Thursday, October 29, 2015

Deflation on the Horizon............

Deflation on the Horizon

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 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 next 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 precursor drop in the stock market. This drop does not constitute a major 
crash, but neither is it just a brief anomaly. It's merely the first downward leg in the overall decline. There has already been a sharp correction to the upside. 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 coming deflation will be severe and long lasting.

The dollar won't go down right away. That will happen in the inflation period. 

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. 

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 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.


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