The American Crisis and the Case for an Inflationary Depression

The collapse of the commodity bubble beginning late this summer erased inflationary worries from the minds of many. Crude at $145/bbl, natural gas at $24/MMBtu, and gold at $1,000/oz were characteristic of the artificially inflated prices of this commodity boom, which began in 2002.

The secular bull in commodities was caused by perceptions of massive demand in emerging markets, particularly the BRIC nations - Brazil, Russia, India, and China - which were growing at unprecedented rates. As they became increasingly wealthy and industrialized, these economies represented growing new demand for energy, food and production inputs.

This great demand, coupled with the perception of quickly diminishing supply (most famously in crude oil), caused the strong price surge in commodities, and self-perpetuated the idea of emerging market demand growth. However, as a global recession sets in, the massive anticipated demand growth from emerging markets is slowly proving unfounded, causing the commodity bubble to collapse. Nevertheless, the decline in commodity prices does not eliminate the threat of inflation in the United States; if anything, it supports such a thesis.

The recent economic collapse can be traced to Alan Greenspan's extremely dovish interest rate policies in the 1990s, which led to artificially strong growth in America's economy. Greenspan's policies caused huge leveraged investment in artificially strong assets, particularly real estate and equities, since low interest rates prevent savings and encourage leveraging capital as credit is cheap. The growing excess liquidity, invested in diminishing opportunities, resulted in a classic speculative bubble.

The housing bubble came crashing down in 2007, leaving Americans significantly less wealthy. Financing home, car, and other big purchases pervades American culture, and consequently, the housing correction affected Americans all the more, as their mortgages suddenly were significantly more expensive than the houses they were paying for.

Encouraged by the cheap credit of Greenspan's low interest rates, banks and mortgage lenders also issued massive amounts of irrational loans to poor-credit borrowers at risk for default. These borrowers, who didn't qualify for safer "prime" fixed-rate loans, were issued Adjustable Rate Mortgages (ARMs), convertible hybrid loans, and other "subprime" loans.

As the Federal Reserve finally started raising interests in response to the bubble collapse, these high-risk borrowers suffered further, as their mortgages grew increasingly expensive. Many of these borrowers were forced to default on their loans, which caused a liquidity crisis in mortgage lenders. It also caused a liquidity crisis in banks, who had accumulated large positions in mortgage-backed securities during the credit boom. This led to a credit crisis, as banks became unwilling to lend almost anything at all with their depleted capital reserves.

The housing correction was followed by a crash in the equity markets, which also had an immediate impact on Americans. Millions of Americans have allocated their savings in mutual funds and pension funds, which are being drastically hurt with the stock market crash. Americans have depleted savings and retirement funds because of the market crash, as well as diminished wealth because of the housing correction. And this is all before the fall-out of the credit crisis sends businesses to bankruptcy, increases employment, and all of the other consequences affiliated with a deep recession.

Alan Greenspan's artificially cheap credit policies caused an internal economic crisis, which coupled with President Bill Clinton's strong encouragement of globalization and foreign trade led to a dependence on debt that will deepen the current recession into a possible depression and cause rampant inflation.

Since the collapse of the Soviet Union in 1989, nations around the world have privatized their economies and issued important reforms. These reforms are behind the emergence of China, India, and other growing economies in the global economic system, particularly through increased trade and foreign direct investment. Since the United States possesses the global reserve currency in its Dollar, it can safely run large trade deficits, causing it to represent huge demand for foreign exports.

The nations exporting to America, whose growing GDPs indicated growing demand for commodities (which are priced in the global reserve currency, USD), represented great demand for U.S. Treasuries. This caused America to issue massive debt to these nations, but used this to finance further consumption. Greenspan's dovish policies in the 90s resulted in significantly low interest rates, which led to America's unprecedented growth as cheap credit financed more business, more houses, and most importantly more consumption. This led to the formation of a debt bubble, as the United States entered a cycle of consuming foreign exports, issuing debt to its trade partners, and using the debt to consume more of their exports.

Theoretically, the United States can continue to print more dollars as long as a demand for them exists abroad, which has as emerging markets grew sizably in recent times. However, the demand for U.S. debt has drastically fallen as the world economy contracts as a result of the credit crisis in America and foreign nations attempt to finance domestic growth. On November 9, China announced a $586B domestic stimulus package, more than triple the size of America's 2008 package. Australia announced a $10.4B package and Japan a $51B.

Not only is there an immediate need for economic stimulus at home, there is decreased demand for exports abroad (particularly in the United States), so nations are focusing on domestic growth instead of externalizing it through foreign trade. This has a two-fold effect on the United States: it places a formidable burden on America's industry as the U.S. can't simply consume its way out of recession, and it prevents the U.S. from just issuing more debt to finance domestic stimulus.

