What if the economy crashes more?

As I mentioned in yesterday’s analysis of Arnold’s May Revise of his budget proposal, he expects America, and California, to enjoy a modest economic recovery. I also noted that his rosy scenario might not happen — that the economy might crash again.

Specifically, what if inflation gets even worse? Already, since 2001, the price of gold has shot up from about $265 an ounce to $1,228. That means the dollar has lost about 3/4 of its value.

We’ve already seen oil and gas more than triple in price. The housing price bubble of the mid-2000s also was caused, in party, by this inflation. Now, I’m noticing food an other prices rising.

But what if gold quadruples in value again, to $5,000 an ounce, from the ongoing crises in Greece, Spain, Italy, Portugal, Ireland, England — and, yes, California? And what if the economy crashes in American and California? Then where is the state budget?

This report discusses investment advisor Doug Casey’s take:

Gold is once again above $1,200 and making new highs. And yet, Doug Casey thinks we’re just getting started, estimating gold could touch $5,000 before this is all over. A titillating thought, to be sure, but… how likely is that?

Gold’s latest rise stems from mounting fear that the Greek bailout will be followed by other euro-area countries queued for a me-too handout. In other words, gold is serving its historical role as a safe haven, a store of value, and an alternate form of money when governments recklessly plunge themselves heavily into debt and abuse their currency.

“But Jeff, $5,000 gold is a long way up,” the skeptics observe.“If you step back and look at the big picture, isn’t the gold price bubbly here?”

One way to test Doug’s thinking is to look at other simmering trouble spots that would similarly impact gold should they boil over. So, let us indeed review the big-screen events I believe could send gold a lot higher. See if you agree….

Greece’s Gordian Knot of public debt has not been solved. In fact, Moody’s is considering downgrading Greece’s debt to junk status, stating that the announced €750 billion aid package will be “inadequate to stabilize the problems in both Greece and Portugal”….

But it’s the long-term consequences of intended ECB actions that are most worrisome. “The ECB is going to crank up the printing presses,” says Anton Börner, head of Germany’s export federation. “In five to ten years we will have a weak currency, with rising inflation and higher rates of inflation that will act as a break on growth.”

Nouriel Roubini notes that “rising sovereign debt from the U.S. to Japan and Greece will ultimately lead to higher inflation or government defaults. While today markets are being worried about Greece, Greece is just the tip of the iceberg”….

The U.S. debt-to-GDP ratio stands at 90.1%, and the projected 2011 budget deficit is $1.26 trillion or 7.1% of GDP. Total U.S. debt exceeds $55 trillion, over $180,000 per citizen, and the new healthcare legislation is expected to add another $1 trillion burden on the economy. These numbers put America in league with our squealing European friends mentioned above.

Plus, the U.S. monetary base was ballooned and remains over $2 trillion. Are we absolutely sure governments are done printing money? How will government leaders react if bank failures continue? Or commercial real estate crashes? Or state pensions begin to fail? Or unemployment remains in double digits?

It’s clear the U.S. dollar will suffer inflation due to high and growing debt-servicing costs, government payrolls, and unfunded entitlement promises. The U.S. can either default or inflate, and the former is unthinkable to a career politician. At some point – and we think it is fast approaching – global investors will see that U.S. indebtedness has reached unsustainable levels and exit the dollar, which today means selling bonds. Interest rates will be forced higher, and the U.S. will face its own Greek Moment.

And before that, that California will face its own Greek Moment.

–John Seiler