Tony Lepage

For the purposes of education, I’m going to detail the causes of our current situation and potential outcomes. We need to understand what is going on in the world today and how we got here. We need to know why the price of gold is rising; we need to know why oil is rising. We need to examine why the housing market is rising and we need to understand why everything is becoming more expensive.

Although I have spoken about inflation in the past, I have not outlined the facts behind these rising numbers. I want to provide you with a reasonable understanding of what inflation is, how it is currently acting in our lives and where it can possibly take us.

The Past
When the US government went off the Bretton Woods system (a gold backing) in the 1970s, the US government no longer had to keep their books balanced. You might be thinking that this is an exaggeration, but it really isn’t. What happened during the 70s is written in the history books; inflation soared and everything went up in price. This was because the US government would simply print money to pay for all of their spending (in other words they monetized their debt).

By the late 1970s and early 1980s it was apparent that something needed to be done to cure the mess. The government turned to the Federal Reserve asking for advice. The Federal Reserve, which was under the guidance and power of Paul Volker, told the government that the overnight interest rate would have to be raised, the government would have to drastically cut back on its spending and, new market reforms would help curb the inflation that was getting out of control.

Raise the Interest Rate
This would become the mantra of the early 80s as the Federal Reserve embarked on harnessing inflation—the medicine that the United States needed (even though it tasted horrible). The Federal Reserve raised the interest rate by 2% at their very first meeting! By the time the Federal Reserve finished its rate raising strategy, lending rates sat at 21%.

The Capital Market Revolution
The government was forced to reduce it’s spending by finding new ways to finance its debt instead of simply printing money (in other words they were counterfeiting the US dollar). The government began financing their debt by providing investment vehicles to the market that would fund their spending. This is when the US government began to sell bonds to institutions (banks) and investment funds (pensions). A bond is simply a promise to repay a loan with a specific rate of return. It is said that government bonds are among the most secure investment options because the loan is guaranteed by the taxation of the nation’s citizens.

Of course, after the interest rate came down, government spending became excessive again. However, the difference this time was that the average person couldn’t see the inflation that was caused. The inflation was now being directed to the financial markets because of the capital market revolution and the creation of bonds. This marks the beginning of our government’s addiction to borrowing. Wouldn’t it be great if you could be in charge of running a business that could incur $800 million extra dollars of debt a year and never have to worry about paying it off?

Just to put this into perspective, the global bond market has grown from $5 trillion in 1990 to over $45 trillion today. Government debt has grown from $3.3 trillion to $8.4 trillion in just 6 years!

The Roaring 90s
During the 1990s the Fed was again creating a lot of inflation and Americans were spending more and more on products that were manufactured in other parts of the world. Because the money was spreading to other countries, this slowed the effects it had on rising prices. The main reason we began buying these products from other countries was because there wasn’t enough manufacturing within the United States to produce all the goods.

The foreign benefactors of these dollars (those who sold us the goods) began to use this new income to invest back into the North American stock markets. This produced rising stock prices and resulted in the boom in the stock market that occurred for over ten years. It was this bull market stock market that caused investors to become short sighted and believe the tech boom could never end. This was inflation. Inflation causes a misallocation of investment which causes asset bubbles.

After the tech bubble burst of 2000, foreigners no longer placed their money in the stock market; instead, they directed investments into the bond markets and began helping the US government finance even more of its debt. With so much money financing the bond markets, rates dropped and this allowed Americans to begin gambling with mortgages (as an investment vehicle) and this caused our current housing market bubble.

A large number of Americans used the new equity they cashed out of the housing market (through refinancing) to purchase even more goods from foreigners. This has caused an even more dramatic increase in production demand. Again, all of this demand is driven by the US consumer and the credit they are spending comes from the Federal Reserve (and Bank of Canada here in Canada).

With more demand, we need more supply. This is also why we see natural resource prices increasing so dramatically over the past couple of years. China is the number one buyer of US debt and the top consumer of concrete, copper, zinc, etc.

All of these price increases (rising stock, real-estate, and commodity prices) are all a result of the Federal Reserve’s inflationary policies. Central Banks are supposed to help to stabalize our currency. They certainly haven’t done anything close to for over 30 years.

Fact: Inflation is caused by the Federal Reserve, the Bank of Canada, the Bank of England… Central Banks are INFLATIONARY.

