In 2008 few Americans were privy to the discussions that determined whether the world financial system would completely implode or be saved. Wall Street was crashing while policymakers argued about what was to be done in the little time before the unthinkable could happen.
 
However, we all know now that the system is potentially being "saved" by the ongoing economic bailout: including Ben Bernanke's QE1 and now QE2. We are now faced with a new economic reality raising the following five questions regarding the potential growth of one's money and one's financial survival in an economy with potentially high rates of inflation in 2011 and beyond:
 

• May the rate of inflation reach beyond the moderate levels of the last two decades in the next few years?
• May gold and silver market prices soar further as a continuing beneficiary of the Fed's QE2 or its potential successors, or in response to ongoing political and economic upheaval in the Middle East or even potential economic disruptions at some point even in America?
• Related to question one, may the expanding level of U.S. deficits and public debt growth and the result of quantitative easing guide us into an era of inflated price levels: a poor economy with record high interest rates and record U.S. inflation for the modern period? In the same vein, is it remotely conceivable in a future America that purchasing necessities may be out of reach for all except those who have hard assets, strong foreign currencies or whose skills can be bartered for goods and services (hyperinflation outcome)?
• May the dollar transition into an unmanaged decline if the U.S dollar's status as the world's reserve currency withers away?
• May some or all of these events potentially occur?

I do not think that it may be a "given" that some or all of these events may happen, but that by our government and Federal Reserve leader's present course: there may be a reasonable probability some or all considerations may occur in the next five to ten years. Yet the power to moderate some of these potential events is in our hands today. But it appears that due weight should be given to these risk factors in planning not only one's potential investment strategy, but also how one may plan one's families daily lives and economic survival strategy in the intermediate term.
 
The first question regarding whether the economy may experience a dramatic worsening of the rate of inflation in the coming years has already been addressed by the current buoyant behavior of the and commodity markets going into 2011. The gold market, addressing the second question, is traditionally a barometer of inflation and economic distress and has experienced a long term bull trend lasting over a decade, potentially telegraphing future price inflation. The mini-gold contract currently trades at $1424.60 per troy ounce.
 
A nascent bull market in gold began at the Millennium as the internet bubble popped, signaling that there were imbalances building in the economy at that time: the growing housing boom and credit bubble. These may have been the creation of the maestro himself: former Federal Reserve Chairman Alan Greenspan, who lowered interest rates to 1% in 2003 in order to combat potential deflation.
 
The recent extension of the gold bull market and the uptrend in equities that began in March 2009 may be in part the result of the economic bailout: Ben Bernanke's QE1, QE2 and Fed-engineered low interest rates. This in turn may have made the gold and the stock market an attractive investment relative to interest bearing debt instruments. Warren Buffett once remarked in an interview after the 2008 Crash that he could envision the likelihood of greater rates of inflation down the road than the double-digit inflation experienced in the 1970's. Gold, silver, oil, and the basic materials sector of the stock market may do very well under that scenario.
 
The decade of the 1970's provides an example to study to gain clues about the future direction of gold and silver prices. The rise in the gold and silver markets during that period was epic: the gold price rose over twenty fold to a height of $850 in 1980, and the silver market price rose to $50 per ounce when the Hunt brothers attempted to corner the silver market. The gold market later bottomed out at approximately $254 per ounce after an extended bear market and silver collapsed as well. If gold were to have the similar percentage gain now from the last 1970-1980 bull market in the metal - it would reach over $5,000 per ounce. However, a reminder is in order that precious metals may not be permanent investments unless you hold them as portfolio insurance. You may encounter both secular gold bull and bear markets over time as we have seen.
 
Yet today, some notable hedge fund managers including John Paulson and George Soros have profited handsomely from the ongoing increase in gold market prices. Soros has even claimed that gold is "the ultimate bubble." I would add that you may have to be nimble in owning precious metals in the likelihood that these markets get ahead of themselves.
 
The third question asks whether U.S. deficit spending may stimulate higher inflation or even economic hyperinflation in the future. While some have said that U.S. policies have contributed to food price shocks in other countries, it is also true that food prices have been going up in every exchange rate. At home, the rate of inflation shows signs of percolating as the producer price index rose by 0.8% in January 2011.
 
The National Inflation Association states that hyperinflation may be caused by 2015 "primarily by the healthcare bill and rising interest payments on our national debt." They state that the healthcare bill may actually cost "several trillion dollars." They further state that annual interest payments on the public debt could reach $1 trillion or 29% of projected tax receipts by 2015. They state that "the only way it will be possible to prevent hyperinflation is if the U.S. government dramatically cuts spending across the board and if the Federal Reserve raises interest rates from near zero percent ...to a level that is higher than the real rate of inflation."
 
The Obama administration is estimating that the deficit for 2011 will reach almost $1.5 trillion. The federal debt is being monetized, as it was in the 1970's, auguring higher market prices for investments such as gold and silver, oil and oil service equities, fine art, and even well financed real estate in select locations.
 
