By Nick Giambruno
The Fed has already printed trillions—and shows little sign of slowing down—which means much higher inflation is already baked into the cake.
The only question is how the Fed will respond to it.
Ludwig von Mises, the godfather of free-market Austrian economics, summed up the Fed’s dilemma:
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
The Fed has two choices:
1) keep printing trillions and let inflation skyrocket
2) tighten monetary policy and watch the markets crash.
In other words, it can sacrifice the stock market or the dollar.
#1 Keep Printing Trillions and Let Inflation Soar
Stopping the money printing would go a long way to cleansing the economy of its massive distortions.
It would be painful in the short term, but it would enable the economy to rebuild on a better foundation.
However, that is politically unacceptable.
When faced with the choice, politicians usually choose the most expedient option. Therefore they are likely to choose the easy option—keep printing money and pretend inflation is under control for as long as possible.
Further, unless Congress makes some politically impossible decisions to cut spending, the US government will have endless multitrillion-dollar deficits that ever-increasing money printing will have to finance.
The Congressional Budget Office estimates the total deficit between 2021 and 2031 will be close to $20 trillion, but that will almost certainly understate the actual numbers.
Who is going to finance this, conservatively, $20 trillion shortfall? The only entity capable is the Fed’s printing presses.
But there’s another compelling reason the US government won’t tone down the printing presses. That is because inflation reduces the real debt burden. It allows you to borrow in dollars and repay in dimes.
Inflation is a boon to debtors, and there is no bigger debtor in the history of the world than the US government, with its more than $30 trillion debt.
That’s why the US government, and those connected to it, are the biggest beneficiaries of inflation. It’s also why you hear ridiculous gaslighting from the Fed and its apologists in academia and media about how inflation is a good thing.
As inflation soars, you can expect other measures.
For example, in Argentina, where prices regularly rise 40% or more each year, they made it illegal to publish inflation statistics that differ from the official government numbers.
I wouldn’t be surprised if the US government did something similar. At a minimum, discussing inflation statistics other than the CPI might be deemed disinformation and cause you or your business to be de-platformed.
Out-of-control inflation is also a common excuse for governments to implement capital controls, price controls, and other destructive measures.
Here’s the bottom line.
The US government is incentivized to continue creating ever-increasing amounts of inflation.
That’s terrible news for the US dollar but excellent news for free-market monetary alternatives such as gold and Bitcoin.
It’s only prudent to be prepared for higher inflation.
However, there will come a time—which may be soon—when rising prices create enough political pressure that could force the Fed to act otherwise.
That’s why we also need to be prepared for scenario #2.
#2 Tighten Monetary Policy and Collapse the Stock Market
The markets have become dependent on the Fed injecting over $120 billion a month of freshly printed dollars into the system. So even the slightest hint that the Fed could cut back on printing could tank the markets.
When Greenspan crashed the markets by saying “irrational exuberance,” he wasn’t trying to signal that the Fed was about to tighten its monetary policy. But the markets plummeted anyways.
Today the situation is much more severe. The markets will understand that the Fed is under pressure to tighten to tame soaring inflation. So they’ll be even more attentive to the slightest sign that the Fed could tone down the money printing beyond a token amount.
If and when the Fed signals tightening—deliberately or not—the stock market will be poised for a crash of historic proportions.
That’s because stock market valuations are nearing the highest levels in history.
The cyclically adjusted price-to-earnings (CAPE) ratio for the S&P 500 is now the second-highest it’s ever been. And at its current level of 35x, it’s well over double its long-term median of 15.6x.
The CAPE ratio is a valuation metric that smooths out earnings volatility by using ten years’ worth of earnings instead of one. But just like the better-known P/E (price-to-earnings) ratio, a high CAPE ratio means stocks are expensive.
As we can see in the chart below, the only other time in history that it’s been higher was just before the tech bubble burst. A major crash has followed each time stocks have approached valuations at these nosebleed levels.
One of Warren Buffett’s favorite market valuation metrics is the total market capitalization-to-GDP ratio. The higher it is, the more expensive the stock market is.
And right now, it looks overvalued in the extreme. It’s at an all-time high.
At 186%, it’s over 40% higher than it was at the height of the dot-com bubble, the second-highest reading on record.
We all know what happened next. The dot-com bubble burst, producing one of the scariest market crashes in history. Unfortunately, the coming crash is poised to be much larger.
Wilshire 5000 to GDP Ratio
In the ultimate aftermath, I think we’ll see this ratio not only hit its historical mean of around 86% (noted in the dotted line above) but dive below it. As you can see in the chart above, the same thing happened after the dot-com and housing bubbles burst.
That means the stock market has a lot of room to fall from here.
The table below shows the top six worst episodes in the US stock market’s history.
The crisis on the menu in the months ahead could be far worse than any of these.
Remember, the Fed’s reckless money printing has warped today’s economy far more drastically than it did in the 1920s, during the dot-com or housing bubble, or any other period in history. So I expect the resulting stock market crash to be that much bigger.