These have alarming consequences in the context of current recessionary conditions. Consumption accounts for over 2/3 of America's economy, and facing depleted wealth, tight credit, and a huge foreign debt, the United States appears to be in fragile condition. The United States has an external debt of $13T, more than any other nation in the world and about equal to a year of GDP.

Now that foreign nations are forced to finance domestic growth internally, they have slowed their U.S. debt purchases and will slowly stop buying American treasuries altogether. This will essentially force America to repay its debts abroad, which it obviously cannot do at the commencement of a deep recession without an enormous budget surplus. However, the United States deficit is getting increasingly large, as bank after bank is bailed out.

The recently-passed Troubled Assets Relief Program (TARP) allocates $700B to liquifying troubled banks, who are overleveraged and undercapitalized, and other troubled companies, the next of which may be the Big 3 automakers. Add that to the $53T owed by the U.S. government for unfunded Social Security, Medicare, Medicaid, veterans' pensions, and other similar programs, and the prospect of the United States paying off its debt appears even slimmer.

The economic conditions will only worsen this deficit, as more and more Americans will be uninsured (as unemployment skyrockets) and forced to retire primarily on Social Security (as pension funds lose value). The government will be forced to socialize more and more, financing it through more issued debt; this as foreign demand for U.S. debt dwindles. So, as external debt worsens, public debt follows suit, leaving no way to finance debt payments or government programs. The Federal Reserve will undoubtedly respond by printing more and more money, but without foreign demand for U.S. debt, this will lead to rampant inflation.

In inflationary conditions, food and energy prices will skyrocket, hurting the American people even further, whose wealth having been diminished in nominal terms, let alone real terms. In the 1970s, President Richard Nixon's wage and price controls led to double-digit inflation rates, which Federal Reserve Chairman Paul Volcker corrected with a strong dis-inflationary hawkwish policy. This ushered in a deep recession with some of the worst unemployment levels since the Great Depression, however, and simply raising interest rates will not do the trick to fix the 21st century inflation.

The commodity price collapse since the summer of 2008 does not indicate inflation is out of the question - it indicates global economies are contracting deeply. As global equity markets collapse, investors are liquidating and deleveraging, fleeing to the traditional safe haven currency, the U.S. Dollar.

This is a temporary response, and is behind the strong selling pressure in gold and partly behind the commodity decline. Recessions of this nature almost always lead to a period of deflation, as aggregate demand diminishes and banks are reluctant to lend any capital they have.

However, this crisis will not remain a deflationary recession forever. When the United States debt bubble finally collapses, the U.S. will be forced to default on its debt and devalue its Dollar, as the Fed pumps more and more liquidity into the system. The CDS price for 10 year US Treasury bonds has already increased by 2500% over the past year, and with more deficit spending ahead, the U.S. Dollar's perceived stability will diminish, as will its demand. Increased supply and decreased demand - characterizing rampant inflation. This will send our recession into a depression, and usher in America's first inflationary depression.

There are two ways to fund external debt - decrease government spending or increase taxes. With TARP passing, government programs further socializing, and Ben Bernanke stating he will increase money supply as long as he has to prevent a 1990s Japan deflationary scenario, government spending is going to increase significantly, rather than decrease. Taxes are all that is left in the arsenal of the U.S. government, and with the diminishing purchasing power of it citizenry, higher taxes will not be met with popularity. Tax revolts, food shortages, and riots are not out of the question when this inflationary depression occurs.

What is left to do? Liquidate all mutual and pension funds into gold and/or Swiss Francs. Precious metals are the only commodities that aren't significantly susceptible to global economic conditions. A recession decreases the demand for oil, for example, because households and businesses will cut costs. However, the demand for gold and other precious metals doesn't lie in its utility in production, but rather in its store of value.

This makes gold a great inflationary investment, as it preserves purchasing power. Gold under $900 is a bargain, and I see it above $2000 by 2010 and above $3500 by 2011. The Swiss Franc is 20% backed by gold and boasts a 0.6% inflation rate, and its demand is only going to rise, as the United State's dominance in foreign currency reserves will diminish and foreign nations and wealthy investors will seek a safe haven currency.

My pessimism for the American economy can best be represented by the fact that I see the Dow Jones bottoming all the way down to around 3,300. However, the United States has leverage aside from its currency reserve status and economic dominance. It is the sole nation in the world that can be self-sustainable if need be, having substantial energy, food, and industrial commodity supplies.

In addition, it has the ultimate leverage of all - the largest and most powerful defense system in the world. At the end of all of this, whether or not after war, demagogy, or whatever doomsday scenarios can be conceived of, I believe the United States will come out as the reigning superpower in the world and through forced domestic investment and industrial development (particularly in alternative energy), will develop even further into the strongest economic powerhouse in the world.

