Marc Faber: Dollar Weakness a Symptom of Inflation in the System

Below are two videos from Marc Faber’s recent interview on Asia Confidential. In it, he takes questions from user emails in regards to the U.S. dollar, economic decline in the U.S. and gold as an investment.

He sees a need for the U.S. to borrow increasing amounts of money going forward – not less. As a result, what was a crisis in finance in 2008, resulting in the nationalization of Fannie Mae (FNM) and Freddie Mac (FRE) will become a national bankruptcy. The U.S. will borrow and print money. The dollar will fall precipitously. Then, “next station is when the U.S. government goes bust.”

Edward here. This might make for good headlines on Bloomberg, but it is patently false. The United States is not now or ever going bust. A sovereign government which borrows in its own currency in a fiat currency system can never go bust. An entity which borrows and prints its own money does not have the same constraints that, say, California or Ireland have. How prices are affected is another issue altogether.

That’s where gold comes into the picture. Here, there are many questions.

• Is it overvalued?
• Is it a good inflation hedge?
• How does gold perform in deflationary environments?
• How does it perform against equities over the longer run?
• What about silver?

Faber takes on all of these.

On the whole, he is an inflationista and does not believe the U.S. will suffer deflation. When asked how gold might perform in a significant deflationary environment, he responds

first of all, I would like to make a very clear statement. I will believe in deflation once we have a significant period of U.S. dollar strength. U.S. dollar weakness is a symptom of inflation in the system.

He goes on to say that gold outperforms other asset classes in a deflationary environment and is therefore a good hedge against fiat currency revulsion whether one expects deflation or inflation.

My own view is similar. However, I would differentiate between consumer price inflation, which will remain non-existent while industrial capacity and employment levels are at depressionary levels. The inflation in the system will manifest itself first in asset prices – with industrial and food commodities or oil being the transmission mechanism into consumer prices. Secular consumer price inflation will not return until the slack in the system is purged.

I would add that this is one principal reason that the Great Moderation occurred despite enormous money printing in Japan and extraordinarily loose monetary policy in the U.S. After China, India and Eastern Europe joined the capitalist system, the enormous increase in labor – both skilled and unskilled – acted as a check on inflation of the consumer price variety.

Alan Greenspan was fooled by this and kept monetary policy too loose. The result was asset bubbles again and again. Going forward, it would comforting to see central banks target asset prices not just to gain policy traction through reflation but in order to cool the economy through deflation.

Comments

[Respirate:]

Good video #2. Faber makes a very clear point that gold is a good store of value but a poor investment.

That in a deflationary environment gold retains value better then some other commodities is welcome and no surprise, but is largely irrelevant because as he clearly states, "inflation is the system" as evidenced by the chronically weak USD.

discl.: long gold E&P companies

Oct 14 06:38 AM

[Michael Clark:]

Actually, inflation has been in our system since the mid-1980's. Look at the cost of higher education, drugs, housing, medical care, cars...there is no end to the examples. Higher education costs (tuition only) have gone up 2500% since 1980. All this talk about INFLATION COMING! fails to recognize why we are having such a problem now. Inflation has been here for two decades. We need the deflation in order to let the air out of overpriced assets and services (especially, now, medical care and higher education).

Oct 14 06:50 AM

[chap08:]

"He goes on to say that gold outperforms other asset classes in a deflationary environment and is therefore a good hedge against fiat currency revulsion whether one expects deflation or inflation."

Whenever I see an argument that gold will outperform in deflation, I see another irrational argument. What's this "fiat currency revulsion"?? Deflation is a fiat currency love in - people can't get enough of it. They don't want to spend it on goods and they certainly don't want to spend it on hard assets. In deflation, the currency gains purchasing power. Why should gold gain more? It won't. It maintains its purchasing power, which means that it goes down against the currency. The only time gold will go up during fiat deflation is at the end, when people start to see inflation coming down the pipe.

As for gold outperforming other assets - what a joke. He is right to say that "stocks would go down 70% say, while gold only goes down 30%", but he seems to forget about cash and bonds. Cash and bonds are (or rather, should be) perfectly respectable asset classes. In serious deflation, Treasury yields could halve from here. That means that treasuries not only gain on the back of the dollar's increased purchasing power, they shoot up in price too. They would leave gold in the dust.

Luckily for him, he get's the most important call right - expect more inflation, not deflation.

Oct 14 07:24 AM

[CautiousInv...:]

In his most recent book, Monetary Regimes and Inflation: History, Economic and Political Relationships, Peter Bernholz analyzes the 12 largest episodes of hyperinflations - all of which were caused by financing huge public budget deficits through money creation. His conclusion: the tipping point for hyperinflation occurs when the government's deficit exceed 40% of its expenditures. By its own accounts, the OMB anticipates breaching this threshold this year and next.

