Deflation or Hyperinflation?

This post is for those who have been taken in by the deflationists recently, and who have begun to wonder and worry about what they thought they knew.


To think about this debate properly, let's look at what the Fed has in mind. The Fed fears deflation and would like to swing it back, in a linear fashion, to mild, controllable inflation. To do this it is using every trick in the book. One thing is certain, there are no physical limitation to how much the Fed can inflate the money supply. Money creation now comes with no physical costs (like paper, ink, and printing press grease).

Some say that any money created must be borrowed into existence and that this is a limitation. They are partly correct, because this is not a limitation. As the borrower of last resort, the Treasury of the United States has the power to borrow as much money as it wants to use for stimulus. This can take the form of rebate checks to taxpayers or spending on public works projects. In both cases, the money enters the economy efficiently.

So when Ben said in 2002 that "deflation is always reversible under a fiat money system", he was correct. Point in fact, if the US government issued Tbills, and the Fed bought them with printed money, and then the government used that money to refund everyone's income taxes for the last 10 years, it is likely that would be enough to reverse the current deflation. I use this example simply to show that it is within the power of central banks and governments to defeat deflation in a nominal way.

So now let's see what is the case if the Fed and the government do not take such drastic measures. Let's say they would never do something as Zimbabwe-crazy as that and let's say that the deflationary forces are now out of control. Well, the only thing that can mean is that the best investment to hold right now is fiat currency, or more specifically, US dollars. And if we accept that this runaway deflation will last for several years, that means the best thing you can do is hold dollars for all those years. Because as time passes, those dollars will always buy more and more goods, for as long as deflation persists.

So I ask you, does this pass the sniff test?

It is the only logical conclusion if you are going to accept what the deflationist's are telling you.

With US government bonds at a parabolic peak right now, this clearly does not pass the sniff test. If you buy this theory and act on it wholeheartedly, you are asking for big trouble in the coming months, both in the dollar and in the Tbills.

So, making a big jump here, I ask, is there any difference between a currency collapse and hyperinflation?

Let's ask a different question. What if the government decides to devalue the dollar against gold as many have suggested. This would solve a lot of problems for the government (and for us goldbugs, but that's for a different post). But it would create problems for other governments holding dollar reserves, like China. Well, there are a couple of remedies for this. Perhaps the US government would make a secret promise to China. But still, there are other's in the world that would be greatly hurt by a USD devaluation. So what would happen?

Governments don't always make rational moves. Sometimes they panic. So the likely response to a USD devaluation would be simultaneous devaluations across the board. Let's say there's no secret deal with China to replace it's reserves with a new currency at a favored rate. Well China would immediately devalue the Yuan against gold so that it would still be holding the same Yuan value of Tbills as it held before the USD devaluation.

If this happened across the board with all currencies (a fairly likely scenario), then all currencies in the world would drop roughly the same amount. In this case, the USDX value of the dollar could remain the same, say 81 like it is today, since that is simply a measurement against other fiat currencies. But the reality is that the dollar, and all other fiat money, would buy a whole lot less. You see, they can't devalue gold, they can only up-value gold. In order to devalue gold, they must do it surreptitiously through the COMEX or else outlaw it all together (which is not going to happen, but that's for another post).

This would literally be like overnight hyperinflation. If you bought your house for $300K in 2007, and this damn deflation has taken it's value down to $200K, and then the fiat moneys of the world devalue by 90% against gold, the very next day your house would be worth $2million.

From there, things would start to diverge. That first day, gold would be $9,000/ounce, and your house would be worth $2million. But because we are in a "deflationary environment", your house would likely continue dropping in price, maybe to $1.8million within the next year. And because gold is actually a hedge against failed confidence in fiat money, gold could rise from $9,000/ounce to $90,000/ounce in that same year.

Trust me, this would be a rough year. And there would be nothing linear or predictable in the TA (technical analysis) that would be tracking price movements.

You see, hyperinflation does not require a linear progression from deflation, to less deflation, to slight inflation, to inflation, to high inflation, to hyperinflation. Nope. As a monetary phenomenon, our money supply was already hyperinflated in the 90's. Counting dollars in the world is like counting stars in the sky. (The main difference being new stars are born at a much slower rate.) None of this recent housing bubble or derivatives monster bubble was even needed to create a currency crisis. In fact, these recent bubbles created their own additional credit inflation and also provided a place to put it, a place that has now collapsed to almost nothing. It sure feels like deflation right now. But that's just because of the collapse of the bubble. The money supply was already hyperinflated before this bubble. Even Another said so in 1997.