Before any of this optimistic speculation influences your opinion, however, I insist you come to terms with the economic collapse that will precede any such positive event. I will leave you with this, a chart of the America's real total credit market debt-to-GDP, which is higher now than it has ever been, including during the Great Depression and World War II. This clearly shows our debt bubble, which is still inflating and will keep inflating until the U.S. Dollar defaults.

click to enlarge

Long recommendations: GLD, TBT, UDN, SDS, DXD, QID, Swiss Franc (CHF) FXF
Short recommendations: US Dollar (USD)

Comments

[CLH:]

You are delusionary. There is no possible way to make a deflation into inflation by magic. Print money? Not possible because no one will borrow it.

This is a deflation (like Japan had) which is caused by the elimination of debt which causes the disappearance of money.

2008 Dec 03 08:42 AM

[User 196790:]

Helicopter Ben has already stated several times he is committed to printing money and inflating us out of economic contraction.

Japan and the US are different in two FUNDAMENTAL ways: 1. Japan did not have a massive exernal debt and 2. Japan did not have the global reserve currency.

There is a GLOBAL economic contraction and every nation is going to focus on DOMESTIC growth first. How do they finance that? Calling in loans to America and selling US treasuries.

There is no liquidity trap here, the Fed won't allow it. And even if somehow it occurs, the debt bubble will collapse itself... simply put, America cannot pay off its debt and there won't be enough demand for US debt to keep the USD afloat.

2008 Dec 03 08:54 AM

[NOWHEREMAN:]

Unless enough dollars are created out of thin air far exceeding external demand for them. No one is borrowing the money being printed, its sitting at the Fiancial institutions as they recapitalize. That's part of the problem. Enough money has to be created for the Financials to feel secure enough to lend again. Just because there is no demand for it doesn't mean it can't be created. (The demand for cars is almost nonexistant, the Big 3 continue to produce them.)

Add Major Stimulus packages throughtout the world and eventual commodity shortages since most of the stimulus is coming in the form of commodity intensive construction/infrastru... and bingo, Inflation. Not overnight but within 12 months?, most certainly.

The elimination of debt causes the disappearance of money...? Read a 10k recently? Ever?

Good Article Naufal, now all you have to do is reduce it by 2/3rds, too much informational history. IMHO

2008 Dec 03 09:14 AM

[investor88:]

Good article by Naufal. He sees Dow 3,300 eventually, this is also the view of some pessimistic analysts who believe major stock market crashes bottom at some 20% of peak [ 20% Dow peak of 14k= 3k approx].

Naufal sees a inflationary Depression as opposed to a deflationary Depression 1930s style - this is due to Helicopter Ben's determination to damn the consequences of printing and printing. Not sure if a inflationary Depression is worse than a deflationary Depression but Naufal says Depression nevertheless.

If Naufal is correct, the coming year is not a time to fool around but a time to be on heightened sense of alert.

2008 Dec 03 09:36 AM

[Nikhil:]

nice article.. though dow at 3300 is too extreme for my apetite.. not that its impossible.. i tried accessing your fund www.gothamfund.org/.. doesnt work ?

2008 Dec 03 09:51 AM

[TimT:]

Probably a smart man but clearly lacking in any kind of wise judgement. He uses good facts but his obvious internal personal bias causes him to come to extreme and wrong conclusions. Gold only has value because people perceive it to have value--no different from fiat money.

2008 Dec 03 10:04 AM

[AlexR:]

Unfortunately there are no examples of a Inflationary Depression in U.S. history. Somebody should study what happened to South American economies from 1982 thru 1992 or so. I've personally experienced sustained inflation rates of up to 250% (10%/month), and I can tell you, it's not as socially destabilizing as you might think. Everyone from rich to poor figures out some surprisingly clever ways to manage through it. The only long-term effect is a population that abominates debt of any kind, for about to 10-15 years after recovery (note, although fixed-rate borrowers get a nice bonus in the initial phase of an inflationary spiral, lenders have the last laugh as foreign-currency and commodity-linked loans quickly become the norm).

2008 Dec 03 10:08 AM

[GMiki1:]

Yes, inflationary depression, and yes, gold has value--it's built into the human consciousness by thousands of years of history. However, I think the DOW will rise with inflation just as the Zimbabwe stock market has risen enormously--that is, in nominal terms.

2008 Dec 03 10:27 AM

[Nikhil:]

i think you should read thru this.. www.federalreserve.gov...

there would be deflationary pressures in the short term but with a fiat currency system it can be taken care of easily.. and chances are one could overdo the fight against deflation..


On Dec 03 08:42 AM CLH wrote:

> You are delusionary. There is no possible way to make a deflation
> into inflation by magic. Print money? Not possible because no one
> will borrow it.
>
> This is a deflation (like Japan had) which is caused by the elimination
> of debt which causes the disappearance of money.