Oct 14 07:39 AM

[bimbam:]

The US may never go bust but their currency policy doesn't differ too much from the Zimbabwean solution... and we all know how successful that approach has been.

Oct 14 08:05 AM

[Uppai Mappla:]

I too am wondering how the legendary Marc Faber missed the fact that US borrowing in its own currency cannot lead to national bankruptcy since it can print dollars as required. I also agree with the argument that inflation was probably kept in check in the last decade due to emerging nations taking up the slack.

Thanks Edward Harrison for this short logical review.

Oct 14 09:16 AM

[Value Added:]

Cash can be expected to outperform gold in a deflationary environment. However, we are not in such an environment, so that point is somewhat moot. Gold *can be* expected to outperform cash in mild to moderate inflationary environments, but it's price is subject to central bank manipulation and therefore not without some risk there. Gold *will* outperform most other asset classes in severe inflationary environments, and I believe we are headed for one - perhaps not this year, but probably within the next five.

A further comment on your statement that "A sovereign government which borrows in its own currency in a fiat currency system can never go bust." In one sense it is true, since the sovereign can manufacture currency to pay internal debts. However, external debts are another matter, and when other sovereigns demand payment in other currencies or gold because of the debtor's plummeting currency value, then that sovereign is in a state of impoverishment that looks a good deal like "going bust."

Absent an abrupt change in US fiscal policy, we will have the opportunity to observe such a history making event unfold.

Oct 14 12:50 PM

[Michael Clark:]

Inflation was 'held in check' the last decade by using an index that overweights income inflation -- and by explorting high paying jobs overseas.
If you look at a chart of American salaries/incomes, these have been stagnant and even declining since 1975.

If you study the prices of consumer products and services, as I mentioned, health-care, higher education, automobiles, financial services most of all...you will find that we have had horrendous inflation these past 20 years.

The government found a way to factor inflation out of the picture, by overweighting income, otherwise they would have been forced to raise interest rates, and this makes the economy look weak and decreases bank profits. Inflation makes the economy look strong, and increases bank profits. Is the economy really strong with inflation....and with the currency losing strength? Of course not. But it feels almost as good to have an AWFUL LOT OF NOTHING rather than just a LITTLE BIT OF SOMETHING.

From my book: 'Turn Out the Lights':

The U.S. government had been telling the American citizen for several decades now that there is no inflation in the American economy.
Of course, Americans know this isn’t true. Oil prices rose from $15/barrel to $150/barrel in twenty years. Housing prices jumped 150-500% is three years, after averaging an appreciation of 2.5% per year over a century. Health care costs explode year after year, averaging 9.5% growth, year-over-year for the last decade. The cost of college tuition has gone up by almost 1000% in thirty years. And we are told that there is no inflation.
It finally became clear to me, after years of musing on this phenomenon, that, there is no inflation, according to government statistics, as long as there is no wage inflation. And there has been little wage inflation – that is true. As long as wages stay low and do not chase the escalating costs of goods and services – and this is almost possible if the cost of credit stays low -- then the inflation spiral is muted. Of course, the consumer, in this scenario, becomes more and more indebted through this method of paying for myriad inflationary goods and materials. Apparently there is no moral dilemma in this. Business profits grow, wages remain low, and workers take on more and more debt. It sounds to me like a volcano that is bound to blow. But what do I know? I’m not an economist. Sometimes logic is only logic for those not sophisticated enough to know the difference between appearance and reality.

Of course, consumers were able to offset stagnant wage growth in the last few decades because of the impressive stock market gains (the first bubble to pop). The stock market became a second source of income for American consumers, to help pay for ever-increasing costs, children’s education, first, second or even third homes. But then the stock market flattened out after 2001, moving sideways for a few years, eliminating wall street as a guaranteed source of secondary income.
Consumers were then forced to borrow against the equity of their homes, as the housing bubble took hold – via Mister Greenspan’s steady hand -- once the stock market bubble played out. Of course, the housing bubble, again, increased American consumers’ indebtedness – forcing them to essentially withdraw savings from their own mortgage equity – in order to pay for the rising costs of health services, food, transportation, energy, education. As long as home prices continued to soar, the system seemed fine. Refinancing meant Americans could continue to draw on their increasing real estate wealth.
Of course, this paper wealth was being fueled by a dubious policy of serial bubble-creation that cheapened real money and turned millions of Americans (and world citizens as well) into credit-slaves and credit-junkies. The dogma of unlimited growth and unlimited wealth was being bruited about by the same bankers and financiers – and Fed Chairmen and Treasury Secretaries and U.S. Presidents -- who were laying the groundwork for the destruction of America and Europe, and all the other ‘emerging’ nations of the world that could not wait to jump on this miraculous bandwagon of capitalism.
Charts of debt accumulation by American consumers shows pretty clearly that phantom inflation of prices was accumulating on American’s credit card accounts....

