I am bearish on the stock market for the short and intermediate term. The Federal Reserve has been way too loose with its monetary policy for the last 2 decades. There shouldn’t be a Federal Reserve (“Fed”) because the market should determine interest rates as well as the money that we use. But if we are going to have a Fed, they can at least not be reckless. Alan Greenspan, who used to be a follower of Ayn Rand and praised a gold-backed currency, has been one of the biggest inflaters (counterfeiters) ever.

The Fed is now in a predicament. It can have a tight monetary stance/higher interest rates, which will cause a tough recession. This is what it should do. It would be painful for a couple of years, but then we could get rid of the bad investment and go forward with prosperity. The other choice is to have a loose monetary policy/lower interest rates. This may hold off a recession or make a recession milder than it otherwise would have been. But this would result in higher inflation and lay the groundwork for a more severe recession/depression in the future.

Chances are, the Fed will inflate. Helicopter Ben Bernanke will live up to his name. If lowering interest rates doesn’t provide enough money to the market, then he will have to drop money out of helicopters as he once suggested.

When Bernanke made the point that the Fed can always inject money into the system, he was correct. He simply said that if low interest rates don’t work, they can theoretically threaten to drop money from helicopters (inflate) and it will do the job. He wasn’t really saying he would do it, only that it is possible. That is essentially what the economic “stimulus” package it doing. It is creating money out of thin air to inject into the market.

The Fed will probably not disappoint (the politicians, that is) and will continue to inflate. Therefore, I would bet on more inflation in the future, but a recession in the near term is still likely. If you are going to own stocks, then you can put a small portion in defense stocks. With Ron Paul having little chance to become the next president, you can probably count on the next president to continue with more war. We can’t be sure which way Obama would go, but even he is not likely to completely withdraw troops from Iraq. Defense is probably the safest bet with stocks.

Earlier this week, President Bush proposed a budget of about 3.1 trillion dollars to Congress. Of course, this could get bigger and it doesn’t even include all costs like the wars. There are approximately 300 million people living in the United States. That means that the federal budget costs each person over 10, 000 dollars per year. This includes everyone, so a family of four would have a share of about 40, 000 dollars. This is just for the federal government, not state and local. There are variations as to how much each person pays, but just the fact that the average cost of the federal government is 10,000 dollars a year is staggering.

With future obligations (also known as unfunded liabilities) estimated around 53 trillion dollars and up and a national debt over 9 trillion dollars, the government is headed towards bankruptcy. They could cut spending, but how likely is that any time soon? Anyway, it would be too little too late for the trouble we are in. The government could raise taxes, but this would just hurt us more. And also consider the fact that increased taxes may not necessarily end up increasing the total amount of money going to government. This is one thing that some Republicans get right. The Laffer Curve shows us that at some point, increased taxes will actually decrease the amount collected by government.

The only real options for the government is to severely cut back on Social Security and Medicare benefits or printing money. The likelihood is that both will happen. Of course, as the government prints/creates money, it causes the value of the dollar to decrease and prices rise.

You should consider this scenario when investing. The only way for the government to get out of this mess is to severely cut benefits and/or inflate the money supply. It would be wise to protect your assets from inflation. Although real estate looks bad right now after the real estate bubble, it is still probably a good long-term “investment” as long as you can afford what you buy. I put investment in quotes because it is really more of a consumer good, but it would be better to have a portion of money in real estate than it would be to have it in bonds or cash if there is a high inflation environment.

I don’t recommend stocks as much to protect against inflation, although they can keep up over the very long term. But if you look at the horrible 1970’s with high inflation, stocks went down. I would recommend precious metals and other hard assets as an inflation hedge. There are now many options to buy these like stocks. An exchange traded fund (ETF) that mimics gold is GLD and an ETF that mimics silver is SLV.

Now that it is looking like the next president will be McCain, Clinton, or Obama, it would be wise to prepare. They are offering the status quo or worse. The problem is that the status quo is driving us off a cliff.

It amazes me to hear financial advisors talk about diversification. They talk about how you need different stocks and mutual funds and maybe some bonds and cash. Although there are a few now that will recommend at least a small portion in gold or real estate, most financial advisors and media talking heads do not account for the U.S. dollar. In order to be properly diversified, you should own some hard assets or funds that invest in hard assets. Another option is to buy foreign currencies, but then you will be subject to inflation in those currencies. It takes time and effort to build real estate and mine for gold. You can’t just print them on a printing press like a fiat currency. Make sure you protect yourself against central bank inflation. Stocks are not the best way to do this, unless the stocks specifically invest in hard assets.

Combining Free Market Economics with Investing