Freedom Fest, mentioned in a previous post, got me thinking about scenarios. As I understand it, “scenario” comes from the Italian word for scenery and refers to an imagined or projected sequence of events. So, while I’m thinking about how to survive between now and the end of the world, I’m imagining a few scenarios.
In these imaginings, I assume as true the following:

1) The USA is already spending much more money that it takes in. In fact, about 30 cents of every dollar we spend right now is borrowed.

2) The USA has made a lot of promises to pay for things without knowing how we will pay for them. These promises are the so-called “unfunded liabilities” for social security, healthcare, government-guaranteed mortgages, and government-guaranteed pensions.

3) Higher tax rates, which is viewed by some as a way of getting out of this mess, leads to lower tax revenues. As tax rates go up, taxpayers work harder to lower their taxes, mostly by using government-approved loopholes. As taxes go up, GDP tends to go down, which means the higher tax rates are offset by lower earnings.

4) Fear, uncertainty, and doubt (FUD) are bad for business. The many new regulations and pending tax hikes are producing more and more FUD.

To these assumptions we have to consider a lot of variables. How many seats will conservatives win in congress in November? Will a lame duck congress pass even more regulations and tax hikes? Will congress repeal Obamacare or the latest financial reform bill? Will the courts find Obamacare unconstitutional? Will President Obama win re-election? When will the Iraq and Afghanistan wars end? When will Iran attack Israel? How soon will congress tackle the unfunded liabilities.

Each different set of answers produces a different scenario. For example, one scenario might be that conservatives gain seats in the House and the Senate, but not enough to repeal Obamacare, that the courts invalidate parts of Obamacare but leave us wondering what to do next, that the wars go on indefinitely, that President Obama loses to Hillary Clinton in 2012, that Iran holds off on an Israeli attack, and that congress does very little to limit spending. Another could be that conservatives take back both houses of congress, Mitt Romney wins the presidency, Obamacare is repealed, the wars go on, Iran threatens an attack, and congress keeps on spending.

As I think through the possibilities, the results of each scenario are not as complicated as you might expect. In the short term, especially because of the FUD factor, the economy will sputter and flounder and recover a little and sputter again. Even though the government is spending, printing and borrowing like crazy, people are afraid to spend money. They hang on to the dollars they have. Employment remains high. In the short term, we can expect very low inflation or even deflation. In the short term, we would want to put our savings into things that increase in value during deflation.

In the medium term, the economy will continue to struggle along, but the bigger deficits will force interest rates higher. In any scenario I can dream up, I don’t see the government solving the spending problems quickly. As interest rates go up, inflation will start up again. In the medium term, we would want to put our savings into things that do well with moderate inflation. By “moderate inflation,” I mean 5 to 10 percent inflation per year.

In the long term, there is the chance the government could tackle its spending, but, if it did not, moderate inflation could turn into high inflation (10 to 20 percent) or hyper-inflation (20 percent per year up to 100% per day). If the government did not tackle spending and continued to print more and more money, we could go from moderate inflation to hyper-inflation almost overnight. In the case of hyper-inflation, investment decisions are the easiest. Pete

More to come.