This is the most important piece of financial information you will learn for a very long time. It will cause the most catastrophic economic event of our lifetimes and it has the potential of making the great depression of the 1930s look like a Sunday picnic.

We Need Heavy Banking Reforms
It is important for everyone to understand this because we need to reform our banking system. We can no longer afford the hidden taxation of inflation. If you don’t think things are expensive now, just wait—things are going to get far uglier. Sell that car while people are still willing to buy it from you.

The banks will continue to expand the supply of credit and this will occur on a grander and grander scale. Price and wage inflation will continue until the whole monetary system is destroyed. For this reason, banks may eventually realize this risk and force us into a devastating depression (as was done in the 30s). They will cause this by stopping the expansion of credit. When this occurs, businesses will re-evaluate most investments and corporate spending will come to a grinding halt. This will have far reaching effects in the global economy.

There is no doubt that Central Banks see this risk. Globally, they are all increasing their money supplies to prevent a collapse of the US Dollar. If the government and Federal Reserve try and halt the upward movement of prices while also trying to prevent a complete collapse in prices, they will end up with only one option—printing more money. This will cause an even more drastic rise in prices.

I have enough reason to suspect this is what they are planning to do (or already doing), since the Federal Reserve announced to the financial markets, in November of 2005, that they would no longer measure the amount of credit in the system. Here in Canada, our Central Bank is expanding the money supply at a rate of 12% a year. Our Looney is still appreciating against the US Dollar.

How long can this manipulation continue? It can continue for as long as we allow. For, as long as the general population has reason to believe that the price increases they are seeing today are only a temporary thing, the longer the charade can continue. As soon as the public realizes that inflation is been running rampant, they will no longer wish to hold onto cash. Holding cash during an inflationary environment means your money loses value.

Currently, we can see that the consumer is fooled. How many times have you heard that oil prices are only temporarily high? Yet, the oil price has been getting higher and higher since 2003. (Yes, maybe oil prices will fall during the second half of this year, but this is more of a political a-la-bush-approval-ratings-are-low type event that will be over by December).

This continual rise in prices and the eventual awakening of the US public will cause a rush into any other type of asset—a “flight into real values.” It is at this point that we can expect the dollar to fall to zero and commodities and a select number of foreign currencies to drastically rise in price. People will buy anything, just as long as they aren’t holding cash.

Other Notes
I had the opportunity to introduce my ideas to a peer that works at a major financial institution. I was quite shocked at how upset he became when I expressed my outlook for the US economy. He was angry that I had the nerve to say the things I was saying and he questioned my economic background. He does have a point—I don’t have formal training in economics and I am entirely self-taught.

My motivation for learning comes from my drive to be successful in the financial markets. I wish to be judged based upon the percent return I can achieve and I want nothing to do with the economic teachings of most universities. I have never had an urge to perform for grades and I have always been one to question the teachings of those in power. Because I have taught myself, I have been able to learn about the different schools of thought in economics. Universities subscribe to the teaching of Socialist and Keynesian schools of economics. Applying the Keynesian theory to an individual (and with heavy generalization) you ebd up with something along the lines of: “Spend as much money as you can get in credit, throughout your life, because at the end of it you’ll be dead.” Apply it to a nation and you get… well… the USA (spend, spend, spend. It all comes back to us anyway).

The point that I’m trying to make is that one should always be able to question their beliefs. Don’t buy into group think. If you do enough work and are well versed in a topic, you’ll find ways to succeed while spreading the benefits to the rest of our society.

Finally, it is obvious that our current government is not very educated in the ways of economics. In fact, a lot of our government leaders don’t have a clue about some of the most basic economic theories. Most investors on Wall Street also have their head in the sand. And it’s no wonder—television has delivered a massive tool to obscure the truth. Television also destroys creative motivation.

If you find it hard to believe that the majority of Wall Street can be fooled on such a significant topic, I ask that you recall the technology bubble of the late 1990s. Specifically, remember the biggest merger of history: AOL Time Warner. Here we have the smartest CEOs fooled into thinking AOL is a great company worth hundreds of billions. Since then, they’ve switched their name back from AOL Time Warner to the traditional Time Warner. Group think must have thought AOL was the cat’s meow; AOL was trading on the stock market at 600 times earnings!

Need I mention the large sums of money that were lost because most investors thought the tech bubble could never end? The herd is often wrong; you just have to make sure that you don’t follow them when they’re running off the cliff.