Will We Have Inflation, Deflation, or Hyperinflation? Part 4 (Final)

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Wed, 06/30/2010 - 09:48 | 444044 ozziindaus
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On top of all this, the politicians will hammer Bernanke to create jobs, which is one of the Fed's mandates.  But how can he do that? He will try to inflate.

How can he do that indeed. I have repeated this in so many other posts. Jobs should not be viewed as needs or wants. Charities are needs and wants. Jobs must meet some demand and be productive (obviously) otherwise it's simply a transfer of wealth.

The Fed's mandate (one of) is not to technically create jobs (Mr Obvious again) but to provide an economic environment conducive to entrepreneurship and expansion of private businesses to meet consumer demands. The caveat is that the Fed is not in complete control of interest rates (another supposed mandate) but reactionary to market forces through the bond market.

Therefore the private sector creates productive jobs and that's the way it should remain. Those waiting for the government and Fed to rescue the economy will die waiting.

Wed, 06/30/2010 - 09:22 | 443996 ozziindaus
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I don’t agree with the deflationists that deflation is a decline in real estate asset values. I believe the deflationists conflate deflation and deleveraging. I agree with the deflationists that deleveraging and the decline in real estate values has and will limit economic activity because it has suppressed bank credit, but it isn’t deflation.

Wanna bet??

A decline in real assets to the extent we are experiencing with RE and CRE, increases the probability (transpiring) of complete default. This is classic deflation since it targets credit (inflation) with leverage.

Wed, 06/30/2010 - 09:06 | 443967 dryam
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In a debt based money system it's all about what the money multiplier is & if the banks are lending.  There are so many reasons why the banks won't lend right now.  In addition to the explicit reasons, the bank cartel is not incentivized to create high inflation.  Overall deflation rules (strong negative money multiplier) until there is some type of bottoming process.

Wed, 06/30/2010 - 08:20 | 443907 moneymutt
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Is this a given, proven dynamic by real world historic examples?

"The downside is that it would cause greater economic distortions than if they bought bank CRE debt because the effect would be to fund wasteful government projects."

The issue raised is a very legit concern and a intuitive sense of what might happen if we monetize, but do we really know this, thoroughly, solidly.

From the very few (too few in my mind) examples of countries monetizing and spending it on infrastructure and such projects, inflation has not resulted, certainly not automatically and inevitably. American colonies did it and did well, Guernsey did, pre-WWII Germany did it (via govt scrip), built the Autobahn and did very well. If govt spending was used for useful things to community and it put money in pockets of workers, would not the lower unemployment and better economy help heal regional banks. These examples show it is possible to do this without debt or inflation...i.e. sustainable.

Wed, 06/30/2010 - 19:28 | 445407 Econophile
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Moneymutt,

Japan proved my assertion.

Wed, 06/30/2010 - 20:08 | 445469 moneymutt
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perhaps, to me they still did it thru debt, not monetization...is my impression wrong?

Mon, 07/05/2010 - 15:41 | 453332 Econophile
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Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Mon, 07/05/2010 - 15:41 | 453331 Econophile
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Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Mon, 07/05/2010 - 15:41 | 453330 Econophile
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Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Mon, 07/05/2010 - 15:40 | 453329 Econophile
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Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Mon, 07/05/2010 - 15:40 | 453327 Econophile
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Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Wed, 06/30/2010 - 08:27 | 443914 Seer
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"These examples show it is possible to do this without debt or inflation...i.e. sustainable."

Sustainable?  For how long?  If it's an issue of growth it WILL end eventually.

Would future generations be happy about out building more highspeed motorways, when in their future they won't be of use to them?

We're still thinking way to short-term.  And as a result it'll not end up well, govt projects or otherwise.

Wed, 06/30/2010 - 07:32 | 443874 MarketFox
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Excellent work....and follow through....

.............................

The total asset valuation and total credit available represented a 100/100 fraction which peaked in 2006/2007....

 

Now the cumulative fraction is approximately 60/100 after one adds current asset valuation and credit contraction....

................................

There are many forms of asset valuation via accounting norms....which are also altered in a legal political manner....

