It’s time to start thinking about inflation

In the year 215 AD, the young Roman Emperor Caracalla, then just 27 years of age, decided to ‘fix’ Rome’s perennial inflation problem by minting a brand new coin.

Caracalla’s predecessors over the previous several decades had ordered an astonishing debasement of Roman currency; the silver content in Rome’s ‘denarius’ coin, for example, was reduced from roughly 85% in the early 150s AD, to less than 50% by the early 200s.

And with the silver content in their currency greatly reduced, government mints cranked out unprecedented quantities of coins.

They spent the money as quickly as they minted it, using the flood of debased coins, for example, to finance endless wars and buy up food supplies for their soldiers.

Needless to say this caused rampant inflation across the empire.

Egypt was a province of Rome at the time, and one of the Empire’s major agricultural producers. Its local provincial coin, the drachma, had also been heavily debased.

A measure of Egyptian wheat in the early 1st century AD, for example, cost only 8 drachmas. In the third century that same amount of Egyptian wheat cost more than 100,000 drachmas.

Caracalla tried to fix this by simply creating a new coin– the antoniniamis.

It was originally minted with 50% silver content. But the antoniniamis was debased down to just 5% silver within a few decades.

Caracalla’s undisciplined attempt at controlling inflation was about as effective as Venezuela trying to ‘fix’ its hyperinflation by chopping five zeros off its currency.

In fact this same story has been told over and over again throughout history:

Governments who spend too much money almost invariably resort to debasing the currency.

In ancient times, ‘debasement’ meant reducing the gold and silver content in their coins.

In early modern times, it meant printing vast quantities of paper money.

Today, it means creating ‘electronic’ money in the banking system.

But the effect is the same: every new currency unit they create reduces the value of the existing ones. This is not the path to prosperity.

Economies flourish when talented, hardworking people are free to produce valuable goods and services.

It’s ridiculous to expect that an economy becomes wealthier when people are paid to NOT work, when debt levels soar, and when central bankers conjure trillions of dollars out of thin air.

Debasing the money supply does not create REAL wealth. It does, however, create inflation.

Central banks around the world, especially in Europe and the United States, debased their currencies last year in record proportions.

The Federal Reserve in the US roughly DOUBLED the size of its balance sheet last year, with ‘M2 money supply’ growing faster than any year in history except 1943.

More importantly, there’s no end in sight. The Federal Reserve, the US Treasury Department, and influential members of the United States Congress, all want even MORE expansion of the money supply.

Of course, they call it ‘stimulus’. But giving it a positive-sounding name doesn’t change the truth: they’re engineering inflation. And we’re already seeing signs of it.

Commodities prices, for example, have surged over the last year. Lumber has tripled. Corn has doubled.

Bear in mind that commodities represent the input costs to other products; so if lumber is more expensive, for example, it means that home construction prices will also rise.

Just this morning, consumer product giant Procter & Gamble announced it would raise prices across the board for its products, from diapers to beauty products, due to rising commodity prices.

Even official statistics from the US federal government show that inflation last month reached a multi-year high.

We can also see inflation when we look at asset prices.

Stocks are trading at peak valuations; the average Price/Earnings ratio in the S&P 500, for example, is now 42, roughly 3x the historic average. It has only been higher two other times– just before the 2000 crash, and just before the 2008 crash.

Bonds are so expensive that more than $13 trillion worth trade at negative yields.

Real estate prices are so expensive that cap rates in many sectors have hit record lows.

These are all obvious signs of inflation.

It’s important to think about inflation, and to prepare for it… because the government’s options to deal with it are extremely limited.

In theory they could clean up their fiscal imbalance and stop spending so much money, which means the central bank would no longer have to debase the currency.

But such political responsibility is highly improbable.

Alternatively, if inflation continues to rise, the central bank could raise interest rates to reign it in.

But higher interest rates could easily cause a meltdown in financial markets; stocks, bonds, and even real estate, whose current record high prices depend on 0% interest rates, could experience a sudden crash.

More importantly, higher interest rates would push the federal government beyond its breaking point; if rates were to rise to just 5%, the government’s annual interest expense would eventually reach $1.5 trillion.

So that leaves the final option: the Federal Reserve could simply ignore the inflation data and continue financing government deficits.

They’ll tell us that the inflation is ‘temporary’ and ‘transitory’, and not to worry because they’re still in control of the situation.

But anyone who visits a grocery store, fills up a gas tank, or pays tuition, will know the truth.

I’m not suggesting the sky will fall and we’ll see some Zimbabwe-style hyperinflation. But a return to the painful inflation levels in the 1970s? That’s absolutely a possibility.

In a future letter I’ll discuss different ways to prepare for it. But for now I’ll leave you with a simple thought–

I am not fanatical about any asset, and I would never describe myself as a ‘gold bug’. I do, however, recognize that gold has a 5,000 year track record of performing well during times of inflation, with very few exceptions.

And at the moment, both gold and silver are among the only major assets that are NOT selling for record high prices.

To your freedom,

Simon Black

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