Phil Anthropy

Gold Still Suggests Inflation, Not Deflation

Economics is a confluence of interacting rates. Some can be predicted, and some depend upon consumer behavior.

Value is an illusion, based on supply and demand for well-behaved markets and on nothing but hype for ill-behaved markets.

Putting these two concepts together, it is difficult to forecast outcomes for economic policies. During the 1970s, the Brookings Institution in Washington, DC experimented with an econometric model of the United States. Changing the model's parameters often led to nonconvergence, meaning that the solutions went into wild oscillation or exponential spikes and did not end up in a steady state.

One thing is clear to me. Making sweeping economic changes, rather than small, incremental changes, is extremely dangerous. It may be necessary to take large steps to offset a large perturbation, but if the dosage is wrong, the economy may end up with other problems of equal or greater magnitude.

The solution of letting the house of cards collapse and building another is a fine, capitalism solution, particularly for the rich, since they will not feel the economic pain. However, it would be a global cataclysm for the financial system to implode in this era of asymmetric weapons and youthful demographics in many countries.

What has been clearly demonstrated is that unregulated, cut-throat capitalism leads to instabilities. The laws put in place by wiser generations, such as the Taft-Hartley Act to stop companies from becoming "too big to fail," should be enforced, not ignored. Manipulative cash flows, such as the recycling of currency by exporting countries into importing nations' treasury debt to keep interest rates artificially low, lead to speculative bubbles. Better by far would be orderly global growth with the relationships between currency values based on balance of trade.

A prevalent theme in many blogs is that we have gone too far down a false trail and leveraged ourselves too far. The "good as gold" securities we used as security for the leverage, backed by credit default swaps, are no longer good as gold, and the leverage pushing back is extreme. We have no real idea of the extent of unregulated derivatives.

it is unfortunate that we didn't just fix the problem at the source, which was to stabilize housing prices by preventing mortgage defaults. This could easily have been done by giving lenders an equity share in the house, or an option to it, while keeping payments the same as before. Then all the mortgages are "performing" again, and can be marked to market at near face value, albeit with a lower percentage of cash flow from the reduced payment. But that reduction is offset by potential profit on the upside when the house is eventually sold.

There are other things that could have been done, which would not have required any government funding, enabling us to keep our powder dry until it was critically needed. As it stands, the Fed is currently monetizing debt with its infinite balance sheet, until at some point the debt burden as a percentage of GDP may simply become overwhelming. We will owe the Fed (and Japan and China) more money that we can ever pay back. At that point, bad things may happen.

So let's spin the roulette wheel and see if we come up red or black -- or double zero, in which case it's game over.