So why no price hyperinflation yet? That's because the rest of the world has been soaking up our hyperinflated currency through the trade deficit. No other currency in the world has had this privilege. That's why so many other currencies, when hyperinflated, were soon followed by price hyperinflation.

There is nothing playful and hippie-like about hyperinflation. I have seen it suggested that inflationary times are characterized by hippies and growth and good times, like the late 60's and early 70's. And that deflationary times are characterized by loss of control, social upheaval, war, and death, like the 30's. So the argument follows that we are obviously headed for the latter and not the former, therefore deflation. But I ask you, which is a better description of Zimbabwe? Obviously Zimbabwe compares more to our deflation of the 30's than to the inflation of the 70's, even though it is experiencing hyperinflation.

I think the point is that hyperinflation is a close cousin to deflation, and only a distant relative of inflation. So don't let the name fool you. Hyperinflation is most definitely not a hippie paradise.

I apologize if this post seems jumpy. It's just that there are so many different angles from which to view this debate. And there are so many people writing on both sides of the debate. I have given this much thought from all the angles I have come across, and I always come to the same conclusion.

Let's take a look at what I call the Prophet angle. Where I think Peter Schiff got it wrong is that he thought the foreigners would abandon the USD Titanic either as it was approaching the iceberg, or soon after it hit the iceberg. But they didn't. They seem to be going down with the USD Titanic. However, they do have their own lifeboats. And at the last minute, before we disappear under the water, they will abandon us. Trust me. Peter was actually correct, only his timing was off, and to great cost to his clients at Europac. But his macro view of the way the world economy works is pretty spot-on.

Eric Janszen of iTulip correctly predicted this deflation years ago during the bubble inflation. He called his theory Ka-Poom. The Ka part is this deflationary cycle we are in, which he calls disinflation. The Poom is the massive inflation that will follow. So far he has been pretty correct.

Nouriel Roubini has been very correct about the collapse. And now he sees deflation. He and Mish both see this as continuing for a long time. But what I think they miss is the massive herd of black swans lurking in the bushes. The black swans are an analogy similar to the pins in Eric Janszen's book America's Bubble Economy. It says that the bubble (currently the TBill bubble) is floating through a maze of many many pins. And it only take one pin to pop the bubble. The odds are much higher for a pin prick than for the bubble to make it out of the house-of-pins in one piece.

Another related problem with Mish's and Roubini's view is that it relies too heavily on a linear analysis of the economy. I touched on this earlier. But I call this the TA angle. Part of the reason most mainstream economists did not see the collapse coming like Roubini did is that they relied too heavily on TA, which prescribes slow, linear movements. Roubini saw big troubles lurking, black swans, and rightly predicted a low probability (rare) yet high impact paradigm shift. But now it seems he is suffering the same blindness to black swans that inhibited the mainstreamers from 2006 to September 2008. He now thinks things will continue in a linear progression.

A good comparison for this TA angle is the POG (price of gold). There are some, like Jim Sinclair, Axstone and Stefanmo on GIM that track the POG using TA methodology. If you followed Stefanmo's thread, It's all in the dollar and his methodology, you'd have a hard time reconciling that POG with ANOTHER or FOA who spoke of a $30K POG back in the late 90's. This difference, a linear progression versus a gapping up due to a rare but high impact event, is analogous to the reason Mish and Roubini see deflation and I see hyperinflation in our future. Don't get me wrong, I too see their current deflation. But I also see a 95% probability that it will change to very high inflation, or hyperinflation, or a collapse of the dollar (mere semantic differences), within the next two years at the VERY LATEST.

There is also the Necessities vs. Luxuries angle. This is the way I see it most likely playing out. All "luxuries" are currently deflating. And in real terms (gold terms) this will continue for years. But when you look at necessities, the things we need to survive like food, we haven't seen much deflation at all. In fact, many prices have been going up (except gas) during this current "deflation". Mikal on USAGOLD listed out some of his bills which have INflated in the last two months:

Dentist bill
Grocery Bill
Heatlamp bulb
Rugs
Vitamins
Books
Magazines
Newspapers
Car parts- do it yourself
Auto parts and service- garage
Car insurance
Rent
Precious Metals
Taxes
UPS, Fedex and US postal shipping
Computer parts and repair
Batteries

All you have to do is look at Zimbabwe. Necessities like clean water are as valuable as gold right now. Yet luxuries that we enjoy in the west have almost no market there. So even though their prices are now quoted in the quadrillions, their real values (in gold terms) are still dropping.

