Peter J. Cooper’s Weblog

This week the entire financial community and most investors are focused on the American bailout plan. No matter that $1.2 trillion was wiped off the value of shares on Monday compared with the $700 billion of the controversial plan. Then again the Fed created another $630 billion in emergency bank facilities this week. You almost wonder why Capitol Hill is bothering with such a small sum, except to enjoy being the centre of attention.

The numbers are so now so huge that they almost become meaningless. One that did catch my eye is the $10,000 each UK taxpayer now owes against the toxic debts of the Northern Rock and Bradford & Bingley.

Then again the European banks have been at it this week, pumping $16 billion into Fortis, guaranteeing the Hypo Real Estate debts and bailing out one bank in France and nationalizing another in Denmark. And creating more borrowing windows for banks, and guaranteeing all bank deposits in Ireland worth twice the national GDP. This runs to hundreds and hundreds of billions of dollars. Japan and Asian countries are doing the same.

The central banks are deliberately inflating the money supply all over the world to offset the impact of bad loans. It is a trick as old as the Roman Empire when coinage was debased to pay down debts of dissolute emperors.

But the consequences are going to be the same: rampant inflation of a kind we have not seen since the 1970s, and competitive currency devaluations. This is going to be the real price of the global financial bailout.

At first this will be hailed as a success: a really deep recession will be avoided, although it may still feel pretty rough next year. Then the downside of pumping money will become apparent with inflation moving higher, and with economies too weak to take the necessary corrective medicine of higher interest rates to purge the system. But believe me higher interest rates will follow and keep real estate markets flat on their backs - we are already seeing market forces work in this way.

Printing money

Populist democratic governments are apt to print money rather than take difficult decisions, and Roman emperors did the same thing to keep their people happy. It is only when people are rebelling against the destruction of their savings by inflation that this can be corrected.

That is not the mood on Capitol Hill now, or even among the world’s central bankers who have become complacent about inflation after more than two decades without this beast at the door. The consensus is to loosen the flow of money to support global growth and nevermind the consequences, that can be dealt with later.

Investors always have to look forwards and try to anticipate future events. It is not good enough to bury your head in the sand and hope for the best. Keeping cash on deposit or in treasury bonds might seem the safest option but clearly as inflation returns this is going to be a losing strategy.

Bond crisis coming?

You have to wonder about treasury bonds. Inter-bank interest rates are presently much higher than returns on T-bonds backed by the US government. Why then do investors continue to hold them? I suppose it reflects a lack of confidence in the global banking system.

But any rational person ought to sell treasuries at that level of return. UAE local banks are paying six per cent on deposits, and you have to ask whether the hydrocarbon backed dirham is not a better prospect than the US dollar.

Especially when you consider that inflation is about to increase, T-bonds look an awful place to keep money. What you need to profit from an era of inflation is a money with a fixed supply, one where the central banks can not print billions and billions to bailout their collapsing economies.

That is the simple reason to be optimistic about the outlook for gold and silver, the world’s oldest and most enduring currencies. You could use the same coin that bought a loaf of bread in Roman times and exchange it to buy groceries today.

Real assets hold value

In investment terms that means you hold something - perhaps one of the few real assets - that will retain its value as inflation devalues everything else around you. This is why I remain confident that as economists and markets digest the true cost of the bailouts in terms of inflation in the future that the value of gold and silver will rise.

Once this obvious truth becomes generally accepted then we can expect a sudden shift by retail investors into gold and silver for protection against inflation. Both are very small markets by comparison to global equities, real estate or bonds - particularly silver, so the price movements will be very large.

Therefore, I would comfortably expect gold and silver to pass their March highs of $1,030 and $20 within a couple of weeks, and head on to $1,200 and $30 an ounce by the end of the year. Next year could be an anus mirabilis for precious metals with a doubling of gold and trebling of silver prices.