Opinions regarding the Deflation vs. Inflation debate

The following is a response by one of our readers to a friend’s question regarding deflation vs. inflation and the impact on the gold price:

Hi Kevin,

Thank you for sending over that report by Nick Guarino. He makes some great points and I believe he is right in many cases although I have some contrary opinions on gold. I have not looked at his oil or stock scenario. I’ve listed his arguments below with my responses to each of them. I also recommend listening to the following audio interview with John Williams of ShadowStats.com where he specifically addresses the inflation/deflation debate:

John Williams Interview
http://wp.me/pHQmz-68

I also recommend listening to the radio interviews with Jim Willie (mentioned below).

1. Nick says: “IMF has plenty of gold to sell into the market.”

Response: This is true. But the real question is will there be sufficient demand to absorb it? I say yes. India bought the 200 tons (which is money they spent on gold instead of U.S. Treasuries). China has continued to buy and plans to continue. This is being referred to as the “Beijing Put” (http://tinyurl.com/n3nvrs). Sri Lanka just recently announced a major purchase of gold and Russia has stated its intention to buy more gold too (http://en.rian.ru/russia/20091119/156903575.html).

2. Nick says: “Prices are in deflation not inflation.”

Response: Yes, prices are down but they are down primarily in financial assets which were previously “inflated” with easy credit. These debt-financed assets will continue to fall in price as defaults rise and lending shrinks. Prices in consumer goods and services will begin to rise as the dollar drops.

It is important to note that the proper definition of inflation is “an increase in the money supply”. Rising prices are only a result of an increase in the money supply and these rising prices may not show up right away or they may show up in specific assets over others (gold and stocks versus houses).

3. Nick says: “Collapsing credit is deflationary”.

Response: Not necessarily. When a debtor defaults on his debt, the money that was lent stays in the financial system. It is not taken out. These debt defaults show up on the financial statements of the banks (more on this later). The pay-down of debt does shrink the money supply but most people can’t pay off their debt because they owe more than the assets securing these debts are worth. This will continue to cause defaults.

4. Nick says: a.) “The dollar and the U.S. Government are too big to fail; b.) If the dollar fails the world will be thrust into an economic Dark Age therefore foreign governments will not let it happen; c.) Foreign governments must buy every dollar of U.S. Government debt otherwise they will be wiped out first; d.) Demand for U.S. Debt is at an all-time high evidenced by low rates.”

Response: I will Respond to these individually:

a.) “The dollar and the U.S. Government are too big to fail” They are not too big to fail. Yes, this would create a lot of pain but at some point foreign lenders will cut off the credit card. There is a point when creditors realize that they will never be repaid and it no longer makes sense to throw good money after bad. Of course, foreign governments can’t do this all at once without hurting themselves so they play a risky game of slowly and quietly diversifying out of dollars hoping not to spook others and create a stampede out of the dollar – hence, the steady dollar decline and relentless gold rise. This is hard to do safely and will likely fail as the dollar flight accelerates. China has been buying every resource company they can get their hands on which is another way of dumping/trading their dollars for these real assets (http://tinyurl.com/y8jby2z).

b.) “If the dollar fails the world will be thrust into an economic Dark Age therefore foreign governments will not let it happen.” In addition to the response in “a.” above, foreign governments must choose between some pain now or more pain later. As they diversify out of dollars and buy gold they hope to be the first ones out of the burning theater. It is their intent to offset dollar losses with gold gains. This will likely turn into a stampede. Yes, a Dark Ages will happen but the longer they wait the worse it will be.

c.) “Foreign governments must buy every dollar of U.S. Government debt otherwise they will be wiped out first.” Same responses as “a” and “b” above.  Also, they are going to be wiped out anyway so they might as well get rid of their dollars as fast as they can while they still can.

d.) “Demand for U.S. Debt is at an all-time high evidenced by low rates.” Yes and no. The demand is high but unsustainable for the reasons stated above. There is also substantial speculation that the Fed is already buying these treasuries (Quantitative Easing) through back door foreign intermediaries (Jim Willie: Systemic Crisis: audio interviews http://tinyurl.com/ydakvlw). Could this be one reason why they don’t want an audit?

5. Nick says: “Foreign Countries are taking coordinated steps to stabilize the dollar. China, Japan, Philippines, Middle East, Singapore, Malaysia, South Korea.”

Response: This is mostly all talk. I’ve already shown above how several of these countries are slowly diversifying out of the dollar in favor of gold. What most countries fear is their currency strengthening against the dollar causing their exports to become expensive and “bad for business”. To combat this, they can either buy dollars or devalue their own currency. Many are simply choosing to devalue their currency. This causes their currencies to devalue against the one currency that cannot be devalued: Gold. Gold is resuming its supreme role as a currency (not just a commodity). Gold is the oldest form of currency and has been around since biblical times – longer than any other currency. (see “What is Money?” http://tinyurl.com/y8ay3y4).