Do we really need an economic deflation? Yes.
I worked for thirty years in administration at the University of Oregon. Each year, as part of my tasks, I developed a statistical study for the department. One such study centered on the cost of tuition for students.
From 1976 to 2007, University of Oregon full-time tuition for undergraduate residents of Oregon climbed from $216 per term to $2107. This is an increase in thirty years of 875%.
In the same time, full-time tuition for non-resident graduate students increased from $320 per term to $5447 per term, an increase of 1602%.
To put this in perspective, a person earning $20,000 per year in 1976 (a reasonable salary at the time), would need to be making $320,400 in 2007 in order to keep up with this suggested inflationary rate.
A person earning $60,000 in 1976 (a higher administration type salary), would need to be making $961,200 in 2007 in order to be keeping up with this inflationary rate.
Not many job categories have increased at this rate. Some have: CEO’s of elite American businesses, successful founders of technology or biotechnology companies, or internet start-ups, Wall Street investment bankers, perhaps doctors and professional and college football coaches. But most Americans have not seen this kind of inflation of salary rates.
It is not just higher education which has inflated so dramatically.
When I was entering college in 1970, a new Volkswagon bug cost $1700. Today, a new bug costs $20,000. This is an increase of 1100%. A person making $20,000 in 1970 would need to be making more than $215,000 dollars today to keep up with that inflation rate.

Then, of course, there are housing prices.
My sister-in-law in Portland, Oregon bought her house in 1988 for $71,000. This was a modest three-bedroom house in a modest part of Portland. She and her husband had just emigrated from Vietnam; both she and her husband were working jobs starting at close to minimum wage. She had $3000 in savings and borrowed another $4000 from her mother to secure a 10% down-payment. In 2007, this house was valued at $700,000. In 2008, Portland housing declined about 10%. A house that has increased in value from $71,000 in 1988 to $630,000 in 2008 has increased 787% in twenty years. A couple making $30,000 in 1988 should be making $236,100 in 2008 in order to keep up with the suggested inflation rate designated by this gain in housing.

Is it any wonder the world is deflating?


On Oct 14 09:16 AM Uppai Mappla wrote:

> I too am wondering how the legendary Marc Faber missed the fact that
> US borrowing in its own currency cannot lead to national bankruptcy
> since it can print dollars as required. I also agree with the argument
> that inflation was probably kept in check in the last decade due
> to emerging nations taking up the slack.
>
> Thanks Edward Harrison for this short logical review.
>
>

Oct 15 06:31 AM

[ed233:]

I cannot accept the proposition that deflation is in our midst. Inflation is the rise of price for input goods. If we are not experiencing inflation then I don't know what you would call it. Some time ago I indicated that commodities would increase in price after the price in gold accelerated. If you look at a commodity index you'll see the increase in price I've been talking about. Now watch while these increases in price travel through to the finished product. The sudden awakening arrives when the CPI index begins the escalate exponentially. It's in the process now. LOL Looking after your money.

Oct 17 01:47 PM

[De Graaf:]

"Edward here. This might make for good headlines on Bloomberg, but it is patently false. The United States is not now or ever going bust. A sovereign government which borrows in its own currency in a fiat currency system can never go bust. An entity which borrows and prints its own money does not have the same constraints that, say, California or Ireland have. How prices are affected is another issue altogether."

Rob here. Never say never. Given, the US is able to print money till the dollar is at par with the manufacturing costs of its dollar paper mache project at the FED, but when confidence is lost in a currency (whether its a fiat currency would take a little longer than Zimbabwe) the dollar will continue to lose value and eventually go bust.

Another thing: Greenspan did one thing good, he kept policy inline with the borrowing capacity of your nation. Bernanke however, is testing the limits of debt to GDP in a time when GDP is shrinking due to deflationary pressures in the private sector. Remember, GDP in the US is based on spending. Contracting credit lines and efficiency (shedding jobs) will deflate GDP as you will see when the final statistics arrive.

I'm glad you acknowledge we are in a deflationary cycle. But I would want to add one thing to your knowledge. Mr. Faber is merely an inflationista (in your words) because of current US policy. The US will print its way out of debt if it needs to as confirmed by speech of Mr. Bernanke in 2002, if I recall correctly. Therefore, US policy is inflationary.

All credits to Marc Faber, who knows what he's talking about.

regards

Oct 18 06:52 PM