Inflation or Deflation?

By: Alex Wallenwein | Sun, Mar 21, 2004
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How about just 'Flation'?

The debate about inflation vs deflation has been raging on these precious metals fora for a long time now. Who is right? Who's wrong? Is anybody right?

Or are all of them right?

"How can that be?!!" your mind screams at me. Who ever heard of inflation and deflation occurring together? What nonsense! At the most, they will cancel each other out, leaving an economy untouched by either. A pristine, Eden-like economy that neither inflates nor deflates to any large degree at all. One of the wonders of the "new economy."


But then again, maybe not.

Until last year, nobody has ever heard of the stock market and gold market running up together, side by side, like old friends, either. But that's exactly what happened. Neither one of those phenomena put a damper on the other. So, why should it be so impossible to happen with inflation and deflation?

Greenspan was heard last year complaining there is "too little inflation." Although that may seem puzzling to the uninitiated (didn't he just get done battling the "inflation dragon" in 1999 when he started raising interest rates out of fear it might, some day, return?), old-timer gold buffs know that no self-respecting central banker can live without inflation.

Gold buffs know that the institutions those critters built were designed to create - and thrive under - a certain "tolerable" amount of inflation (tolerable to whom, I ask?).

The Case for Inflation:

As to the argument that "there is no inflation" one has but to look at the following chart showing the buying power of the US dollar since 1900:

The confusion comes from the sloppy use of terms. Nobody in their right mind would maintain that "there is no inflation" in the face of such a stark and graphic reality. What they actually mean is that the rate of inflation has slowed, and that is obviously true, as the decline shown has markedly flattened in the graph above.

"Inflation" here is simply the opposite of the dollar's decline in purchasing power. It is usually depicted like this:

(United States CPI from 1900 til 2003. Source:

One can say that, from the days of Nixon's abandonment of the dollar's last ties to gold, things have definitely gone pretty much "uphill" all the way - for the CPI, at least.

Bob Prechter is one of the main proponents out there who argue that we are currently in a deflationary depression period - we just don't know it yet. I myself, along with everybody else who has looked into the "euro vs dollar" issue, have often predicted a huge hyper-inflationary wave approaching - as the world's nine trillion reserve and trade-dollars are slowly displaced by the euro, and driven back home into the US economy by lack of world-wide demand.

Who's right?

All of us are.

The Case for Deflation:

Debt levels never before seen in human history are being piled on by US consumers, producers, and the government alike. At the same time, productive capacity and installations are moving offshore due to "free trade" policies (from the US side) and "vacuum trade" policies (from the Chinese/Asian producers' side). By "vacuum trade" I am referring to monetary policies designed to keep export competitiveness high by means of keeping the Asians' currencies artificially low against the otherwise falling dollar, thus sucking productive installations and jobs out of the US into low-cost China and other countries.

The result,. A phony "recovery" at home, paid for by consumers going deeper into hock, further boosted by a government going even deeper into hock (but that doesn't matter, because the government can always "borrow" and force the Fed to print unlimited amounts of cash which it promises to "repay" by stealing tax money from the population - an activity for which any upstanding citizen would be thrown into a prison cell forever).

Anyway, the "recovery" has been paid for by highly interest-rate sensitive debt (speak "ARMs") that cannot be repaid without sufficient job generation, and that at some point in the not-so-distant future will cause the heroic (stupid?) US consumer to pull in his severely damaged horns and spend no more. The reason: interest rates are bound to rise sooner or later, as was discussed in The Gospel of Higher Gold.

So, when that WTC-like debt-structure finally collapses, deflation will most definitely set in. Borrowers will default on loans, which will be written off by the banks, which will contract the "money" supply (somehow I always feel a compulsion to put that term into quotation marks due to the fact that what goes under the name of "money" these days is not lawful money of the United States at all, but simply "legal tender" - pure legislative scrip).

Yet, at the same time, we will have an ever-increasing tsunami, a "paper-slick" if you will of epic proportions, a flood of no-longer-used international dollars washing up on US shores, further goosing up an already goosed-to-the-max US "money" supply, which will serve to further - and this time catastrophically so - deflate the dollar's purchasing power, driving up prices right here at home to levels never before seen in the US.

Will these effects "cancel each other out"?

No. Sorry.

The Case for 'Flation':

What we will end up with is simply the worst of both worlds.

Any "cancelling out" effect that may appear will appear to a limited degree only in the money supply. Some of the "homecoming" dollars will be soaked up by the dollars destroyed by the deflationary debt collapse here in the US. But for all of it to be "soaked up" so that the result is a wash would require that ninety to 100 percent of the domestic US "money" supply will be destroyed in that coming depression.

Why is that so? Because there are about equal amounts of dollars floating outside the US as there are inside the US. About eight to nine trillion dollars on both sides of the mighty waters.

But the economic effect of rising interest rates and mounting debt-defaults during a time of continuing and mounting overall job (and therefore income) losses will in no way be alleviated by this flood of money. There will be more "money" than there would otherwise have been somewhere in the economy as a result of this returning dollar flood, but it won't be in the pockets of the strung-out consumers who can't find a job out there in this oh so productive "new economy" of ours.

This dollar-flood, however, WILL serve to drive up the prices of virtually everything around you, making the task of making ends meet even more impossible for our hapless consumer friends (who happen to be you and me).

Of course, these mounting debt defaults will cause uncounted bank and lender "reorganizations" (a nicer term for bankruptcies), and since banks are always bailed out by the government (as they are the ones who own the government), and because the government's own tax revenues will drop like a leaden duck in an empty well shaft since so many "consumers" have no income and no longer deserve that name, the government will have to "borrow" even more "money" from the Fed which will further drive up the deficit and thereby interest rates, spiraling the whole mess even deeper into the ground.

No, I'm sorry. Nobody is going to "win" this deflation vs. inflation debate. We will all suffer. There will be wide-spread "flation" all over the place, and nobody will care whether this "flation" is of the "in" or the "de" flavor.

When it finally all "flates", what will happen will be much closer to the audible effect of what we commonly call "flatulence": a rapid succession of opening and closing of a certain human orifice that makes a most ridiculous sound - except that this time, nobody will be laughing.

There will be only one way to survive this with your wealth position more or less intact: having a good amount of real money stocked up somewhere within reach - and trying whatever you can to get your family, friends and neighbors to do the same. (Good luck on that one!)

Got gold?


Author: Alex Wallenwein

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

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