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2009.03.30
Inflation? Deflation? ... Indeflation!!!
About a year ago I had a series of email discussions with a well known silver bullion expert and financial blogger regarding inflation. At that time the prevailing wisdom was that we would experience ongoing inflation. I wasn't so sure. I predicted that the financial gurus would soon be arguing whether we were in a period of inflation or whether it was in fact the beginning of a deflationary period. The second part of my prediction was that we would experience inflation in essential goods such as food, energy and health care but that we would have deflation in almost all other goods and services. Well the first part of my prediction came true but the second part has not ... at least not yet.
I call this uncertainty about inflation versus deflation "indeflation". It is a combination of the two words but it is also a play on the word indecision. The fact is that most people (many economists included) do not understand what inflation really is. I define inflation as the increase of money and credit in excess of the growth in productivity. Deflation is the opposite ... a decrease of money and credit. Inflation is not a general increase in the level of prices ... which is merely a symptom of true (monetary) inflation ... as most financial "experts" would have you believe. The fact is that the world's fiat currencies have been centrally managed by the various world central banks since the early 1970's and one could argue that this process has occurred since 1944, 1933 or even 1913. The most influential currency manipulator during this period was the US Federal Reserve (Fed). In the past 40 years the Fed has increased money and credit greatly in excess of any increase in productivity in the US economy. Since the US dollar is the world's reserve (fiat) currency this led to inflationary pressures in the US but even more so in the rest of the world. This increase in money resulted in increasing prices of all goods and services but especially so for commodities which saw a top in prices in early to mid 2008. Since that time we have been seeing falling commodity prices. How can that be since the Fed has continued to increase its monetary base since then ... even more than doubling this monetary base over that period? Many financial gurus were calling for prices and wages to explode upward in an inflationary spiral reminiscent of the 1970's.
The reason for this discrepancy is that the fall of Lehman Brothers and the bailout of AIG in the fall of 2008 resulted in a massive de-leveraging of the world banks and shadow-banks which is ongoing today. Remember that I said above that inflation is the increase of money "and credit". It is the function of our banking system to take the monetary base created by the world central banks and lever (or "gear") this money many times over through bank credit. Since the 1990's this process went completely out of control and the banks geared to unimaginable levels using both legal and illegal methods. This has now reached a point where the banks have created so much credit that the world is awash in debt. In fact there is now so much debt in the world that the world income base cannot support the interest payments required to service the debt ... let alone try to pay off the principal. This has resulted in a period of destruction of credit which by my definition above is deflation. However, this deflation has not yet resulted in a general decrease in the level of prices and wages. Why not?
Although the Fed has more than doubled its monetary base since the start of 2008, this new money has largely been quarantined or sterilized on the Fed's balance sheet. In addition it is highly likely that the amount of new money created by the Fed during the past year (although massive) has not kept pace with the destruction of credit that we have seen during that same period. As a result, prices of most assets (housing, stocks, commodities and consumer discretionary goods) have either fallen (sometimes drastically) or remained flat.
So what is it ... inflation or deflation ... that we are experiencing? I maintain that it is both simultaneously. In the short to intermediate term we are experiencing deflation as the amount of credit destruction overwhelms the money creation by the Fed. In the longer term expect inflation ... massive inflation ... even hyper-inflation to rear its ugly head. Which is worse? That's like asking someone to pick their poison. Both are bad. We will either experience a deflationary depression or an inflationary depression or cycle between the two. In any event it will be bad.
How do you deal with this? First of all cut back on your spending and either pay off your debts or increase your savings. You will absolutely need this cushion to weather the storm. Secondly if you have any money invested inside or outside of a tax deferral investment plan (RSP, 401k, IRA) make sure that a significant portion (10 to 40%) is invested in gold or silver bullion and/or stocks of silver and gold producing companies. Most importantly do not assume that the "powers that be" will be able to fix this mess. If either by luck or by skill these wizards behind the curtain are able to slow or stall the credit destruction this situation would not last. The excessive amount of debt in the world must be destroyed. This can only occur through inflation or deflation. Expect that we will be cycling between the two for some time ... therefore expect INDEFLATION.
Gerry
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