True asset valuation is private side induced...such that it is the private side valuation that pulls the tax wagon....

................................

Thus it will not be until there are tax structure reforms that prove to add to the private side.....whereby private side valuations will improve and multiply...

Until then...the 100/100 which has shifted down to 60/100....will shift even lower with more monetary dilution or increased taxation....

Thus the answer truly relates to government tax reforms....

ie a 15% consumption tax that replaces all other taxes ...especially the individual/corp. income taxes....would add to the private side such that 100/100 could go to 140/100...or even 200/100.... 

And the 60/100 could go to 30/100 from 60/100 if there are increases in taxation or further monetary dilution....

 

Wed, 06/30/2010 - 07:18 | 443866 yabs
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comparing the situation of the 70's  to today is like comparing a fart to hiroshima

Wed, 06/30/2010 - 07:17 | 443865 yabs
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comparing the situation to today is like comparing a fart to hiroshima

Wed, 06/30/2010 - 07:12 | 443862 Nobody
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One of the effects of Nixon's policy was:

Farm commodities prices doubled and tripled.  Farmland doubled in value

One of the effects of Reagan/Volcker's policy was:

Farm commodities prices dropped 40%.  Farmland lost 65% of its value.  

Wed, 06/30/2010 - 07:42 | 443880 Seer
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Nixon's administration helped push big Ag.  Reagan's helped push big Banks.

BIG  = FAIL!

Wed, 06/30/2010 - 05:59 | 443825 chrisina
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<blockquote>The deflationists’ analogy to Japan’s experience from 1989 to 2003 is only partially applicable. The American tradition is to allow banks and businesses to fail.</blockquote>

Haven't seen much of this "American tradition" lately, have we?

<blockquote>To prevent runaway inflation the Fed would raise interest rates, increase reserve requirement, and sell assets to stabilize money supply. The hit to the economy would be worth the risk. This is essentially what Volcker did back in 1979-1980.</blockquote>

FYI, the level of Govt debt in 1979 was 30% of GDP (the lowest it's been since WWII). Today it is 90%. Same thing with private debts, about 3 times as much as in 1979.  So you think Bernanke raising rates like Volcker did then is realistic?

And what about the Fed selling assets? You mean the junk they bought recently? Who is going to buy it? At a tenth of the price the Fed paid for it? That's not going to help much reducing the Fed's balance sheet is it?

The situation today has ABSOLUTELY NOTHING to do with 1979. Back then leverage was low and nobody had even thought of peak oil. Today leverage is astronomical and won't get any bigger no matter what the Fed does and the supply of oil isn't going to grow any further limitting future growth prospects.

Our problem today is far too much debts and not enough cheap oil. Central banks do not have any magic wand that can solve this. If a sufficient percentage of creditors loose confidence in the ability of debtors to honour their obligations (either via default or via being paid with freshly printed paper) central banks won't be able to prevent a run on the dollar. Rest assured that in that case, the tools that will need to be used won't be those of a central bank (raising rates and selling assets) but those of a totalitarian military and police state that will need to control every aspect of the economy.

Wed, 06/30/2010 - 08:58 | 443954 Variance Doc
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My thoughts exactly.  Nice summation!

Wed, 06/30/2010 - 05:57 | 443824 yabs
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You say that Japan kept zombie companies alive but the Us doesn't?

so what are Fannie Mae, bank of America, AIG, Citigoup etc

I think they would fit the definition of a zombie wouldn;t they?

Also I think the delevaraging will be greater than money printing and as this money does not go into the real economy at some point

a deflationary collapse is mathematically guaranteed.

All money is debt in this system remember and when debt saturation occurs as is happening now the system cannot grow anymore

Deflation First is my view with bouts of inflationary epissodes like last march to now but these are just short term bounces not the general trend

Wed, 06/30/2010 - 06:16 | 443833 Ned Zeppelin
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Agree - I disagree with the author, and believe we have moved mountains to preserve the TBTFs which are the poster child for "Zombie."  This is the massive failure of Bernanke, Summers, Geithner, Rubin, etc., and a hard rain's gonna fall because of it (or is it in spite of it).  What has been avoided is massive losses in one sector, the sector that has been running the pols for years, since the repeal of Glass-Steagall.