Hyperinflation need only hit the necessities. That is why it is so bad. The way I see this going down is that we'll see inflation start creeping into necessities in the next few months followed by shortages in those same necessities, and then a currency collapse which we could call "hyperinflation", because that's what it is. If we have hyperinflation is that not also a collapse of the currency? Yes. And the opposite is true as well.

The last angle I will discuss in this post is what I call the Manipulation angle. Remember that we had high "price inflation" in commodities including oil for the first half of this year. Note that I said "price inflation". This is a distinction from the Austrian "monetary inflation", which was already hyperinflated in the 90's (and which we are piling cash on top of now). Anyway, we had oil going up to $140/bbl in July. That ended July 15th, right after INDYMAC collapsed.

Many notable writers including Don Coxe and Jim Puplava have speculated that Paulson (and the PPT) engineered the commodity collapse simultaneously with the rally in financials and the ban on short sellers (in financials only) starting on July 16th. This commodity collapse, currently called deflation, continued through November. Now if I were to believe that Paulson started this "deflationary" collapse in commodities, must I now believe it is real? Should I believe it will continue once he is out of office? I don't know. But I think I know.

One thing I am fairly certain of is that gold is going up, way up, and relatively soon. Another thing that I'm sure of is that the dollar is not a safe investment. Even now. It can lose massive (like 90%) value overnight if the wrong thing happens. Don't get me wrong. I do have some dollars. But gold is no longer my hedge. Gold is now my wealth reserve, and the few dollars "under my mattress" are now my hedge. Since I don't know the timing of the future events I see coming, I still need to be prepared to pay my bills and to lose some value on those dollars if things happen as soon as I think they could.

One other thing I'm 95% certain of is that we will see what I am calling "hyperinflation" within the next 24 months. And I say 75% by next fall. 50% chance of it by summer. And 25% by spring. There are just too many black swans/pins in the room.

Once again, apologies for the jumpy post. But I have been reading too many things about "the big D" lately that I wanted to write a post. Don't get me wrong, the big D....epression is coming. And the big D.... flationary head-fake is happening right now. But take solace in the people that tell you gold will do well in both deflationary and hyperinflationary environments and don't worry about your gold. But as for the rest of your preparations, just be aware of the black swans.

The following article will show you the state of the money supply and the panic. Note that statistics can be interpreted in many ways, but this article highlights some of the most applicable statistics and graphs to what we are facing. It is by Rich Dad advisor, Michael Maloney.

The Greatest Wealth Transfer in the
History of Mankind Starts Now!

by Michael Maloney
December 19, 2008

Right now, the Treasury, the Federal Reserve, and the banking system seem to be gearing up for an event the likes of which has never been seen. I believe the crisis that will unfold over the next few years will add up to the biggest economic event in history. The scale of what is happening will dwarf all other economic events combined. The Tulip mania of 1637, John Law's "Mississippi Scheme" of 1720, and the dot-com / tech bubble of 1999 will pale by comparison. Even the hyperinflation in Weimar Germany in 1923 and the Great Depression will seem like a walk in the park compared to what is coming.

But wealth is never destroyed - It is merely transferred. Neither you, nor I, have the power to stop what is coming. But we do have the choice to either freeze in panic and be crushed under the wheels of the economic freight train that is bearing down upon us, or catch the ride of our lives on the road to immense wealth.

While speaking at a recent wealth conference in Florida, I showed the audience some charts to try to impress upon them the enormity of what is going on right now! The chart I call my Panic Meter is made up of LIBOR rates (the rate which banks lend to each other) divided by the 3-Month Treasury Bond yields. By dividing LIBOR rates by bond yields you get a measurement of just how panicked the banks and large investors really are. This chart is saying that something is really, really wrong.

Panic Meter (2006 - November, 2008) (Click charts to enlarge)

I then showed a chart of the monetary base (all paper dollars and coinage in existence). It took 200-years for the monetary base to go from $0 to $800 billion, but in just the past 3-months it has grown from around $800 billion to $1.5 trillion, and by the time you read this it will probably be surpassing $1.6 trillion. That's double the number of paper dollars in existence since last summer!

