Open Forum

Recovering Deflationists

If you came here looking for the post Deflation or Hyperinflation?, please click on the link.

Otherwise, here are a few odds 'n ends for those of you that like a little "content" with your Open Forum.
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In the past week, I have had economic discussions outside of the context of this blog (and not online) twice. And there was a striking similarity between the two conversations. One was last night and the other was about a week ago. The one last night was with a gentleman I had just met through a mutual acquaintance, and the other was with a friend I've known for decades, probably the most book-smart person I know. Both men are leaders in their respective fields, and both have significant wealth to protect. Neither one reads my blog nor knows or understands my positions and arguments.

Both of these men agree that the purchasing power of the dollar is headed down, and that their wealth is best protected when not denominated in dollars. In other words, they are not deflationists. Both are also voracious readers and both expressed an interest in economics. They both have their wealth spread out between real estate, paper investments with counterparties that may or may not deliver as promised when you most need them to (which, in an unstable economy, will likely be when it is most difficult to deliver as promised) and "precious metals."

I asked them each what they thought about gold as an investment, and they were both quick to announce that they are not "gold bugs." This was a credibility-establishing announcement in the context of the conversations. As it turns out, one has a tiny amount of gold and the other has none. They both explained to me that their (limited) interest is in precious metals, not gold. And remember, these are two separate conversations at different times, with two men that do not know each other.

They explained to me, each in his own way, that what they don't like about gold is that there are so few industrial applications for the metal compared to the other precious metals. My friend greatly prefers silver over gold, and the guy last night is heavily into palladium, with no gold exposure. My friend even told me a story in support of his silver position.

I will save the full story for later because he agreed to write it down for me so that I wouldn't get the details wrong. But the gist of it was that an industrial silver user, a vendor he buys from and is friendly with, is already substituting another metal where he has always used silver because his clients refuse to pay the higher price for the parts he manufactures. I'll admit that the price-sensitivity of this particular manufacturer may not be the norm, but that's not even the point of telling you this story.

The point is that this price-sensitive substitution of silver was confirmation to my friend that silver is a better store of value. And again, this is one of the smartest guys I know. Seriously smart!

What these conversations tell me, at least, is that this subject needs a little more of my attention.
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I have added a fun little video to an older post. I have never done this before, but this one just fit so well where I put it, I wish I had it when I wrote the post. Hat tip to DP whose Ye Olde Blogge is linked in the sidebar. Here's the beginning of the post, up to the new video:

Focal Point: Gold


In game theory, a focal point (also called Schelling point) is a solution that people will tend to use in the absence of communication, because it seems natural, special or relevant to them. The concept was introduced by the Nobel Prize winning American economist Thomas Schelling in his book The Strategy of Conflict (1960). In this book (at p. 57), Schelling describes "focal point[s] for each person’s expectation of what the other expects him to expect to be expected to do." This type of focal point later was named after Schelling.

Consider a simple example: two people unable to communicate with each other are each shown a panel of four squares and asked to select one; if and only if they both select the same one, they will each receive a prize. Three of the squares are blue and one is red. Assuming they each know nothing about the other player, but that they each do want to win the prize, then they will, reasonably, both choose the red square. Of course, the red square is not in a sense a better square; they could win by both choosing any square. And it is the "right" square to select only if a player can be sure that the other player has selected it; but by hypothesis neither can. It is the most salient, the most notable square, though, and lacking any other one most people will choose it, and this will in fact (often) work.

Schelling himself illustrated this concept with the following problem: Tomorrow you have to meet a stranger in NYC. Where and when do you meet them? This is a Coordination game, where any place in time in the city could be an equilibrium solution. Schelling asked a group of students this question, and found the most common answer was "noon at (the information booth at) Grand Central Station." There is nothing that makes "Grand Central Station" a location with a higher payoff (you could just as easily meet someone at a bar, or the public library reading room), but its tradition as a meeting place raises its salience, and therefore makes it a natural "focal point." [1]

Salience: the state or quality of an item that stands out relative to neighboring items.



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I read a lot of comments posted around the Internet that show up in my stats report. Occasionally I send an email to someone that impresses me. This guy was one such.

His name is Bill Quick and he seems to be (from what little I've seen) a political and survivalist blogger. Apparently he is known as "the guy who named the 'blogosphere.'" What really grabbed me was not only that he said he was a deflationist before reading this post, but that he is a complete outsider to FOFOA's world. He'd probably never even heard of FOFOA before this day. Yet I could tell through his comments that he "got it" in a deep way that very few do. Anyway, here is his short post and a few of his comments that caught my attention:

FOFOA: Deflation or Hyperinflation?

It is long, very long. Perhaps only two or three of my readers will make it through the whole thing - although I hope nemo and kennycan will give it a shot, maybe over a weekend or something.