Wed, 06/30/2010 - 05:23 | 443808 reckoning
reckoning's picture

still no chart of M3... 

Wed, 06/30/2010 - 06:28 | 443843 Hedge Jobs
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here is a link reckoning, you cant discuss deflation without looking at M3. looks like this was left out either through ignorance or to justify the Inflation bias of the article (no offence meant econophile i enjoyed the read but disagree)

http://www.shadowstats.com/alternate_data/money-supply-charts

If M3 at -6% doesnt point to deflation i dont know what does. At -6% deflation is already here.

the delusional shalom bernanke better fire up the printing press pretty soon.   

Wed, 06/30/2010 - 14:01 | 444554 Econophile
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I don't use M3 because it includes savings and MM accounts which aren't demand deposits. Only M1 and True (Austrian) Money Supply accurately reflects money in circulation. Also, Fed doesn't use it any more, although Williams does. Thanks.

Thu, 07/01/2010 - 14:06 | 447015 Eternal Student
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You should. It provides a much bigger picture of what's going on.

As for the artcile as a whole, I really don't think you understand what's going on. No offense intended. Like the Chicago School of Economists, you seriously leave out the impact of Credit, and that's where the game is. Unless you take that into account properly (as in including the Ponzi Finance of the Global Derivatives Market), you're not going to have a chance of understand why Deflation is happening. M1 just doesn't cut it. Neither does M3 fully, but it gives a better clue.

Also, while I found the articles enjoyable, what serious Deflationist is saying that deflation is about Real Estate prices? As you well note, inflation/deflation are a monetary phenomena. Going off on that Straw Man detracted from the general quality.

Still, I enjoyed the article, and thank you for writing it.

Mon, 07/05/2010 - 15:34 | 453322 Econophile
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No I don't. I discussed this point at length. I just don't agree with Steve Keen and I explain why. I explain that RE prices are declining and that is deflationary in one sense of the word, but then, why is CPI rising? I think I explain all this in detail. I am fully aware of credit and I go into this in great detail. Again, it's a monetary phenomenon. Right now money supply is contracting, and this will lead to a decline in economic activity, perhaps deflation. But the Fed has the ability to inflate, if it wishes, and my guess during the next downturn, starting this half, they will pump. I explain how and why. I urge you to re-read the article carefully. I also explain why I don't use M3. I consider myself to be Austrian, not Monetarist. 

Thank you for reading.

Wed, 06/30/2010 - 05:00 | 443797 Kimo
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Hyperinflation implies inflation runaway.  Fed can throw money at the system, but not jobs.  Prices may go up with each infusion, and wages may adjust, but it will not be self sustaining, so it will not be hyperinflation.

Wed, 06/30/2010 - 04:28 | 443782 Nout Wellink
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IMO the biggest flaw in this article is the assumption that the Fed and other central banks can 'control' everything. They can't. The Fed can use many tools to try to inflate the money supply and increase lending, but they have no idea how the reaction will be. As far as I am concerned, the greatest mania in mankind, excessive credit, borrowing and consuming, has come to an end. Social mood is low, so there is no chance the mania will return any time soon. So deflation is really a big threat and if they start panicking at the Fed, I believe Hugh Hendry is right: prepare for hyperinflation.

Wed, 06/30/2010 - 04:58 | 443796 Popo
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+1

History tells us that the Fed cannot control everything.   There is lots of revisionist (ie: bullshit) history, written by Keynesian economists which tries to pretend that past failures were simply the result of flaws in policy implementation.  It's simply not true.  The reality is that central banks are not the most powerful force in the market over the long term.

 

 

Wed, 06/30/2010 - 04:37 | 443788 GoldBricker
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+1

The essence of the article is that markets are now under government control, thus the variables are what decisions TPTB will make going forward. This may or may not be true.

The arguments of the deflationists I read (Rick Ackerman, Mish) are that the collapsing debt bubble will not be controllable, that it will be like pumping air into a leaking balloon, where the leak is faster than your pump.

Wed, 06/30/2010 - 04:01 | 443769 laosuwan
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great article. Zero Hedge leads the way.

