Is the Safe Haven called Government Bonds really so or instead eating into our investments while fooling us into believing its safeguarding our investments?

Are we robbed of our investment by investing money into the Government bonds, lets take the example of the US Government and see whether investing in Government Bonds is protecting our Capital or not (Most other Governments of the World fall in the same category, but it is the US Government which has been caught first). The US government issues Long Term Treasury bonds for common public, Foreign Investors & Sovereign Institutions, but now due to lack of demand for the huge record amounts of debt issued by the United States government, the US Federal Reserve is planning to buy more than $1 trillion in debt, which is like a taking loan by one hand and printing note by the other hand to giveback the money, means creating money out of thin air, now this money when it reaches the market it causes Inflation as I have explained in my previous post http://niftywhatcanhappen.blogspot.com/2009/11/what-drives-inflation.html

now lets see the consequence of this inflation on the lender, and how he has been fooled into believing that he is getting some return on the investment, nurturing the view that lending money to the government is the safest investment, as the government takes money from you and returns the original investment with some profits on expiry of the contract, and government is most unlikely to fail in repaying the loan, the lender falls into the trap, but the lender fails to understand the complete implications of investing money in government bonds, when the government is going to print money to repay the loan, suppose the lender is saving money to buy his dream home in a posh area, which he cant buy immediately due to shortage of cash, and doesn’t wants himself to be in debt so he saves the money instead and to get some return on investment, he invests it into the Government bonds thinking it as the most safe investment, but the government is printing money to repay the debt leading flooding the markets with paper money, increasing the cost of the lenders dream home much more than his assured return, so at the time of the expiry of the contract if the lender is getting 150 for very 100 invested the price of the dream home has rocketed and reached 300 for very 100 making it a loss of 150 Rs for the lender, so actually the dog kept to safeguard the house has stolen the beef in the house, so then where to invest money in this highly unpredictable situation where the unemployment is increasing but prices of the commodities too are increasing, the government is reporting deflation but the expenditure from the pocket is showing inflation, well you have to decide in the mind whether you expect growth to pull down the inflation, or the inflation to pull and show some inflated growth, if you feel inflation is going to win then you are better off investing in Indices via Exchange Traded Funds (ETF’s), albeit putting a stoploss somewhere round, for example Dow Jones Index has traded for most part of this decade in the range of 10K to 12K, so breaking up above 10K and maintaining it for considerable time could be considered positive while a break down below 10K should be considered negative and the Dow can then retest the March 2009 lows. An alternative investment could be buying Gold and maintain a stoploss of close to $1040, as gold has traded for a long time close to $1040 and just given a breakout above $1040, so keeping a stoploss at $1040 one can go long in Gold for an initial target of $1400, and if $1400 also broken sustainably then Gold can target $2000.

 

What drives the Inflation?

Well the answer is quite simple it’s printing of money which drives the Inflation, many already know this, but let’s illustrate

Suppose there are four People A, B, C, D in a very small town. There are four types of skilled workers in the Economy, suppose A is a Farmer in the Economy who produces agricultural products like Wheat, Rice, fruits etc. B in our hypothetical example is an Transporter who transports goods. C is an Artist who entertains people by enacting small stories, scripts, etc. D is a Mechanic who repairs vehicles, machines etc. Now suppose there is a Government in place which has issued Currencies which the people have to use while buying or selling goods, they cant reject the Government Notes, now suppose that D has found a machine which can print notes, now he becomes lazy and stops working as the printing machine suffices all his needs, he starts buying food from the farmer and pays him though the notes he has printed, when he needs entertainment he gets it from the artist and pays through the printed notes, but whenever the Transporter needs to repair his vehicles ‘D’ does not oblige and refuses to work, now lets see how the situation turns out, Farmer has a limit of producing agricultural goods, and also whenever any machines at his workplace stop functioning there is nobody round to repair them as the Mechanic refuses to work and repair the machines, so whenever any problem arises he has to use the services of Transporter to carry the machines to city for repairing, If he needs to entertain himself, needs relief from stress after rigorous work in the weekdays, he cant get it has the Mechanic with all of the printed cash he has already booked the artist for his service, Also since the Transporter cant get his vehicles repaired from the Mechanic he has to use the services of the Mechanics from the city and render them extra money as travelling allowances, to get all his vehicles repaired, increasing his cost which he passes on to the farmer whenever he needs to transport machines, All this leads to the farmer in believing that the current prevailing prices for his goods are not sufficient for him, as he has to render more money to the transporter, also he is not able to get refreshment after the rigorous work of the week, he hikes the prices of his goods, but to no avail as this is not sufficient due to the printing press of the Mechanic which renders money as and when required to get the services of his choice, but there is saying you cant fool all the people for all the time, slowly and steadily people start sensing something fishy is happening, after coming to know about the printing press they start pricing in such a manner that they might be able to beat the printing machine and all this leads to hyperinflation.

Well I have used a small example of a small town with just four Individuals, but this is what might happen when more people are involved but the price discovery would be albeit at a smaller pace. Printing Money not supported with sufficient goods money can buy lead to Inflation. User comments welcome.