It may seem obscure in places, boring in others, and impenetrable in even more.

But this is the most important piece of analysis I have yet read on the big question of our financial future: Inflation, or deflation?

-Bill Quick
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Bill Quick April 28th, 2011 | #4

Guys, listen.

He “couldn’t have simply said…”

He is making a dead serious argument about a very complicated question, and that argument cannot be couched in sound bites.

I understand that this is not a very accessible argument. But it does reward if the effort is made.

Golden nugget: “Losses can’t be avoided: but they can be socialized/collectivized.”

Big money, via monetization, is at this very moment in the process of collectivizing its losses - the profits are theirs, and the losses are being moved to the public books - that is, your front lawn.

And that is why hyperinflation is inevitable. All the people who really matter benefit. You, on the other hand, lose.

Do you think the trustees of the accounts of the University of Texas bought a billion bucks worth of gold on a whim? And they are buying that gold with fiat money, now.

Because they are first in line for the money spigots. Later on, the confetti won’t buy gold. Hell, it won’t even buy hamburger.
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Bill Quick April 28th, 2011 | #5

By the way, this changes my own thinking about political strategy.

We are not going to be able to stop the hyperinflation. Even the Tea Partiers are not going to demand that we do, or prevent its onset.

So I think we need to think hard about the sort of politicians we want to be in charge when it does happen. And that is a very interesting, very thorny question.
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Bill Quick April 28th, 2011 | #7

The worst hyperinflation in the past hundred years - Zimbabwe - has mostly burned itself out, and the government that caused it is still in power.

If that gives anybody a clue as to what choices our own ruling classes are likely to make.
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Bill Quick April 28th, 2011 | #9

Razor, in our lifetimes, the dollar has been less and less good. In fact, it is 97% less good than it was in 1913.

We haven’t noticed it so much because of massive productivity gains due to first, industrialization, then technologization, and then putting our wives to work, and then borrowing several trillion dollars from Europe and Asia, and then another hundred trillion from our kids, and now inviting those kids to move back home and keep working to help out the household income.

But there isn’t anybody else we can put to work, and shortly, there won’t be anybody we can borrow from except our own money printing presses.

At that point, hyperinflation.

I’m no longer even convinced it’s even worth wasting any time trying to prevent it. In fact, if the choice is only hyper deflation or hyperinflation, I much prefer the latter. Less bloodshed, for one thing.
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Bill Quick April 28th, 2011 | #11

However, there isn’t enough gold, silver, platinum, etc. in the world to allow the banksters & billionaires to transfer their wealth from the dollar to the next fiat currency

Actually, there is. Read the whole article. I told you it repays careful attention.
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Bill Quick April 28th, 2011 | #14

Well, I certainly didn’t say it was an easy read, and my confirmation bias ran the other way - I’ve always thought we were heading toward a deflationary reckoning.

He changed my mind - and once you grasp the reasoning behind his primary contention - that inflation, rather than deflation, is better for the rich and powerful, then the rest falls into place.

Because that notion is so counterintuitive, once you do get it, it is a genuine Aha! moment.

You also suddenly understand why Paul Krugman, economist to the rich and powerful, is advocating the things he does.
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Bill Quick April 28th, 2011 | #15

BTW, I read parts of that article quite a few more than two or three times before the murk finally cleared.
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The point I hope you'll take home is that by really trying to understand this debate, you can find your own ways to front run the threat we all face. What's most important is doing that which brings you peace of mind in the face of a threat that could wipe you out. And that can only come from understanding the debate. Here's another comment I liked, this one from Zero Hedge:

by Transformer
on Sat, 04/30/2011 - 19:53
#1224627

"i have heard all this before. can someone please explain what the ultimate end game for gold is. no one ever explains what they are going to do with their heap of gold at the end."


Here's a letter I sent to my friends. It is the complete explanation of your question, at least the FOFOA article is.


Without a doubt, understanding the current financial situation that we live in, and the possible effects of it upon our future lives might be the most important intellectual challenge we ever undertake.

If you think that the next 20 years is going to be quite different than the past 20 years, then it might be an extremely good idea to have a good understanding of what is going on. To me, the pinnacle of this intellectual exercise is the ongoing debate about whether our system is headed for a deflationary collapse or a hyperinflationary collapse. Both arguments are very esoteric and seem equally remote to someone living in these United States today. There are several commentators out there in the blogosphere, who go back and forth with their arguments. It has become a theme at Zero Hedge, where they post both sides of the argument.

Whether you care about the ins and outs of this debate or not, understanding the debate will lead to a complete understanding of the current situation we find ourselves in. Frankly, til now, I have not completely understood any of the arguments I have read. One practically needs a degree in economics and another degree in political science to really get it. None the less, I just spent about 4 hours reading and working hard at understanding what I consider the definitive treatise on this subject. I urge you to read it also.