 

Is anyone else here old enough to remember stagflation and the oil crisis?

 

What were the investments that did well during that period of stagflation?

Wed, 06/30/2010 - 08:58 | 443956 LePetomane
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Price inelastic industries did well: oil, nuclear, grocery, tobacco & alcohol etc.

Fri, 07/02/2010 - 10:53 | 449156 laosuwan
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the industries did well or their stocks did well?

Wed, 06/30/2010 - 06:23 | 443836 MichiganMilitiaMan
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My family invested in a very large garden.  We podded peas, snapped beans and canned corn/tomatoes for hours and hours.  We had a basement full of canned and frozen vegetables, and purchased bulk berries for freezing.  Many summer nights were Not spent playing wee and other non-sense.

Fri, 07/02/2010 - 10:55 | 449158 laosuwan
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Arent snap beans very high in estrogen?

 

 

Wed, 06/30/2010 - 04:33 | 443785 GoldBricker
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Hey lao,

Yes, was in my 20s in that era.

What did well:

  • luxury housing
  • collectibles (my thing was coins)
  • gold (silver's rise was sharper and briefer)

Inflation was quite palpable then, plus we were not used to it, so everyone was trying to put their cash into real assets.

What got slaughtered:

  • blue-chip stocks
  • bonds, paid-up insurance policies, annuities, and anything else denominated in dollars.

The investments that got killed were precisely those that my parents (the WW2 generation) would've considered responsible, conservative investments, while the things that did well they would've considered frivolous, akin to gambling. I wonder if the future will be able to say the same thing of our own times.

Fri, 07/02/2010 - 10:49 | 449138 laosuwan
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GB:

 

I think I was 15 at the time and I just remember gas lines, union actions for higher wages, coupon clipping, etc.

 

Stocks are supposed to be an inflation hedge so I am guessing stocks got slaughtered because people had to sell to raise cash. = buying opportunity if you can call the market turn?

Avoiding dollars, we can all agree on that one.

So, commodities, real estate and gold it is then. Hey, sounds like Jim Rogers.

Wed, 06/30/2010 - 11:00 | 444166 ozziindaus
ozziindaus's picture

Generally, the public is always wrong.

Wed, 06/30/2010 - 04:23 | 443779 duncecap rack
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Gold did very well.

Wed, 06/30/2010 - 03:31 | 443754 Apostate
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This is fantastic work. I'm glad that you've stepped in to moderate this debate (so to speak) and put out a measured, reasoned paper independent of personal attacks, emotional reasoning, and other cruft.

This here is actually my greatest fear:

To prevent runaway inflation the Fed would raise interest rates, increase reserve requirement, and sell assets to stabilize money supply. The hit to the economy would be worth the risk. This is essentially what Volcker did back in 1979-1980. If it really got rough, price and wage controls would be instituted on a temporary basis to cool things down. I am aware of the implications of such controls and the massive price distortions they cause, as is Mr. Bernanke. But it would politically acceptable on a temporary basis. That famous Republican, Richard Nixon, did this in 1971. We all understand that such controls only further distort the economy because only market prices enable us to make economic decisions, which is why such controls would be short lived.

I've had panics about it repeatedly - that the government could actually keep its game going for a while longer. 

The trouble here is that raising rates and selling assets would push the states off the reservation even further.

The Fed could very well blow up the government, but save the dollar. I'm not sure if that playbook could work.

But I suspect that they might try. How do you jive that measure with the political situation? If a Democrat attempted to implement those policies, it would quickly annihilate the party. The Republicans could potentially pull off such a policy, but at the risk of incurring vast amounts of civil unrest from former government workers.

Any route the Fed takes will be messy.

How could the Fed raise rates without forcing a Federal debt crisis? 

Fri, 07/02/2010 - 10:57 | 449164 laosuwan
laosuwan's picture

obama is all about control. I look for something unexpected from him before the election. its going to get nasty in the states. 

Wed, 06/30/2010 - 19:26 | 444527 Econophile
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Apostate, you bring up very good points. My answer is that I don't know. As I've pointed out, I'm just making an educated guess and try to figure out what is probable. But, as you say, shit happens and I'm not ruling that out.

