long over, the buzz on every street is all about the fiscal cliff.  We’re all told to fear it, but do we really understand what it is and how far-reaching it’s effects can be?

Simply put, it boils down to two fiscal fears.

Fear One is the expected consequence from the expiration of the Bush-era tax cuts.  January 1, 2013 is D-Day, folks.  Such an event will be tantamount to a tax hike for everyone.

Fear Two is the potential for automatic government spending cuts should the current debt ceiling be breached without consensus to have it increase.  Past estimates were that the current $16.4 trillion debt ceiling would hit sometime between November 2012 and January 2013.

According to Congressional Budget Office estimates, our already job-starved economy could lose as many as 3.4 million jobs and shrink by $600 billion dollars.  Other estimates are much higher.  Are you going insane yet? Think for a second.

We just added $6 trillion to our national debt to stimulate the economy. More than $1 trillion a year since the credit crisis unfolded some 4 years ago.  For it, we have no real job growth, nearly immeasurable economic growth, more volatile markets and a higher cost of living.  What do you think is going to happen when the water shuts off?

These are not “other people’s” jobs at stake here.  This is not someone else’s lost $600 billion dollars.  According to an estimate from USA Today, we can all say goodbye to $2000 – $3500 a year of disposable income.  But, what cannot be measured is the “ripple-through” effect that lost disposable income will have on the markets and the economy down the road — the road where we kick the can.

What is disposable income?  Think of disposable income as an economic transformer that takes on three forms.

Transformation 1:  One person’s disposable income turns into someone else’s primary income.  Let me drive this point home using a car purchase as an example.  If I lose $350 per month of disposable income, I have to delay the purchase of that new car.  That could be $30,000 not earned by the car dealer, the salesman, the service department, the transporter, the car manufacturer, the factory worker, the tool supplier, the internet provider, the sub-contractors, the parts makers, the landscape company and ….. well, you get it.

That’s $30,000 of economic stimulus created out of thin air by $350 of disposable income. Lose it and the effects ripple through the economy like a tidal wave of destruction.

Transformation 2: Disposable income as savings.  Generally, one person’s savings turns into someone else’s loan.  Annuities are loans. Life insurance policies are loans.  So are CD’s, Bonds … even bank deposits are loans.  When you decrease the amount of money there is to lend, you stifle the ability of another to turn disposable income into a house, car, boat, TV, stereo, credit card —- the things we borrow money for to buy.  See how we start to move full circle?  If there is no money to lend, disposable income has no value other than the paper it’s printed on.

Transformation 3: Disposable income as the market’s life-blood. No disposable income? —-  No markets!  Corporate America is all about disposable income.  You lose it and the markets get hit with a double whammy.  If a consumer can no longer afford to buy your goods and services, how can they afford to own a piece of your company?  Or, worse yet, if too much disposable income is lost, investors are forced to sell in order to meet daily budgetary needs.  Pretty soon, earnings fall, investors sell, and corporate America cuts wages, jobs and whatever operating expenses they can to maintain profits for the shrinking pool of investors.  And the circle is complete.

While this may seem an argument for extending the tax cuts and raising the debt ceiling, don’t take it as such.  These are just the facts.  Also factual is the consequence of raising the debt ceiling, spending more money and embracing a perma-deficit strategy – one that can’t last forever.  Eventually, you can’t borrow enough to pay your bills, and then — if you can’t borrow enough or tax enough — you end up right back to the situation we find ourselves in today.  The circle now becomes a death spiral.

So when you really think about it, it all boils down to timing.  We can face our sins today and hope that raising taxes and cutting spending is the answer.  Or, we can borrow more and spend more till the day comes when the option to borrow and spend is gone.

In my humble opinion, it makes no difference.  The end is the same.  DEFAULT!  It has been proven millions of times a year as businesses and households attempt to borrow and spend their way to prosperity only to finally embrace bankruptcy.  At some point, you just have to start over.  So it will also be with our government and our spending – default seems inevitable.  I believe it’s already begun.

No, I am not talking about some conspiracy to stiff China or to steal oil under the guise of war.  The default of which I speak is more insidious.  I speak of inflation.   If the price of a gallon of gas doubles over the next 4 years, as it has in the last 4 years, your savings and retirement accounts will endure a form of default.  It’s a fact.  If, 4 years ago, you had plans to retire today, your plan has changed.  For millions of would-be retirees, net worth has been lost while the cost of living has gone up.  You can’t buy enough cheap TV’s to recover the trillions of dollars of lost wealth and income we have all endured.

This is why I believe the world will print more money.  Not just in the U.S. but throughout all world markets.  Without global inflation (money printing), payment defaults are inevitable.  Whatever the politicians decide, I believe there will be so much money printing — hence inflation —  that our current debt and deficits will be put to Lilliputian scale, while debt and inflation grow to Gulliver-like proportion.

If you buy into the thesis that inflation, perhaps hyperinflation, is all but a foregone conclusion, this forces one to seriously consider changes to the way you invest for the future.  It’s inarguable that saved dollar assets have diminished in value over the last 4 years.  To many, it is also plain that over the next 4 years we are going to experience more of the same.

In a recent interview, Treasury Secretary Geithner provided enlightenment in this regard.  According to an article and video provided on CNSNEWS.com, the next 4 years could deliver more of the same economic pressures as the Secretary advises Congress to “lift the debt limit to infinity.”  If that is not a clarion call for inflation, then you better hope Christmas comes early because the world likely will end on December 21, 2012.

If you plan on being here December 22, then you should consider ways you may adjust your investment and retirement strategy to allow for 4 more years like the last 4 years.  The question, then, is what investment could you have made 4 years ago that would have left your savings and retirement largely intact today?  Over the last 4 years, gold prices have doubled and silver prices have risen even further.

Do the Math.  If your savings and retirement back then was comprised of just 20% gold and silver bullion, a $100,000 portfolio comprised of stocks, real estate and precious metals could have suffered a 25% loss in stocks and real estate before the overall portfolio value would have drifted into the negative.  That’s why you may consider diversification.

As always, it is your call as to whether or not you see inflation in your future and in the future of your savings and retirement accounts.  My crystal ball is cracked so all I have left is my opinion and to some, just my uneducated guess.  But, if you want more information, free for the asking mind you, visit LearCapital.com to request the latest FREE News Subscriptions, Special Reports and Guides.

Now is not the time to put your head in the sand.  It makes it hard to breath.

Copyright Lear Capital All rights reserved.