Should we be scared of a depression and maybe hyperinflation?

The European debt crisis. Our continuing jobs gloom. Oh, and let's not forget the rocketing national debt that is financing the entire stock-market boom. In past months I've been watching with amazement as Wall Street -- and a lot of investors -- have been trying to sweep these under the carpet. But they won't stay there. On Thursday, markets were spooked when Moody's downgraded Spain's government debt. But why is anyone surprised? Had investors been paying attention, they would have known that the market for default risk was already sending serious warning signals about Spain and Portugal's credit -- not to mention that of Greece.





Also from the lows of two years ago, the S%26amp;P 500 has almost exactly doubled. By any measure, it's been a remarkable boom. The Russell 2000 index of smaller stocks has soared 130%. So has the S%26amp;P Mid Cap 400 index of medium-sized companies, taking it to a new record high. But look at the fundamentals. Over that time economic growth has been sluggish. The economy today is no bigger, in real terms, than it was three years ago. The true jobs picture remains a disaster, and far worse than the official data will tell you. Wages have been stagnant. Yes, companies have boosted profits -- to near-record levels -- by slashing costs. But how far can that take you? (Perhaps in the end there will just be one, very productive guy left with a job. It would be Apple's Steve Jobs, of course. But then, alas, he'd have to buy all those new iPads himself.)|||Increased inflation is inevitable.



There are three ways to resolve the massive Government debt that we are now encumbered with: (1) Rapid growth in economic productivity to grow our way out of the Federal Debt burden, (2) Public Sector Default, or (3) high inflation to to reduce the effective debt burden in real terms.



I see no evidence of #1, above, happening given our tepid and fragile economic recovery and persistently high unemployment levels. Option #2 cannot happen in an orderly fashion at the State level (State bankruptcy in not permitted under US law) and would be an absolute last resort at the Federal level, although increased levels of default and bankruptcy are likely at the municipal level (School Districts, Municipalities, local revenue bond issuers, etc.).



That leaves Option #3, high inflation. We have already seen some effort to monetize a portion of the Debt through Quantitative Easing. Additionally, since our major social programs (Social Security, Madicare and Madicaid) are already on a "pay-as-you-go" basis, they are unsustainable without either severe rationing of services, significant tax increases to fund the programs going forward, or inflating our currency. The first two options are too palatably unsavory to politicians to contemplate, which leaves inflation as the most likely alternative.



The best case outcome is Stagflation similar to that which we lived through in the 1970s. The other likely outcomes are much more unpleasant, but may prove to be unavoidable....



The real question for investors is how to preserve principal and purchasing power in the years to come. I don't want to highjack your thread, but I would be interested in members' thoughts on how to best accomplish that.