Inflation and Deflation: These Strangers

By: Castrese Tipaldi | Wed, Apr 28, 2004
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Whoever had the misfortune to hold investment money in gold and silver could not be more happy that the last week finally got an end. Indeed, what a week it was!

Silver sank at one point more than 1,5 $ lower in just two days, something of absolutely amazing that has never happened before, except in the post-Hunts era. The action in gold was not much different, except for the magnitude.

This carnage in PM arena was preceded and accompanied by several articles and comments from people who was (and are, I suppose) among the strongest supporters of the precious metals' merits. As such, their latest words, as always, had an enormous impact towards the investors in this category, I guess. And these words, this time, urged caution, with various degrees of authoritativeness.

Dismissing the minor degrees, which could be synthesized with "nothing goes just up, and in 1975-76 gold had a 45% correction" (forgetting to specify that in the few years before gold went up 471%, a not so little difference with the state of art at present), I wish to focus on the remarks from Richard Russell, for the sake of the arguments I want to point out with this article: that is, inflation/deflation and silver. His comments are the following:

"Silver is a chameleon. In a inflation, silver becomes a "precious metal," and a monetary metal, and silver goes up with inflation. But in a deflationary situation silver is viewed as an industrial metal. In a deflationary environment, silver is not, as in the case of gold, viewed as money.

If we're going into a deflationary economic collapse, holding gold doesn't worry me. But holding silver would worry me."

First of all, some clarifications: it's not possible to get a deflationary environment living in a world completely plunged in a fiat-money regime.

I think that inflation and deflation are the most abused words in the economic camp, with a lot of people who use them in an improper way, creating so much confusion.

What is inflation? Inflation is an increase in the supply of money released in the system. Period!

And deflation is the contrary, that is a decrease in the supply of money infused in the system.

From this, I'd be daring to draw the following corollary: in a fiat-money regime a deflation is something that can not exist! At least in the real life. And in fact that's never happened in such a regime, and never it will.

Many refers to Japan to argue the contrary, but again it's just a confusion of terms and concepts. In Japan we have witnessed a collapse in the price of the assets, and a minor retreat in the consumer and producer price. But the release of money in the system has been relentless. And that is inflation!

There were two things a little strange in such a context: a substantial firm yen and the interest rates decreasing. But this can be explained with the fact that Japan had not foreign debt, its citizens had a huge pool of saving and its trade balance showed a cronic surplus. All things that US today can't boast of, and that's the reason why the outcome there will probably be different under this aspect.

So what Mr. Russell really meant with his expression "deflationary environment" was probably just this: an environment where the price of the financial and real assets go down dramatically, an environment where the economy recede and where the untenable debt's level is like a stone tied to the feet of the society.

But even in such an environment, that will not be deflationary in a proper sense, I repeat, because the Fed will keep on doing the only thing it knows and for which it was created, that is to pump ever more money and credit in the system, will the silver be a poor choice of investment, an asset to worry about if you hold it? I don't think so!

Even if people don't realize that silver is money, the only real money with gold, and in fact the most circulated money at all in the mankind history, I would consider it anyway the safest investment to hold also in this scenario.

This scenario would be characterized by a desperate and growing need of cash (rectius: legal tender) for people and corporations to meet their obligations, so that they'd get rid of all their other assets to obtain it, with a dramatic effect on the price of those assets. Mr. Russell talks about something similar with his remark about debt as a "synthetic short position against the dollar". So everybody will dump stocks and bond and real estates and everything under the pressure of the enormous debt. This theory surely has got sense, but will it affect the precious metals? Will the people sell even gold and silver to get an ever more scarce (for them) legal tender? Maybe! Maybe they would, but how much gold and silver american people have now as asset? The answer is very, very, very little! Very, very, very little of gold, and maybe even less of silver. The percentage of those metals in the total of their assets in this moment is absolutely negligible. So we can reasonable conclude that the effect of their hunger for legal tender can't be significant for precious metals.

Things could be different for gold and silver stocks maybe. They are first common stocks, and in a general demise of the stock markets they could certainly suffer. But I'd conclude that finally the public will come to realize why they should buy them: because of their assets! The rule in this camp is that universal one: do your own due diligence, examine the goodness of their reserves and resources and projects, and the competence and trustworthiness of the managment, so to avoid the garbage that abounds here as everywhere, the "hot-stories" full of nothing.

Even less significant, I think, that will be for the value of US dollars on the Forex. The foreigner have not obligations denominated in USD, opposite: they have a lot of rights denominated in USD. To talk about an appreciation of the US dollar, therefore, is to go a little astray; the US dollar may appreciate in relation to stocks, bonds, houses, et cetera, but I don't see how that "synthetic short position" could make a case for its appreciation against foreign currencies.

