MLR - The sky is falling? No, but the dollar is. The U.S. economy has cancer. Unemployment may stay stubbornly high for several years. How should the fed cure the patient?

Unemployment and The Dollar

Unemployment, besides the first order consequences of being out of work, creates second and third order consequences, where psychological devastation sets in from being unemployed for an extended period in addition to seeing one's skill sets deteriorate. The pressing question is how best should the fed best engineer a lowering of the unemployment rate, as current projections are that unemployment will stay stubbornly high for the next several years.

The answer is not a kind one. Because Bernanke is a politician, he is interested in being reelected. This means giving voters false comfort by delaying the cure which will be painful. If the U.S. economy is the patient that has been diagnosed with cancer that is in a treatable stage, instead of using painful treatments that will eventually rid the patient of their cancer, Bernanke is pumping the treatable cancer patient full of morphine, making the patient feel better, while doing nothing to deal with the cancer while giving the patient a morphine addiction to boot. In the meantime, the cancer cells continue to multiply.

If we see the reckless printing of money as the multiplication of cancer cells, we see that the printing of money continues to devalue the dollar, thus increasing the cost of living for all Americans. Did you know the U.S. dollar lost nearly 40% of its buying power against a basket of major world currencies from 2002-2008? And the U.S. dollar is dangerously close to breaking to all time historical lows. One might ask if the dollar's days are numbered as a fiat, reserve currency.

Interest Rates

The fed has a tendency to stay behind the interest rate curve, being late to raise or lower rates. Since Bernanke is terrified of a depression or a derailing of the fragile economic recovery, and we should put the word, recovery, in quotes, it is likely he will be late to hike rates. This means inflation could get out of hand as prices of commodities and precious metals soar and the dollar continues to fall. This has potentially long term damaging consequences to the health of the U.S. economy.

The solution is a painful one, but politicians know it will not win them reelection: Stop printing money, let the dollar strengthen, and let interest rates rise on their own accord. This will derail the economic recovery which could be argued is fictitious at best, causing unemployment to rise. But at least after a couple of years of pain, the excesses will have been wrung out of the system. Banks and businesses that deserve to go bust will go bust. This will enable new, enterprising companies access to a truly recovering economy. And we all know that the lifeblood of economies are new shoots, ie, the new companies with powerful visions that can execute. The patient may then be saved before its condition goes critical.

That said, Bernanke is hoping he can engineer a relatively soft landing. Federal funds futures estimate a 25 basis point hike in rates in early 2012. This is a good forecasting tool as it has a relatively high accuracy rate. Now contrary to popular belief, rising rates are actually indicative of a strengthening ecnonomy. Thus Bernanke hopes the economic recovery will strengthen by 2012, giving him room to ease off various forms of quantitative measures and the printing of money. Will Bernanke be able to engineer a soft landing?

To paraphrase a speech from the film Wall Street:

Selfishness, for lack of a better word, is good. Selfishness is right. Selfishness works. Selfishness clarifies, cuts through, and captures, the essence of the evolutionary spirit. Selfishness, in all of its forms; selfishness for life, for money, for love, knowledge, has marked the upward surge of mankind and selfishness, you mark my words, will save that other malfunctioning corporation called the U.S.A.

Bernanke's selflessness to make the cancer patient feel good in the short run at the expense of the patient's long term health has historically been shown to have dire consequences. The fed sees two options: default or devalue, and they certainly are not going to choose to default.

In the meantime, we will continue to issue reports on our best stock and ETF buy and short ideas so we can take advantage of these challenging times.

Gil Morales
Co-founder
The Virtue of Selfish Investing