2008 Dec 03 10:35 AM

[User 257752:]

CLH - No one will borrow it? What about AIG, GM, Chrysler, etc. etc. Are not these 'too big to fails' borrowing like crazy and distributing the money into the economy by continuing to pay wages and suppliers?


On Dec 03 08:42 AM CLH wrote:

> You are delusionary. There is no possible way to make a deflation
> into inflation by magic. Print money? Not possible because no one
> will borrow it.
>
> This is a deflation (like Japan had) which is caused by the elimination
> of debt which causes the disappearance of money.

2008 Dec 03 10:50 AM

[NOWHEREMAN:]

Thank you all, I only got into this article because N. S. appeared to be getting a bum rap. I personally disagree with the 3,300 level since I can't see inflation without inflated assets of some sort.

There are opinions and then there are opinions held by only one person. Those who are selfopinionated will never listen to anyone else. Hopefully, I will, at least listen. IMHO

2008 Dec 03 10:55 AM

[Jason Rines...:]

Where will all that created money from the U.S. go? Where did that initial round of $200 B in February go? It went into the IB's and created $150 barrel of oil.

This downturn over the last year has been painful and will get worse. I am in the camp of further deflation for another three quarters whipsawing a bit then a period of relative calm before we see inflation jumps. So I agree with the writer to some degree.

To posters comments, article too long on why this happened and it seems we are now entering into the acceptance phase/market capitulation.

What the government, investment community and entrepenuars can do proactively is accelerate technology and information sharing to increase the efficiencies of returns on where the liquidity goes and decreasing imbalances as mentioned in the oil example. Let's hope government relearns the words 'market research'. I am not a big Obama fan but I do respect his repeated mention that utilizing technology is critical. Of course, the younger innovators and entrepenuars that can execute such technologies are shut out of the market at present. Washington will have to think outside the box on that point for faster implementation on that point.

2008 Dec 03 11:16 AM

[Jason Rines...:]

Bravo.


On Dec 03 10:55 AM paultaut wrote:

> Thank you all, I only got into this article because N. S. appeared
> to be getting a bum rap. I personally disagree with the 3,300 level
> since I can't see inflation without inflated assets of some sort.
>
>
> There are opinions and then there are opinions held by only one person.
> Those who are selfopinionated will never listen to anyone else. Hopefully,
> I will, at least listen. IMHO

2008 Dec 03 11:17 AM

[wheeler4040:]

Hopefully someone can answer my question here. I am under the impression that the yield on ultrashort etfs comes from excess cash that is invested in treasuries with the interest received being paid out as a dividend. So in the case of TBT, which is bearish on bonds and yet still pays a dividend, where is this dividend coming from?

2008 Dec 03 11:47 AM

[User 196790:]

what bias? what wrong conclusions exactly? and yes gold, like everything else in the world, has no inherent value other than the value given to it by mankind. however, fiat money can be printed, causing an increase in money supply, which lowers the value of that money. gold supply is nothing like fiat money supply, and its merits as an inflationary hedge will cause demand for it to rise sharply, just as fiat money demand decreases.


On Dec 03 10:04 AM TimT wrote:

> Probably a smart man but clearly lacking in any kind of wise judgement.
> He uses good facts but his obvious internal personal bias causes
> him to come to extreme and wrong conclusions. Gold only has value
> because people perceive it to have value--no different from fiat
> money.

2008 Dec 03 12:56 PM

[User 196790:]

You're right, asset prices are not immune from inflationary pressure, and may in fact rise in nominal terms. However, I still see the Dow below 4000 within the next few years and a real decline beyond that as well.


On Dec 03 10:55 AM paultaut wrote:

> Thank you all, I only got into this article because N. S. appeared
> to be getting a bum rap. I personally disagree with the 3,300 level
> since I can't see inflation without inflated assets of some sort.
>
>
> There are opinions and then there are opinions held by only one person.
> Those who are selfopinionated will never listen to anyone else. Hopefully,
> I will, at least listen. IMHO

2008 Dec 03 01:00 PM

[Greg Pinelli:]

The reinflation taking place is a process..paultauts comment that no one is borrowing this money is..as usual..blindsided by the truth. The Fed has taken over much of what everyone saw the Treasury doing for decades...handling internal debt. The Treasury has to go hat in hand for every dollar..the Fed answers to NOBODY..as in NOT A SINGLE PERSON. The money (liquidity) the Fed is pumping into financial institutions is finding its way into T bill and bonds. Voila! Who the hell needs Chinese to buy these things..the Fed thru proxies does it.
Mr. Obama is no fool...he will tell his new financial people to tighten the screws on lenders to loosen the loan spigot to the public..this will happen when programs are in place and appropriate acronyms have been established so they can be sold on the nightly news programs.
May-June of 2009 this money..which now exists in ENORMOUS amounts as free reserves in the Fed....starts shopping itself. The reflating will take on headline proportions and be sold as "Rebuilding the Economy.." "Investing in a Sustainable Economic Future.." work out a few..it's not that tough.
As for the deflators...there will continue to be this whipsawing..When China throws in the towel in about 6 weeks it could get very nasty..but China also knows how to play the reflate game..and as Alan Greenspan
showed the world for years....don't worry about money..there's plenty more where that came from.
By the way..the article is retro and linear....