The fourth question concerns the fate of the dollar. The dollar index currently trades at 76.67. The U.S. government may not be able to continue the massive deficits without risking destroying the dollar and making most Americans poorer. Creditor nations are already taking actions to break away from the dollar as the world's reserve currency. Should that occur in full force, the U.S. may succumb to the folly of its own monetary ease and fiscal mess. The advantage that the dollar enjoys as the current world reserve currency may allow our policy makers the luxury of proceeding with monetizing 30% of our national spending with the prospect of more to come. Our leaders are trying to save us, but they may starve us instead. The result of this strategy in the past in the U.S. has been greater inflation: a further reduction in living standards for most all Americans. In other words, a cascading cost of living could potentially throw millions more into poverty.
 
The fifth question asks whether a confluence of some of these risk factors may come into play. I think that the answer is that they may, but there is a lot Americans may do now to prevent a unwelcome outcome. I would encourage you to ask your legislators to seriously address the federal deficit which includes finding a more cost effective solution to our healthcare needs than we currently have in place. An unwelcome economic outcome may be brought about by our own inaction on the deficit front, or if the financial market vigilantes or our foreign bondholders force us to balance our books during another crisis. As an aside to my comment on healthcare, I do not believe any individual should be denied health insurance because of a pre-existing condition (which is true for adults under the current law until 2014) or should go bankrupt as a result of not being able to obtain insurance.
 
What may individual families do (i) that still have some assets left or (ii) are living from paycheck to paycheck in order to protect themselves financially from further economic downsizing in a potential inflationary economy? Though I am not an investment advisor and cannot give specific investment advice, I can relate my own financial strategy and describe what I am doing with my own funds:
 

• I own some gold coins and bullion, and silver bullion as portfolio insurance and for growth of capital in the current economic environment. In addition, gold and silver represent potential financial protection against the worst case scenario of hyperinflation.
• I am trying to keep expenses down; for example, by buying cheaper food ingredients and cooking all in one meals such as soups (which helps me with my weight control).
• I use a financial software program to keep track of the growth of my money and track in categories my spending every month. There are also free websites that may do this task for you.
• I have a fixed rate mortgage on my residence which may allow me to pay off my mortgage with cheaper dollars if the value of our currency is debased by a continuation of quantitative easing and the potential emergence of embedded inflation in the coming years.
• I monitor the stock market carefully and adjust my equity positions as necessary (the Dow Jones Industrial Average closed at 11,193.16 and the S&P 500 closed at 1296.39 today). I subscribe to equity selection services that provide me with a flow of investment ideas and I plug the symbols into analytical software for study. Should I have positions that have large percentage gains in companies whose businesses are improving and where the technical outlook remains strong in my view, I usually give them room to run. I sell losers unless my ongoing fundamental research and analytical software indicate that I should stick with them.
• Most of my U.S. equities are companies with strong growth characteristics or special situations with catalysts for growth. For example, two equities that I own are restaurant companies whose businesses are strong enough at this time to overcome increases in their commodity costs.
• I have a long term position in an international oil firm, and have a few smaller positions in resource plays.
• I have a position in a mutual fund that invests throughout Asia and a fund that invests in currencies of countries with low inflation rates. The potential downside risks to U.S. equities as opposed to that of Asian stocks include (i) if the U.S. federal debt growth is not curtailed and spending cuts not enacted sufficient to reduce our $13.8 trillion federal debt, (ii) should Bernanke launches QE3 or QE4, or (iii) if an external economic event or another economic downturn cause the dollar and U.S. equities market to decline in a crisis atmosphere. Asian creditor nations' stock markets may then decouple from the U.S. and offer potential purchasing power to the U.S. consumer. Regarding the ongoing awful tragedy in Japan and the threat of multiple nuclear meltdowns at the Fukushima Daiichi facilities, the situation is still fluid at the plants as I write this. If there were one or more complete meltdowns at the facilities and radiation were released into the atmosphere, I think that the U.S. market's reaction may be a short to medium term correction that appears to have already begun. But bear in mind that the threat of more than one meltdown at a single facility has never happened before.

If our leaders in government choose not to seriously tackle the federal deficit, then the financial markets may force us into another economic crisis in the coming years. Ben Bernanke should end QE2 as planned in June 2011 and not embark on another round (easy for me to say!). So investors' stock portfolios may go down.

May we really postpone indefinitely the next bear market for stocks when the next downturn hits in the future? The business cycle ensures that there will always be another recession. Yes, we are currently no longer in a downturn. The recession officially ended in June 2009! At some point the stock market's ability to rise further may have to rest on the coattails of the economy and not on the growth of the Fed's balance sheet. That being said, for now we have QE2 and its potential successors to keep the market going for now. Though employment is lagging, the prospect for future economic growth during the rest of this bull market seems fairly bright.

Related posts:
Inflation Hedge Strategies and Thoughts for 2010 and Beyond
The Bernanke Exit Strategy: Seven Stock Market and Economic Consequences
The End of the Dollar as We Know It?