Clearing Up a Misconception (as if this were possible)

He said, “Rod, you’re loaded up with gold, right?”

I said, “You think gold is going to go up?”

He said, “Heck yes, with all the money the government is printing now, inflation is going to soar, and gold along with it!”

This is a very smart businessman telling me inflation will be a problem, an article of faith he shares with every sentient being in the universe, it seems. I’ve heard it from all kinds of people, including any number of financial professionals. “With all those dollars the Fed is pumping out, it’s just a matter of time before inflation rears its ugly head!”

Offhand, I can’t think of anything more wrong, or backwards. We are in the midst of a horrendous financial environment, but it is a very destructive deflation, not inflation. Deflation started six years ago and it will persist for another twenty years or more.

The Federal Reserve Bank, a privately owned institution, can and does create more money when it buys bonds from the government and pays for them with new deposits to the treasury’s account. But the government’s obligation to redeem those bonds at maturity offsets the “new” money. If the government cannot pay off the bonds, the money disappears into thin air. The Greek government just defaulted on a hundred billion dollars worth of bonds. That money is gone, no longer available to levitate the price of spanakopita.

The same thing takes place throughout our commercial banking system when banks lend against deposits. With fractional reserve banking, banks only keep a small reserve against loans so, in effect, most of their loans are with money that is not there, which is the real inflation.

The textbook definition of inflation is an expansion of lending, which results in rising deposits, increasing the demand for goods. Lending activity has been expanding for over sixty years, which has driven price rises for most everything. Lending cycles are very long, but when they reach an unsustainable level, deleveraging (deflation) gets underway and it doesn’t stop until great masses of borrowed money disappear through paydown, foreclosure, default and bankruptcy. Loan expansion peaked in the US six years ago. Check what you might sell your  home for today and compare it with comparable home sales in ’05. Deflated, right? Now check out the chart below:

 The previous deleveraging cycle in the US was between 1933 and 1952. There were no meaningful price rises during that time. Oh, broccoli might be higher one season over the other owing to crop failure or an infestation of weevils, but the broad economy did not experience price inflation because lending was contracting.

We are in a new cycle of deflation. It is one degree of trend higher than the 30s, a Grand Supercycle deflation versus a “mere” Supercycle event. For at least the first few years of this era, gold, stocks, real estate, commodities, collectibles, art and anything else that passes for an investment vehicle will lose value against CASH, the asset investors presently love the least.

Not that I expect anyone to believe me.



The author makes no representation as to the accuracy of the quoted material, but believes the sources to be reliable. No one should consider any part of this presentation as a recommendation to buy or sell any securities whatsoever.





This entry was posted in Economy, Socionomics. Bookmark the permalink.