2008 Dec 03 01:02 PM

[VennData:]

"...President Bill Clinton's strong encouragement of globalization and foreign trade led to a dependence on debt that will deepen the current recession into a possible depression and cause rampant inflation..."

What are you talking about? Your ability to pick and choose causality is fanciful.

2008 Dec 03 01:15 PM

[User 196790:]

www.federalreserve.gov...

look at our external debt under clinton and our trade deficit under clinton. he vehemently fought for increased trade with china and the rest of the world, thinking the united states would gain from exporting its expensive goods and services to the chinese, who couldn't afford any of it.

he financed the strong economic growth of the 90s through foreign debt, the issuance of which has caused a debt bubble whose collapse could spell a devalution of the USD.


On Dec 03 01:15 PM VennData wrote:

> "...President Bill Clinton's strong encouragement of globalization
> and foreign trade led to a dependence on debt that will deepen the
> current recession into a possible depression and cause rampant inflation..."
>
>
> What are you talking about? Your ability to pick and choose causality
> is fanciful.

2008 Dec 03 01:32 PM

[NOWHEREMAN:]

Ah, the seflopinionated CLH, Please read the first post in this series. I responded to it. What is your resonse to it.

As usual, taking words out of "context" is just a means for you try to mislead others. Do you actually read all of the posts or just the ones you feel deserve your attention?

Take a book, read any page in the middle of it, close book, make comments about the entire book. That's exactly what you did CLH. Its your specific style: Denigrate, Belittle, Smear, Its my way or the highway.

IMHO

2008 Dec 03 03:15 PM

[NOWHEREMAN:]

Oooops, meant the above for Georealist, but do admit that Geo does find a nut occasionally. And I have agreed with the posted comments more than once.

Sorry, CLH. But one question, is there any posted Article that you have liked, have not posted some sort of derogatory comments? Just curious.

2008 Dec 03 05:58 PM

[Lawrence J....:]

"The recent economic collapse can be traced to Alan Greenspan's extremely dovish interest rate policies in the 1990s, which led to artificially strong growth in America's economy."

Not hardly. The collapse can be traced to the trade deficit, exacerbated by the oil bubble. With all those dollars looking for a home, we had to pretend there was value here for them to buy. So we said that homes were worth what people paid for them, even though they paid with liars' loans. Then, the AAA paper backeed by the stupid loans proved not to be AAA after all. Duh. That seized up the credit markets, and it has nothing to do with artificially low interest rates. (The flood of petrodollars looking for dollar investments guaranteed that rates would be low, whatever the Fed did.)

2008 Dec 03 07:44 PM

[sparkyboy:]

"The Swiss Franc is 20% backed by gold.."

I was under the impression that this is no longer the case and in fact, the Franc currently has no more gold reserve backing it than the reserve currency of the world. Anyone care to comment ?

2008 Dec 03 10:13 PM

[DJT:]

I'm not anything like an economic expert. I read your article with interest, but I have one question... where do you get the idea that the US is self-sustainable in energy? Food and industry I get, we already pretty much make all our own food, and there is enormous untapped potential in US industry. We can certainly mine enough coal to power ourselves electrically, or mine enough Uranium to do it with nuclear, but we'd fall far short in oil for our vehicles. We only make 1/3 of the oil we use on a daily basis. That figure could certainly be increased in a couple ways, but I don't think we can get all the oil we need from US sources. The conversion to a non-oil-based economy is going to take much longer than the timespan I think you are talking about here. That assumes we start converting right now as well. I don't see that happening.

2008 Dec 04 01:33 AM

[lnardozi:]

Well that's stupid. Money doesn't have to be borrowed to be printed. You're thinking of T-Bills. They can simply create money supply without the bother of selling T-Bills. Perfectly acceptable, just leads to hyperinflation.


On Dec 03 08:42 AM CLH wrote:

> You are delusionary. There is no possible way to make a deflation
> into inflation by magic. Print money? Not possible because no one
> will borrow it.
>
> This is a deflation (like Japan had) which is caused by the elimination
> of debt which causes the disappearance of money.

2008 Dec 04 01:35 AM

[lnardozi:]

Untrue - the value in gold lies in the effort to get it our of the ground and refine it. There is a certain labor involved at this time, and more labor involved the further back you go. You have to find it, mine it, smelt it, refine it and cast or stamp it. Each part of the process costs money and it is that value that is represented in the price of gold.