Now, I must say that this is not easy to understand (at least for me). I would suggest you approach it not as an easy read, but something you are going to spend some time studying, as if you had to know it for a college level course. There are links within the article that lead to other articles, and likewise, links within those articles. Go back as deep and as far as you need to. Make your goal understanding, and not just getting through it. Maybe leave the window open on your desktop and go back to it when you feel like more.

http://fofoa.blogspot.com/2011/04/deflation-or-hyperinflation.html

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Finally, some of the readers have asked me to post a list of links to relevant Freegold-related posts, primarily for the noobs that arrived here thanks to the last post. There is such a list at the bottom of the first post linked in the following comment. But as I never know which posts will speak to any given individual on any given day, I prefer to do it this way, in the context of a reader trying to help. This comment comes from our own JR (who knows my archives better than I do) and it was posted on another site to assist someone who seems to hate the idea of Freegold, primarily because he obviously doesn't understand it. Hopefully this explains the context of this comment:

It's not hard to figure it [Freegold] out. Go here to start: Freegold in the Proper Perspective:

Quote:
There are four key aspects to Freegold. There are also many more, but these four are key. That's not to say they are all necessary. They are not. But it is to say that in order to understand Freegold you must at least understand the significance of these conditions:

1. The end of the dollar standard (the end of its timeline as the main global reserve currency)
2. The end of parity between paper gold price discovery and physical gold price discovery
3. The Euro-Freegold concept/project, (at least) 31 years in the making
4. The flow of oil

Then try Freegold Foundations.

And if you like the gold standard, stop by How is that different from Freegold? and then think about this:

Quote:
A basic review of economics and market principles reminds us that free price movements are the necessary swing point upon which physical supply and demand can be balanced. A mere discounting of the price/value of commodity derivatives amounts to little more than a cheap parlor trick — a trick which, although creating a nice illusion of cheap prices, completely disregards the physical supply/demand pricing balance and thus sets the stage for shortages and other dire dislocations of the physical supply/demand dynamic.

(link) in light of the recent history of monetized gold.

Then maybe you are primed for:

Quote:
...
I hope that this little analogy helps you visualize the separation of monetary roles, because those talking about a new gold standard are not talking about this. I understand that sometimes you have to speak in terms familiar to your audience in order to not be tuned out, but I also hope that my readers come to understand how and why a new gold standard with a fixed price of gold, no matter how high, will simply not work anymore.

The full explanation of why it will not work is quite involved, and I'm not going to do it here. But the short answer is that the very act of defending a fixed price of gold in your currency ensures the failure of your currency. And it won't take 30 or 40 years this time. It'll happen fast. It wouldn't matter if Ben decided to defend a price of $5,000 per ounce, $50,000 per ounce or $5 million per ounce. It is the act of defending your currency against gold that kills your currency.

You can defend your currency against other currencies… using gold! Yes! This is the very essence of Freegold. But you cannot defend it against gold. You will fail. Your currency will fail. Slowly in the past, quickly today. If you set the price too high you will first hyperinflate your currency buying gold, but you won't get much real gold in exchange for collapsing the global confidence in your currency, and then you will have to empty your gold vaults selling gold (to defend your price) as your currency heads to zero. And do you think the world trusts the US to ever empty its vaults? Nope. Fool me once…

If you set the price too low, like, say, $5,000/ounce, you will first expose your own currency folly with such an act and have little opportunity to buy any of the real stuff as the world quickly understands what has gone wrong and empties your gold vaults with all those easy dollars floating around. You will sell, sell, sell trying to defend your price, but in the end, the price will be higher and you'll be out of gold. Either that, or you'll close the gold window (once again), sigh, and finally admit that Freegold it is.

From Focal Point: Gold

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Maybe ask yourself who does the "setting" of "gold's currency price" in a traditional gold standard? It's almost as if the government, by *FIAT*, is trying to define the "value" of its paper currency in terms of gold. Maybe like a government price control set by fiat dictate....

Thanks, JR!

One last thing. I have a favor to ask. You deflationists are more than welcome to make your case here! But please give us two things, which I have also given. Give us a cogent description of your deflationary process and PLEASE PLEASE tell us what you recommend as the safe-haven investment to carry our wealth through the crisis you foresee.

And to the regular commenters, please hold the deflationists accountable. Keep asking them for their investment recommendation until they answer. Don't answer their questions until they tell you what they recommend. Our position is very clear here at FOFOA. Everyone knows it. But deflationists don't all agree on the best investment / store of value. I want to know what you recommend? Dollars? Treasuries? Gold? Silver? Physical dollars in a shoebox? Or maybe it's just guns, garden and prayer. Whatever it is, please tell us.

Sincerely,
FOFOA