Today, I am going to sum up my economic outlook for 2012 (from a libertarian perspective of course). While I don't like to make specific predictions, I do want to lay out some possibilities.
Nobody really knows what will happen with Europe. Can the bureaucrats keep kicking the can down the road for a while longer? Will Greece break apart from the European Union? Will Greece decide to default on all of their debt? Will any major European banks go under? Will the European Central Bank bail out the major banks? Will the Federal Reserve bail out major European banks?
These are all questions that are impossible to answer right now. But even if there is a big event, the U.S. economy has seemed fairly immune. There might be blips in the stock market. There might be some fleeing from the Euro (which has actually helped the U.S. dollar). But until something major happens there, it seems that the U.S. is on its own clock.
I still see a major fight right now between the forces of inflation and recession (or depression). The Federal Reserve has tripled the adjusted monetary base since late 2008. While prices are certainly going up at the grocery store, it is mild compared to what it could be. Price inflation has been quite tame considering the massive monetary inflation.
I see two major reasons that price inflation has remained in check. First, most of the new money created by the Fed has gone into banks and held as excess reserves. The banks have not used fractional reserve banking for this new money. Second, the depressed economy has led to a high demand for money. Another way of saying this is that velocity is low. The speed at which money changes hands has been slow. People are uncertain about the economy and have cut back on their spending. They are trying to pay down debt and build up cash balances. This has had the equivalent effect of keeping prices down.
Regardless of the two points above, the monetary base has still tripled and it is almost impossible to keep prices down at this point. Perhaps they could stay down in the electronic industry where technology is increasing at an exponential rate. Perhaps housing prices will stay down due to the previous bubble. But in most sectors, that money is going to leak out and cause price inflation.
In 2012, it would not surprise me to see a mini-boom occur. This would be an artificial boom. We have already seen stocks do well, with the Dow around 12,500. This could very well be because of hot money. Perhaps this is the first sign of money leaking into the system from QE2.
On the other hand, the Fed has been tight with new money since QE2 ended over 6 months ago. With the adjusted monetary base being basically flat since then, we could see the economy tip the other way and head into another recession. At that point, we would probably just see more money creation.
While I am bullish on gold for the longer term (5 or more years), I am more uncertain in the short term. If we see a mini-boom cycle, then gold will most likely go much higher. If we see the return of a recession, then I expect gold to go lower, at least until more money printing is announced.
Either way, there is more pain to come with the economy. Even if we have a mini-boom cycle, it will eventually turn into severe price inflation or it will turn into a market crash.
There has been severe malinvestment in the economy. The interference of the Fed and the federal government has caused huge distortions. These were not allowed to correct in 2008 and after. It has been made worse. The market economy is trying to sort things out and properly reallocate resources, but the crazy laws and crazy monetary policy are not allowing it to happen.
Prepare for a continued roller coaster.