On Dec 03 10:04 AM TimT wrote:

> Probably a smart man but clearly lacking in any kind of wise judgement.
> He uses good facts but his obvious internal personal bias causes
> him to come to extreme and wrong conclusions. Gold only has value
> because people perceive it to have value--no different from fiat
> money.

2008 Dec 04 01:43 AM

[NOWHEREMAN:]

Thank you Inardozi, I did not want to appear insensitive, so I did not call the Idiot an "Idiot personified".

"Well thats stupid" stands on its own. IMHO

2008 Dec 04 01:47 AM

[neocon4jesus:]

Well the next thing you know, my billions went up in air,

the kin folk said Jed, move away from there, so I loaded up my car and left

California, the place I used to believe.

I now live in Wisconsin where the air is nice and clean, I traded in my jag

for a more practical machine- Deere that is, John Deere, Green, Yellow,

it gets me the new black gold- food.

Glad to be living in Spring Green WI.

2008 Dec 04 02:38 AM

[JFS:]

MR. CLH!!! You are delusional! Just how do you possibly think our country is going to eliminate its debt! And what do you mean no one will borrow money, the banks will gobble it up as they are presently doing, every time the FED auctions another 150 billion thru their term facility auction. Get with the program, when you say comments like you do, everybody else knows you are clueless. Stop embarassing yourself!!!

2008 Dec 04 07:50 AM

[JFS:]

UH, the stimulus didn't cause $150 dollar oil, are you nuts!! The rest of your article is good, though.


On Dec 03 11:16 AM iThinkBig wrote:

> Where will all that created money from the U.S. go? Where did that
> initial round of $200 B in February go? It went into the IB's and
> created $150 barrel of oil.
>
> This downturn over the last year has been painful and will get worse.
> I am in the camp of further deflation for another three quarters
> whipsawing a bit then a period of relative calm before we see inflation
> jumps. So I agree with the writer to some degree.
>
> To posters comments, article too long on why this happened and it
> seems we are now entering into the acceptance phase/market capitulation.

>
>
> What the government, investment community and entrepenuars can do
> proactively is accelerate technology and information sharing to increase
> the efficiencies of returns on where the liquidity goes and decreasing
> imbalances as mentioned in the oil example. Let's hope government
> relearns the words 'market research'. I am not a big Obama fan but
> I do respect his repeated mention that utilizing technology is critical.
> Of course, the younger innovators and entrepenuars that can execute
> such technologies are shut out of the market at present. Washington
> will have to think outside the box on that point for faster implementation
> on that point.

2008 Dec 04 07:54 AM

[Tony Daltorio:]

CLH, you are the one who is delusionary. Deflation is just some erotic fantasy dreamed up by greedy bond market guys and promoted by the shills on CNBC. It's the latest get rich quick scheme dreamed up by Wall Street. You will NEVER see it in the US except for anything more than a few months.


On Dec 03 08:42 AM CLH wrote:

> You are delusionary. There is no possible way to make a deflation
> into inflation by magic. Print money? Not possible because no one
> will borrow it.
>
> This is a deflation (like Japan had) which is caused by the elimination
> of debt which causes the disappearance of money.

2008 Dec 04 10:44 AM

[David Lentz:]

I gotta chuckle at the recommendation to shelter assets in Swiss Francs, what with Switzerland preparing to follow Iceland into default.

Doesn't this guy read the news?

2008 Dec 04 11:09 AM

[Chris B:]

More gold myths...

"Precious metals are the only commodities that aren't significantly susceptible to global economic conditions"

Oh? Then I suppose the real price of gold, as expressed in the exchange rate for merchandise, energy, or services, has remained steady over the past 10 years? Ha! Gold = (a) an inflation futures contract, (b) a mineral useful for jewelry and some electronics manufacturing roles. Its value changes every day, and not just in terms of currencies. It is notoriously volatile and reflects daily forecasts for inflationary conditions.

"the value in gold lies in the effort to get it our of the ground and refine it. There is a certain labor involved at this time, and more labor involved the further back you go. You have to find it, mine it, smelt it, refine it and cast or stamp it. Each part of the process costs money and it is that value that is represented in the price of gold."

Suppose that this was true for lead. Existing lead mines produced 8M tons a year at a cost of $100/ton. A new, more difficult, deposit is then discovered that can produce another 8M tons a year at a cost of $300/ton. Does the value of lead then rise to $200/ton (the average cost for maximum available production)? Of course not. The price and production of lead is set by the market, not the costs of marginal producers. Why should buyers pay twice as much for twice as much lead as they need? Because it cost that much to produce? Do you buy every Rolls Royce you see just because they're expensive to build? No, you don't need it, so you don't buy it. Supply and demand set the cost curve, not production costs. The value of gold, too, is determined by supply and demand.