Base Money (1919 - November, 2008)

But here are a few charts that I didn't show at the conference...

The next chart is "Cash in Circulation". So far only a small amount of all that extra currency shown in the above chart has leaked out of the banking system and into circulation. But you can bet your assets... IT WILL. When it does, it means that prices must rise to soak up all that extra currency, like a sponge soaking up water. This is bad news for someone holding dollars, but cause for celebration for a precious metals investor.

Currency in Circulation (1919-November, 2008)

Here is a chart of how many dollars the banks have borrowed from the Federal Reserve through the end of last year (2007). Please note the spike that indicates the banks had to borrow $8 billion from the Federal Reserve during the Savings and Loan Crisis of the late 1980s.

Bank Borrowings from Federal Reserve (1919-2007)

Here is the same chart, but I've now taken it out through November of 2008. You can't even see the $8 billion S&L Crisis peak anymore! In fact, the banks are approaching $800 billion in borrowings. This means that the banks perceive this crisis as being 100 times larger than the S&L crisis.

Bank Borrowings from Federal Reserve (1919-Nov., 2008)

This next chart is Reserve Bank Credit. It is the total amount the Federal Reserve has loaned out of its bottomless checkbook. This chart includes all the rest of the bailouts (at least through November 2008). This chart also rises to roughly $800 billion by the end of 2007, but by November 2008, it has risen to $2.2 trillion. As Brent Harmes would say "It's climbing skyward like a homesick angel."

Reserve Bank Credit

Last, we have a chart of "Excess Bank Reserves". These are reserves in excess of the amount that the Federal Reserve requires the banks to have. It looks almost identical to the chart of Bank Borrowings, except for two small features; there is a tiny blip in 2001 and a small bump around 1941. Could it be that the banks perceive this crisis to be 50 times larger than 911 or even World War II?

Excess Bank Reserves (1930-November, 2008)

With the exception of the Panic Meter, all graphs in this article are taken directly from the Federal Reserve's website. Personally, I'm pretty sure that in a few years a chart of the price of gold will look similar to these charts, and a chart of the U.S. dollar will look like one of these charts flipped upside-down.

If you don't believe me, just take a look at this!

Bloomberg, Dec. 15 - Dollar Staggers as U.S. Unleashes Cash Flood:
"U.S. policy makers are flooding the world with an extra $8.5 trillion through 23 different plans designed to bail out the financial system and pump up the economy. The decline (of the dollar) shows that the increased supply of money may be overwhelming investors...."

In my book, "Rich Dad's Advisor's Guide to Investing in Gold & Silver," I show how virtually every time governments, and/or the banking system, abuse a currency enough to push it to a tipping point (such as in these charts), the free market and the will of the public revalue gold and silver to account for the excess currency that was created since the last time they were revalued. But this time, for history to repeat, and for gold to do what it did in 1980, 1934, and hundreds of times throughout the world going all the way back to Athens in 407 BC, it will require a gold price of over $10,000 per ounce... And that's if they turn off the printing presses today!

I believe this is the greatest opportunity ever offered to anyone in the history of mankind! Gold below $1,000 and silver in the $10 range is a gift from God. You can ignore this gift at your own risk, or graciously accept it and be on the road to great abundance. I don't know about you... but I'm buying lots of gold and silver.

Things I believe every investor should do:

Step 1: Get educated. Don't take my, or anyone else's, word on this. Read books and newsletters on the subject and decide for yourself.

Step 2: Buy physical gold and silver and take possession of it (or have it stored at a third party depository).

Step 3: Avoid "Fools gold" such as:
ETF's, pool accounts, futures contracts, leveraged accounts etc. Many of these are just "paper contracts" with little or no gold or silver behind them.
Collector coins with excessive premiums above the worth of their metal content. These are a better deal for the dealer than for you.

Step 4: Relax knowing you have protected your wealth and positioned yourself to profit greatly from what history tells us is inevitable.

By Michael Maloney
GoldSilver.com

Michael Maloney is a precious metals expert, monetary historian, author of "Rich Dad's Advisor's Guide to Investing in Gold & Silver, and the founder of GoldSilver.com

GoldSilver.com is an online precious metals dealer that specializes in delivering gold and silver to your door or securely storing it for you in a Brink's precious metals storage account.

To read the book that predicted the current financial crisis and what will happen next, check out Michael's book "Rich Dad's Advisor's Guide to Investing in Gold and Silver". (Amazon $11.55)