Gold - Confidence and Inflation

By: Julian D. W. Phillips | Fri, Apr 17, 2009
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"You can fool all of the people some of the time and some of the people all of the time, but you can't fool all of the people all of the time, but you can give it a good go and discredit the rest who won't be fooled!" If it doesn't go like that maybe it should?

The issue of Money.
Many are still digesting the outcomes of the G-20 meeting in London. So a thought occurred to me. If I went to my bank and asked, "May I have another loan? Oh, I know I am terribly over-borrowed already, but could you lend me my entire year's income on top of my present loans?" He would ask me, "against what collateral?" I would say, "none!" His reply would likely not come from the best of English. Now I tell him that, "I am your only client and say no and you'll go bust as well as me." Then he might smile and hail me as his financial savior too?

Isn't that what the issue of $1 trillion on top of the $12 trillion already issued as guarantees, 'quantitative easing' and the like [equivalent to the entire production of the U.S. in one year] really is? Just think of it, where is the money coming from? What collateral is being given, what repayment terms. It is simply another tranche of the huge mountain of I.O.U.'s already given, but this time to lift the lesser developed nations out of a potential Depression.

Confidence restored?
Let's face it, the financial system has broken down and still has not been repaired. Yes, steps are underway and are trying to restore the system. Yes, the banking system is being checked to ensure it will be healthy, but something else has not been repaired and remains structurally damaged. "Confidence!" Without this no matter what mechanics are applied the repairs won't work. And we are not talking about professionals in finance becoming confident, we are talking about the drivers of the global economies, the consumers. Unless he is confident going forward he will not spend freely again, he will save, reduce debt, remove his vulnerability to his lifestyle being reduced again. At the moment the repairs to the system are starting at the top not at the bottom. You may reply but homeowners are receiving assistance and seeing a reduction in the threats to their homes. This may be true, but what we are talking about here is the full restoration of confidence so that the consumer will buy houses again, they will go out and finance cars again, without that sneaky feeling that he could see them foreclosed on or repossessed. Until that happens don't expect much improvement in the overall national or international economies.

Will the present issues of mountains of money restore confidence? Only to some extent and that with such caution, that a retreat into fear can be sparked in just a day to a week. After all, confidence in the banking system has been badly mauled in the last 18 months and presently still stands on the edge of a precipice.

Can fear produce confidence?
How can the system speed up the process? Through a different kind of fear! With very few choices in the hands of governments and central banks the most obvious way forward is an unpleasant one. If the consumer is made to believe that his income will rise because of inflation and his savings further decimated by inflation, he will stop saving and start spending if only to gain value through the rising prices that his house and perhaps his car will enjoy through inflation. That would be a quicker process, moving at the same speed as inflation.

We don't advocate this path at all, but there has to be a policy of saving what can be saved and letting go of that which cannot be saved and savers will be the victims as their wealth is erased. [That is unless they switch to precious metal now and shield themselves from inflation? We do expect to see this happen, but sad to say, most investors just don't know gold and silver] Until the powers that be accept that the system is structurally faulty and rectify this, the path ahead will not be just.

Such a course will produce convincing benefits. The consumer would see the burden of debt drop as inflation pushed his income up and that sufficient for him to repay debt quicker. Institutional debt would face the same outcome enabling the system to produce a larger after-tax, cash flow and lowering of debt ratios. Yes, it would be tough on those who live on past savings, unless they hold these in the unprintable precious metals. Unfortunately the dangers are so vivid that this may well be taken as collateral damage, as was the case in the past.

In the sixties through the eighties debt re-scheduling was used in the same way to the point where such bad debt was written off and ceased to be a threat to the banks. A similar path can be followed speeded up by inflation. Toxic assets will have to be "contained" until that process is well underway, emasculating such toxicity. As inflation scythes it way through debt [and the mountains of debt we now see with the lenders of last resort have never been seen before] so confidence [likely misplaced] will be restored as the threats hanging over the consumer diminish.

So the printing of money serves a dual role.

  1. Restore the system [if only in the short-term].
  2. Pressure the consumer into spending again. Remember the target remains the consumer, so that inflation must encourage spending out of both fear and the preservation of value.

However, the entire experience of the last two years will not be erased. The system has broken down and can't be fixed in this way. All the moves to date simply restore the system to a workable one. Genuine confidence, the sort that inspires hope in the future, has gone. What is most concerning is the way the market is receiving bad news in dribs and drabs. We are aware that another $500 billion in write-downs is on the way and that the process of new liquidity flowing to trouble spots is usually inefficient, so we must expect more shocks to the system. But that takes away a bit more confidence each time and belittles any efforts made to repair the system. Can a resuscitation of confidence take place in this environment?

The consumer driven growth has been found to be wanting. It engendered a "Live now, Pay later" attitude, which has now become "lived once, now paying". And in the current environment the consumer doesn't harbor dreams of wealth beyond his means, he is in survival mode. How can one get the system right without the traumas that usually attend system reformation? Only if the short-term answers have produced an environment that takes away the traumas at the lowest common denominator of consumer, the blue collar worker level. In the Depression he was revived through infrastructural spending where he would simply be paid to work, even if that work produced few goods. In China the government has instituted massive infrastructural projects to keep workers busy and paid. This process must be on-going until confidence is restored, but across the entire world!

Effective Reformation?
One economy from history, millenniums ago, had laws that had debt written off every seven years, with property being returned to it original owners every fifty years. This prevented the building of banking and property empires and spread wealth more evenly through the nation, bringing integration to that society that made it survive and prosper on a broad front. In that economic system there was no mass production, no mass distribution system and no unemployment because of that.

But there is little will to change the current system into anything that produces that sort of result. The focus is now on to get our consumer driven system with its financial empires, restored to what it was. This implies it will remain vulnerable to what it has already experienced.

Change investing?
Consequently, wise investors have to take precautions against the potential damage they may suffer. Leveraged investing with time limits will be seen as what it is, gambling! More and more, investments will be fully paid for up-front and short-term investments relying on short-term results will be seen as unacceptably risky. The prudence of investments in assets that are at the same time assets and cash, such as gold and silver, will come firmly back into fashion and institutional portfolios.

We cannot emphasize enough the dangers of the inflation that lies ahead! Gold and Silver have yet to have their day!

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Julian  D. W. Phillips

Author: Julian D. W. Phillips

Julian D. W. Phillips
Gold Forecaster

Julian D. W. Phillips

"Global Watch: The Gold Forecaster" covers the global gold market. It specializes in Central Bank Sales and details, the Indian Bullion market [supported by a leading Indian Bullion professional], the South African markets [+ Gold shares shares] plus the currencies of gold producers [ Euro, U.S. $, Yen, C$, A$, and the South African Rand]. Its aim is to synthesise all the influential gold price factors across the globe, so as to truly understand the global reasons behind the gold price.

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