"gold, like everything else in the world, has no inherent value other than the value given to it by mankind. however, fiat money can be printed, causing an increase in money supply, which lowers the value of that money"

Does anyone have statistics on how many tons of gold were mined this year? Just because mining activity is more obscure than treasury actions, does not mean supply isn't being increased. However, US currency can be much more effectively withdrawn from the market than minerals via bond sales. Gold can lose 90% of its value just like currencies. Look at the early 80's, when inflationary expectations collapsed.

As usual, debunkings are longer than slogans.

2008 Dec 04 11:16 AM

[Gaucho:]

The concept that we can get deflation and be unable to do anything about it is totally wrong. The FED can just print money to finance projects and give stimulus packages etc. The deflationary times that occurred during the great depression were a direct result of the FED tight money policies bank reserves. The government saying that we had deflation is a lie. Go to a site called shadow government stats we have been having inflation over 10% for the last few years yet the government has reported 3-4%. It is in the government’s best interest to understate inflation for programs such as Social Security. Inflation and higher interest rates will be the norm no matter what where the government sets the discount rate. The foreigners will not continue to buy us treasuries at the same rate that they have been and cannot buy the ever increasing amounts that the Fed is demanding.

I think gold and other depleted metals are a good inflation hedge since the cost to extract an ever depleted amount from poorer ore with ever increasing fuel costs will drive the prices much higher ‘in the long run’. So it you have a 5 year old, buy him a large silver or palladium bar for $10K and fully fund his college in 15 years. Things are not going to get better.

2008 Dec 04 11:17 AM

[woodsey:]

Great historical perception, Naufal.

2008 Dec 04 02:28 PM

[Joosterbooster:]

Hi, a great superb story, except from the wishfull thinking at the end.

I have some comments and some questions.

Firts of all, I am from Europe. If the US Long Term Treasuries Bubble bursts, the dollar will fall, and gold will rise. But what will it mean to the price of gold in euro's?

Secondly: what will be signals the bubble is bursting?

Third, is buying real physical gold not the best option at this time?

Fourth; what will happen to the US dollar when the world decides in wants oil and gold in another currency then dollars. Say: yen or euro or maybe even a new basket. What will be the consequences for the dollar?

Thanks for your help!

2008 Dec 04 08:22 PM

[User 196790:]

Euro toast. Europe is too socialist, more and more deficit financing = more debt. Debt culture in Europe is just as bad if not worse than America's.

2008 Dec 04 10:01 PM

[User 142738:]

The Swiss franc hasn’t been backed by any gold since the “Nazi Gold” scandal — before, banks had to back 40% of their currency with gold. Today Switzerland wouldn’t have enough to back half their currency in the same manner.

In addition, the Japanese government had actually fluctuated between a budget deficit and surplus since the 1960’s. Japan had their last surplus hurrah in the late 1980’s and, after issuing 100-year bonds yielding 0%, quickly went into a permanent budget deficit.

Just thought I would chime in to clear up some historical misconceptions.

2008 Dec 04 10:56 PM

[Big-P:]

Stop thinking in terms of "inflation" meaning "everything increases in price" and start thinking in terms of what has been happening over the past ten plus years, i.e. "rolling inflationary bubbles." There's a big wad of cash and it chases (and creates) bubbles of all varieties as it washes arounf the globe. Lose the focus on real estate, stocks, art, collectible cars, etc. (all the stuff that has already inflated and will now deflate) and focus on the stuff the world really needs, like FOOD. Do yourself a favor and buy some wheat tomorrow. Also do yourself a favor and join Big-P (me) as I crush the S&P FUTS tomorrow and Monday. wallstreetprick.com


On Dec 03 08:42 AM CLH wrote:

> You are delusionary. There is no possible way to make a deflation
> into inflation by magic. Print money? Not possible because no one
> will borrow it.
>
> This is a deflation (like Japan had) which is caused by the elimination
> of debt which causes the disappearance of money.

2008 Dec 05 12:38 AM

[nmelendez:]

I agree with those that say the Dow will reach 20,000 in the next 8 years. I also believe in the 10 USD coke can. Inflation will become rampant for a while. Remember though. This world is global, so if US banks have so much money and the USD is the strongest currency, don't you think these banks are buying up foreign assets. jejeje. So when the dollar goes down in value in relation to foreign currencies these bank values go thru the roof. Since Uncle Sam has invested over 700 billion dollars in these banks, what do you think these gains will be? I think everyone is being blinded by the market and does not see the governments end game. US won't default, US will own a whole bunch of markets worldwide. This is an end game to end all others and i like it. Buy the big banks while they are cheap, it's going to be a wild swing up!!!!