6. Nick says: “M3 money supply is not growing, global liquidity and credit are collapsing…there is no freakin’ money.”

Response: Yes, M3 has slowed but this is only temporary. Here’s why. Banks’ excess reserves have exploded from 2 billion in July, ’08 to 1.06 trillion today (Money Supply chart: [http://tinyurl.com/yfv54aq] and Dr. Reisman article: http://tinyurl.com/yfnv4rn). These excess reserves are funds that have not been lent out and have not created additional credit expansion. In my opinion, the reason is that the banks are still experiencing (and expecting) horrendous losses and are looking to restore their balance sheets. At some point their insolvency and inability to resume lending will frustrate the government (due to the continued cratering of the economy) and the banks will be nationalized. This will give the government, as the new owners, the ability to begin lending again which has the potential to increase the money supply by an additional $132 trillion! (see Reisman: http://tinyurl.com/yfnv4rn). Of course, the FED can be forced into QE beforehand if foreign governments dramatically slow their treasury purchases.

The lack of cash, or as Nick says “there is no freakin’ money”, is due to the incredible leverage before the crash. Instead of saving more, folks found it more profitable to invest most of their cash and borrow multiples on top of it. When the leveraged investments failed, their equity and cash holdings were wiped out.

Conclusion:

In dollar terms, if someone is short gold it means that they are long the dollar. I see no reason to have any confidence whatsoever in the dollar. I tell people to look at the dollar as the “common stock” of the USA – just like you would look at the stock of a corporation. When valuing a stock you would look at the management and balance sheet of the corporation to determine what you would pay for the the stock. When I apply this same analysis of the USA I conclude that the dollar is not a “stock” that I would want to own. Sure, the government can increase revenue because they have the power to tax but even a 100% tax is not enough to correct the problem (source: ShadowStats.com Hyperinflation Special Report: http://www.shadowstats.com/article/hyperinflation).

If you are still unsure as to which scenario to believe, it might make sense to put half of your assets in cash and the other half in gold.  Any drop in purchasing power in one would likely be offset by the increased purchasing power in the other and your original purchasing power will likely be preserved.

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3 responses to “Opinions regarding the Deflation vs. Inflation debate

  1. Nick Guarino is correct on the big picture of gold and deflation. You cannot create major inflation without real demand to drive prices higher. The Fed printing does not in itself create inflation. Look, we have had decades of inflation now we are in for a decade of deflation. It’s real simple, the standard of living in the US is adjusting to the global economy. We cannot compete against slave labor in China and India and their standard of living will rise over the next several decades while ours here in the US will decline. The dollar ultimately is doomed due to the eventually defecits of the US and its corrupt political processes which the American people may eventually be able to change but not before many deaths and a lot of poverty. When the reality of the economy slipping back into a deep recession is realized, the price of gold will fall tremendously and the dollar will rise dramatically. Trust me, in any market or trading event, there is no straight line up or down, volatility will be with us for quite a while. All the individuals that are bullish gold at these levels will learn a difficult lesson. How come no one, and I mean literally no one in the investment community other than Nick Guarino was recommending purchasing gold 10 years ago when it was truly a tremendous value and represented the best time to buy. I purchased my bullion coins at $272 an ounce, so you are getting the opinion of someone that has been long gold for a while and knows how to make real money, like Nick Guarino. Nick is by far the best global analyst the world has seen and has been right time and time again. I have followed him personally for the past 11 years. May those that read this take the warning seriously, don’t follow these lemmings over the edge of the cliff that is the price of gold. Either patiently wait for prices to fall and retrace 50% or if you have some guts, short gold over the next 6 months. A tremendous amount of money can be made in the next several months, not buying gold but short the crap out of it.

  2. Hi Seth,

    You wrote:

    “How come no one, and I mean literally no one in the investment community other than Nick Guarino was recommending purchasing gold 10 years ago when it was truly a tremendous value and represented the best time to buy.” END QUOTE

    James Sinclair called the bottom as well:
    http://www.forbes.com/global/2001/1210/064.html

    He is considered by many to be the world authority on gold. He is calling for much further gains:
    http://www.jsmineset.com

    Another excellent piece on the future of gold is the series by Alf Fields:
    http://www.kitco.com/ind/Field/dec022008.html

    I think the following quotes sum up my opinion nicely:

    “For more than two thousand years gold’s natural qualities made it man’s universal medium of exchange. In contrast to political money, gold is honest money that survived the ages and will live on long after the political fiats of today have gone the way of all paper.”
    Hans F. Sennholz

    “If you don’t trust gold, do you trust the logic of taking a beautiful pine tree, worth about $4,000 – $5,000, cutting it up, turning it into pulp and then paper, putting some ink on it and then calling it one billion dollars?”
    Kenneth J. Gerbino

    “Betting against gold is the same as betting on governments. He who bets on governments and government money bets against 6,000 years of recorded human history.”
    Gary North

    “Gold is worshiped in all climates, without a single temple, and by all classes, without a single hypocrite.
    Caleb C. Colton