Wed, 06/30/2010 - 02:06 | 443743 Johnny Bravo
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I'd say that hyperinflation is not probable because we can still add a LOT of money to the system without breaking old price levels.  Simply put, there is not enough money in the system (and there won't be for a LONG time) to sustain the inflated levels created by the credit bubble.

I do think that attempts at reinflation are a real possibility, but there is nothing that can be done to this end without deflation occuring first.  Once deflation occurs, we should see a natural reversion to the mean.  Yet, people will not let the natural process of deflation cleanse the system to a level that is acceptable to spur new investment and growth.

Wed, 06/30/2010 - 03:54 | 443766 Seer
Seer's picture

"Yet, people will not let the natural process of deflation cleanse the system to a level that is acceptable to spur new investment and growth."

In your opinion, what level would That be?

Due to core resource depletion our existing infrastructure will either not support the new investment activity OR it will be irrelevant (to it).  While it 's possible that TPTB have some magic up their collective sleeves, the proabability is, at this point, clearly low.  So, assuming that no magic exists AND that fossil fuel depletion is as terminal as it appears (both possible, AND, given the available data, quite probable), could it be probable that no real investment opportunities, ones that would have a signficant economic lift, exist?

I would argue that not until our entire infrastructure collapses, and the controlling interests behind it,  will we see any significant "growth."  The big failing entities won't allow upstart competitors to further erode them (kind of like unions bargaining their companies into the ground); they will litterally kill our future as they attempt to hold on to their control.  But, for argument sake, let's say that a new paradigm shift was possible, how then would new upstarts manage to operate when the bulk of humanity is unemployed  (think Barbarians at the gate)?

It is, as suggested, about deleveraging.  Inflation, deflation, irrelevant.  The entire fucking infrastructure/paradigm is being deleveraged, and the velocity of this delveraging will suck everything into a black hole.

Have a nice day :-)

Wed, 06/30/2010 - 07:16 | 443864 anony
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What is an 'investment opportunity'? 

From the results of the last 30 years it appears that those so-called opportunities were nothing but phantoms, engineered by sophisticated quant squads spread over the globe, to move a great many quadrillion dollars, euros, yen and renmimbi into the coffers of a select few of tightly connected criminals. 

The 'Manufacturing' of derivatives began a long time ago, so it could be surmised that genuine investment ceased to exist decades ago and everything done in that name till now has been and is pure bullshit.

I wonder how many 'investors' who bought gold at the low still own it, how many times they have bought and sold it, ditto with stocks, and other paper 'investments'. It's probably like mortgages. The originator is so far back in the line of subsequent 'investors' as to be invisible.

You're likely right, but i'd say deleveraging has been going on a lot longer than we think by those who 'created' the leverage in the first place.

 

Wed, 06/30/2010 - 08:56 | 443951 living on the edge
living on the edge's picture

I agree with your astute observation regarding derivatives. The banksters created these pieces of shit to either unload risky bad loans or to create a casino like investment atmosphere where they knew they could profitably control the final outcome. They essentially created credit out of thin air. The problem is they flooded the world with these malinvestments and now derivatives are blowing up worldwide. Additionally we are in the early stage of lawsuits being filed against the derivative originators, and I expect this trend to continue.

There is an epic battle to re-inflate the market by the Fed but in the end deflation will rule the day. Nearly 100-years of inflation will soon end. This is not going to be pretty. The only question remaining is will it end sooner rather than later?

Regarding your question of early buyers of gold holding their investment. I can speak for myself and a handful of others and we still own every ounce ever purchased. I have no desire to sell at these prices. The curious thing is with all the talk about gold today, I still know few people that own it.     

Wed, 06/30/2010 - 07:34 | 443875 Seer
Seer's picture

You make an excellent point, and that's what is investment.  In my context it's something that facilitates a long-term, positive contribution to society.  As you note, there has been lots of investing going on which has been anything but meaningful.

And yes, I'd have to agree with you that deleveraging has been going on for a long time.  I'd reckon that it's been happening since about 1970 (when the US dumped the gold standard, and when it also peaked in oil production).

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