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For years, a rather pointless argument has been ongoing amongst economists - that of inflation vs. deflation.
The principle countries of the world have amassed a greater level of debt than the world has ever seen and, of course this can only end badly. But will it end in inflation or deflation? To me, this discussion is akin to arguing whether the sun will rise in the morning or set in the evening.
Those who predicted inflation and those who predicted deflation will both get to be right. This will be an “equal-opportunity disaster.”
Certainly, whenever there’s an increase in the currency in circulation, there will be inflation. Yet we don’t seem to be witnessing significant inflation. But, then, the massive quantitative easing that’s occurred hasn’t been widely circulated. It has, instead, been pumped into the banks, where most of it has stayed. Also, there has been inflation in the world in general, but less so in the US, as the US dollar is rising against most currencies. As a result of these factors, the traditional inflation before a crash has been limited.
The next major event in the row of dominoes is likely to be a crash in markets. Whilst it’s obvious to anyone who studies economics that the bond and stock markets are in a bubble of historical proportions, the majority of people (those who rely upon the media for their financial guidance) are vainly hoping that political leaders will come up with an economic aspirin of some sort that will make the debt problem go away, eliminating the possibility of market crashes.
But, now, we’re beginning to close in on the first crash. It’s within view and is finally giving pause even to the many who had maintained that it would somehow not come to pass. It’s beginning to look more real to the average person.
The bellwether has been a significant drop in the stock market. This drop does not constitute a crash, butnor is it an anomaly. It’s merely the first downward leg in the overall decline. There will be a correction to the upside, then another downward lurch, and so on. Decades from now, economics students will look back on The Greater Depression and their education will include a graph that begins in late 2015 – a jagged downward line than finally bottoms at or below 50% of the present level.
Plan on deflation following the crash.
Deflation always follows a crash. The dollar won’t go down right away. That will happen in the inflationperiod. (More about that later.)
Investors tend to muse that, if a market begins to decline, they will view the situation carefully and decide whether to sell some stocks and which ones to sell. Unfortunately, in a crash it’s very unlikely to turn out that way. In a crash, the price is heading south rapidly and there’s little time to ponder the situation. The investor is likely to find that his broker has made the decision for him.
When the equity in a brokerage account falls below the maintenance margin, the brokerage issues a margin call that forces the investor to either pony up more cash, or have his portfolio sold off to make up the loss. This may come as an unwelcome and badly-timed shock, but there’s worse to come. The greater downside is that the broker is not obliged to contact the investor prior to the sell-off. The broker may choose to sell any of the stocks he chooses in order to save himself, so, not surprisingly, he may well choose to sell those stocks that are not headed south, as it will be easier to find buyers.
Plan on a drop in the Gold Price
Many investors maintain in their portfolio a percentage of precious metals stocks “just in case.” This, they consider to be a diversification; an insurance policy. If the stock market heads south in a significant way, there’s every likelihood that this will drive up the price of precious metals. But, of course, in a crash, even a moderate one, this position will be the easiest one for the broker to sell. The investor may discover that, overnight, both his more conventional stocks and his insurance policy have diminished or disappeared.
In addition to the above, those who hold physical gold as an insurance policy against stocks may find that, if they depend upon the stocks for income, they cannot afford to pay their bills if stock earnings suddenly disappear. Something will have to go. Maybe it will be the family boat, or that beloved Harley in the garage. Maybe it will be the precious metals.
For these reasons, even the most adamant of goldbugs should be prepared for a downward spike in precious metals following a significant crash. And, if the overall crash is a series of downward thrusts, interspersed with smaller upward corrections, it shouldn’t be surprising if the gold price follows a similar path.
So, does that mean that gold and silver are not a safe haven against stormy economic periods? Not at all. It merely means that, in addition to the major clean-out of the gamblers and traders from the gold market from 2011 to 2015, there will be a final (and possibly very sudden) cleanout after a fall in the market. In my estimation, it will reflect the crash – the more severe the crash, the greater the downward spike in metals. However, the reverse will be true, in terms of its duration. The deeper the crash, the quicker those investors who still have cash will jump onto the gold truck. Therefore, the spike could be very brief and pronounced.
For those who have been prudent enough to exit the market prior to the crash and still be holding money in their hands, this would be an excellent time to buy gold. In fact, it may be the very best opportunity, because, at that point, it’s likely that gold will have reached its bottom and will be poised for an historic rise.
Plan on Inflation, in Addition to Deflation
At this time, or relatively soon thereafter, the central banks can be expected to fulfil their oft-repeated promise that they will fight deflation with money printing. In all likelihood, we will see quantitative easing like never before. The banks will print as much as they feel is necessary to counteract deflation. However, this will have a more dramatic effect on increasing the cost of commodities than to relieve the fear of purchasing assets. (The average person will readily buy food and fuel, but will not buy the boat or Harley that’s for sale in the driveway down the block.)
The increase in the cost of commodities will exacerbate the situation and the banks will respond by doing the only thing they know how to do – keep printing. Historically, when this happens, wages never keep pace with the rising prices of commodities, so the situation will worsen – deflation in asset prices with inflation in commodities.
Again, historically, this is a recipe for dramatic inflation that becomes hyperinflation. To my mind, this is the only uncertainty. Whilst the other dominoes described above are almost certain to fall, each in their turn, hyperinflation is the wild card. Hyperinflation occurs when the people of a country lose faith in the political/economic governance of the system. If it occurs, no government has ever succeeded in reversing it. It plays out until full economic collapse occurs.
If and when this happens, precious metals will most certainly retain their lustre and may provide a soft landing for those who have held their metals position during the doubtful times.
One caution: Since most of the traders and gamblers are already out of the gold market and most gold is now held by those who are long, the window of opportunity will be brief if a spike does occur. Whatever precious metals are on offer will be gobbled up quickly.
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Jeff is British and resides in the Caribbean. The son of an economist and historian, he learned early to be distrustful of governments as a general principle. Although he spent his career creating and developing businesses, for eight years, he penned a weekly newspaper column on the theme of limiting government.
He began his study of economics around 1990, learning initially from Sir John Templeton, then Harry Schulz and Doug Casey and later others of an Austrian persuasion. He is now a regular feature writer for Casey Research’s International Man.