2008 Dec 05 10:34 AM

[cornpone:]

Hay people,you all are head and shoulders above this county boy,I dont know (or understand) a lot of what is written here,but i know this for sure,,YOU can not survive when 50% of the people pay nothing and live off the other 50%,and that is where we are at. no bull no hype, just the truth.until that gets corrected, you aint going nowhere. but down


On Dec 03 01:02 PM Georealist wrote:

> The reinflation taking place is a process..paultauts comment that
> no one is borrowing this money is..as usual..blindsided by the truth.
> The Fed has taken over much of what everyone saw the Treasury doing
> for decades...handling internal debt. The Treasury has to go hat
> in hand for every dollar..the Fed answers to NOBODY..as in NOT A
> SINGLE PERSON. The money (liquidity) the Fed is pumping into financial
> institutions is finding its way into T bill and bonds. Voila! Who
> the hell needs Chinese to buy these things..the Fed thru proxies
> does it.
> Mr. Obama is no fool...he will tell his new financial people to tighten
> the screws on lenders to loosen the loan spigot to the public..this
> will happen when programs are in place and appropriate acronyms have
> been established so they can be sold on the nightly news programs.
>
> May-June of 2009 this money..which now exists in ENORMOUS amounts
> as free reserves in the Fed....starts shopping itself. The reflating
> will take on headline proportions and be sold as "Rebuilding the
> Economy.." "Investing in a Sustainable Economic Future.." work out
> a few..it's not that tough.
> As for the deflators...there will continue to be this whipsawing..When
> China throws in the towel in about 6 weeks it could get very nasty..but
> China also knows how to play the reflate game..and as Alan Greenspan
>
> showed the world for years....don't worry about money..there's plenty
> more where that came from.
> By the way..the article is retro and linear....

2008 Dec 05 11:43 AM

[sheridan:]

Foreign governments have not reduced tehir purchase of US Debt -yet in fact China is increasing purchases in a desperate attempt to support their own economy- that is what Paulson was doing over there earlier this week.
Also, why does everyone use the word deflation and not dis-inflation?
hard assets were over-inflated and must revert to their true value.
If your house went up 100% in 5 years, it should go down to reflect a 30%ish appreciation level over that same time period. I would not call that deflation.

2008 Dec 05 04:10 PM

[eight years...:]

I can't believe there's no mention of the Bush contributions to this mess. To claim that Greenspan/Clinton were the sole architects of this fiasco destroys your credibility.

2008 Dec 05 05:13 PM

[james bond:]

I agree hyperinflation is the only way USA can pay the huge debt with IOUSA . ? dow at 14000 at end of 2009 but in 50% depreciated us currency. Lehmann Brother bank was founded by GERMANS in 1889 ,do you think this was any subcounstious reason to let it FAIL by HANK and his golf partners at Goldman Sac?

2008 Dec 07 05:49 PM

[Vox Rationalis:]

"Alan Greenspan's artificially cheap credit policies caused an internal economic crisis, which coupled with President Bill Clinton's strong encouragement of globalization and foreign trade led to a dependence on debt that will deepen the current recession into a possible depression and cause rampant inflation.. look at our external debt under clinton and our trade deficit under clinton... he financed the strong economic growth of the 90s through foreign debt, the issuance of which has caused a debt bubble whose collapse could spell a devalution of the USD."

I just love it when ideologues try to twist economic history to support their views. Here are some facts:

The government, under Clinton or other, does not finance economic growth. It helps to create the environment under which economic agents make the decisions that drive the economy.

Since at least Volcker, the Fed's most important responsibility has been to moderate inflation. With inflation low, there was no reason for the Fed to keep rates "artificially" high.

By the way, the lowest interest rates of the Clinton years were higher than during almost all of the 1945-1965 period. Why didn't the low interest rates of the mid-century cause bad things to happen?

If you think the growth of the 1990's was financed by foreign debt, well, so what? If the decision to borrow to invest makes sense, does it matter to the borrower where the money comes from? Economically, does it make any difference whatsoever whether the lender is around the corner or around the world?

But perhaps you're talking about the national debt. Have you forgotten that the ONLY budget surpluses the government had in the last 35 years were under Clinton? Does it matter to you that the part of the debt held by the public (which includes the foreign-held debt you fear) DECREASED by 16.6% in real terms under Clinton? Compare this to the 103.4% real increase that happened under Reagan, or the incalculable final total under Bush II. [source EROP tables B-73, 78]

2008 Dec 08 09:25 AM

[Jim1618:]

Can someone explain how this asset responds to a change in the dollar's value? I would assume its an indirect relationship but would be related to how foreign investors will feel about dollar based assets, dollar's relative value to their own currency, and US consumption in the future...

2008 Dec 16 05:53 PM

[Jim1618:]

Nobody will borrow it but they'll take it for free


On Dec 03 08:42 AM CLH wrote:

> You are delusionary. There is no possible way to make a deflation
> into inflation by magic. Print money? Not possible because no one
> will borrow it.
>
> This is a deflation (like Japan had) which is caused by the elimination
> of debt which causes the disappearance of money.

Jan 06 07:34 PM