Submitted by Jeff Thomas via Doug Casey's International Man blog [12],
In 2008, we projected that the crash in the market was in fact a mini-crash and that the day would come when a more major crash would occur - one that reflected the level of debt. In recent months, this prognostication has been gaining traction - that a second, more severe crash is inevitable.
There are two primary camps amongst economists with regard to the economic direction that a crash will generate: inflationists and deflationists.
Inflationists tend to feel that the governments of the world that are now in debt over their heads will do what governments always do in such a situation. Rather than get off the monetary heroin, they will instead increase the dosage. Inflation will then ramp up dramatically, eventually causing collapses in currencies.
Deflationists, on the other hand, argue that when there is a market crash, there will be deflation. And since the debt level is so great, the severity of the deflation will likewise be great.
The argument goes back and forth, yet there seems to be the misconception that one must be either an inflationist or deflationist. This is not at all the case.
Recently, there have been vehement arguments from some very notable people in the deflationist camp that we shall soon see major drops in the Dow—first to 6000, then to 3300. They feel that, as this occurs, there will be a further real estate crash, gold will sink to $750, and unemployment will go through the roof.
Inflationists will inevitably reply that, in the event of a crash, the central governments will print money like never before, as soon as there is even a whiff of deflation. (Their argument is strongly supported by the repeated confirmations by the previous chairman of the US Federal Reserve, Ben Bernanke, that no deflation will be acceptable to the Fed, that they will indeed print as much as it takes to counteract any possible deflation.)
However, each camp is overlooking a significant factor. The deflationist reasoning tends to lead up to the occurrence of deflation… and then stops. They rarely comment on what happens next: the influx of newly-created currency units.
The inflationists overlook the fact that, when a major crash occurs, it happens suddenly and when it occurs, it carries other markets with it. No amount of monetary printing can react quickly enough to simply cancel out the precipitous deflationary force of a crash. All that can be hoped for by the Fed and others in their situation is that they “play catch-up” as quickly as possible—injecting money into general circulation (not just crediting it to the banks, as they are now doing) to reverse the deflation and to hopefully return to “controlled” inflation.
Are we headed for a crash in the stock market? Almost certainly, and probably a more severe one than in 2008.
Are we headed for dramatic inflation or even hyperinflation? Again, almost certainly.
So what will this look like? How will it play out?
Consider the following as an order of immediate events (in brief form):
- The Dow crashes, in downward lurches, interspaced with false recoveries.
- As the crash unfolds, we will see innumerable people who bought on margin selling everything to cover their losses. (If they hold gold or gold stocks, these will be sacrificed even if the holders remain confident about gold. Their goal will be to cover immediate losses, at whatever cost.)
- Due to the dramatic selloff in gold, the price of gold plummets.
This is the deflationist argument and it is a logical one. (Popular estimates for the gold price are between $1000 and $750 as a potential floor.)
But this scenario rings true only if all those who hold gold are forced to sell.
What could actually happen might be similar to what we have seen with the unravelling of paper gold - that the development only serves to encourage those who understand gold to buy all they can. This serves to create a floor for the gold price.
There may well be sudden downward spikes that would tend to prove deflationists right, but as we now live in an electronic age, the turnaround by purchasers will be almost as quick as the crashes themselves. It may be that we will see sudden precipitous drops in gold, followed by immediate rises in purchasing - a real rodeo ride.
It is entirely possible that gold stocks will stay down longer than the gold price, and some (otherwise viable) companies may even go into liquidation. However, gold itself will not drop to $750 and stay there, as deflationists imply. More to the point, its recovery may be quite swift.
The market is experiencing a divide that didn’t exist before. Until recently, there have been many people (millions) who misunderstood gold, treating it like a stock. Many of those people are disappearing from the market (having been washed out by the paper gold failure), and soon, most of those who are still in gold will be those who understand it. The higher the percentage of gold ownership that is in their hands, the more solid the floor.
Whatever that floor may prove to be, gold will stabilise. Then, inevitable inflation will cause renewed interest in gold by the misinformed, as it begins its inflationary rise. By the time gold passes $2000, the misinformed will be falling all over each other to get back in—still not understanding gold, but desperate to ride the coattails of “a winner.” It would be at this point that we would go into a period of dramatic inflation, with a concurrent gold mania.
Whatever level of drop gold experiences as a result of deflation, gold will rise up from it like a phoenix - long before other asset classes rise.
In fact, it will lead the pack.
The question for the investor should not be whether we shall see inflation or deflation. We shall see both. The rodeo is underway and we are, whether we wish to be or not, in the saddle of the bronc. Soon, the chute will open and he’ll start bucking for all he’s worth. When he does, it will matter little whether he bucks to the left or to the right. The only objective should be to ride it out.
In investment terms, what this means is that we need to have avoided those investments that are most greatly at risk and have chosen instead those investments that are likely to be intact when the ride is over.
If we have loaded up on precious metals, in truth, it matters little if gold drops to $1000 or (gulp) to $750 as deflationists have predicted. All that will matter is whether we have had the fortitude to stay in the saddle until the ride comes to an end.
Editor’s Note: Gold is inherently an international asset because it is disconnected from any government and its value is universally recognized everywhere in the world. Buying some is perhaps the easiest step you can take toward internationalizing your savings. The next step is to store your gold in a safe foreign jurisdiction. Perhaps one of the easiest and most convenient ways to own physical gold offshore is with the Hard Assets Alliance [13]. To get a free report on how you can internationally diversify your physical gold see here [13].