In such a scenario, Mr. Russell warn us that silver would not be perceived as a precious metals, as money, but rather as an industrial metal. And sure, in an economic recession any commodity would suffer, at least according to the common economic thinking. But I confess I'm not so comfortable with this conclusion. In general, I would strongly argue that the monetary affaire should not be eliminate when coming to determine what could be a fair price for the commodities. What do I mean? I mean this:

U.S. Debt - All households, governments, business


$ 4 trillion



$ 31 trillion


Economic expansion of 80's and 90's questionable.

Dow  + 1,000%

Debt  +  700%

Energy Consumption (barrels of oil consumed) only +34% in 20 years


U.S. money supply:

1787 - 1970

2 centuries

$600 billion

1971 - 2003

32 years

$6 trillion

1. Globally, money being printed at alarming rates. (In last 3 years: Japan +50% (M1); U.S. +25% (M2)

They are just a few quotes to realize the monetary orgy that has happened in the world in the last few decades. I could go on for a long time, but I hope I was able to make my point. But if someone wants some really strong emotions about this, he has just to check the archive of Doug Noland on Prudentbear website. Just, if you are easily affected, avoid it!

At this point, I urge everybody to confrontate the price of gold and silver, but even just that of the other commodities, then and now; after that is done, I think I can save further words.

But in the case of silver that view is even more flawed, as I see it. First, if commodities' prices go up and down just according to economic expansion or recession, could someone please explain me why silver price has been flat at best in the last two decades, a period of time where powerful economic boom took place?

Anyway, even leaving this simple question apart, the major flaw in applying that view in the case of silver, even considering it just an industrial metal, is that it fails completely to consider the paper manipulation going on the Comex, the supply/demand equation with a productive structural deficit lasting by then a decade and half, and known inventories above the ground approaching to zero. I will not dwell on this, because these things have been exposed and examined much better than I could ever do by Ted Butler, and you have just to go on his website to know the details. I'm still waiting to find someone or something contradicting seriously the resulting of Mr. Butler researches. True, a certain individual has appeared recently, trying to do that; unfortunately for him, the only thing he has accomplished is to insult Mr. Butler with no restraint, because nothing supports his conclusions but his apodictic assertions. A lot of silver all around? Just a question, baby: WHERE???

Maybe in the dreams of the Silver Users Association!

So what's happened the last week in gold and silver markets? Nothing special indeed. Just the usual flood of paper gold and paper silver sold on the markets to scare away the public and the brainless technical funds; just the usual avalanche of paper gold and paper silver hurled in the market by the usual subjects to manipulate it, gold and silver which do not exist, which they do not possess, and which in the case of silver the world will not produce in a whole year; just the usual killing of the commodity law with the speculators setting the price, with the paper setting the price for the physical. In a word: just the usual Fraud, exposed in all its glory, shameless and unpunished, under the pleased and benevolent sight of the CFTC and the Comex. Nothing special indeed.

Just the usual ambush! And every time it happens, we get of course "experts" and "economists" ready to rationalize the irrational. This time the gag was centered on the last CPI release, which showed a monthly increase of 0,5%. You would expect that such a new would boost the precious metals' price, wouldn't you? But alas you are not an "expert", neither an "economist". Because if you were, you'd realize that such increase means that maybe the Fed could be less available to keep the interest rates to the emergency level where they are now, and that would kill tangibles and would make the US dollar a "must own".

With an incommensurable effort to stay serious, I am ready to concede that the Fed will raise the rates of a quarter, half or even a full point in the coming months. I'm not so sure, but I will concede it. Will that mean a reversal in US dollar fortune, and an unsuperable shock for gold and silver? If you think so, you could go towards a lot of surprises in the future.

The Fed should increase the rates to 6% just to match the increase in the CPI (CPI is then a joke in itself; I consider it just to show how much I am temperate), 6% just to get zero real return on money. And a zero real return on money is still not a credible challenger for gold and silver. So give me a break here, please.

The true is that any increase in interest rates made just to catch up the increase in producer or consumer prices will not really harm gold or silver. As Jim Siclair points out, that would require a substantial change in the spending habit of the government, and a serious effort of monetary policy, to effectively address and reverse the monstrous deficits which now affect the US dollar system. Do you see something of similar in the near or even intermediate future? If you do, your sight is much, much better than mine!

Therefore, the usual subjects at the Comex can continue to deceive themself thinking that the fractional reserve way-of-life can be effective even in the gold and silver realm, but time will come when they will be forced to wake up, realizing that it's impossible to inflate gold and silver supply with the simple pressure on a computer keyboard. To achieve that, it's needed a lot of money, a lot of time, a lot of hard work and know-how, sometimes even human lifes are rquired, all along the production chain. And the people, the general public will realize that too. That will be a very interesting time.

I don't know if last week we have seen the last gasp of those usual subject trying to cap gold, and I don't know if we have now the very last possibility to get silver at a price so cheap. I just know that all the above the ground known silver inventories has almost gone by then, and that ever less gold is available to continue the fiction. My only humble conclusion is that in our future ever increasing amount of legal tender will be required to get some weight of real, honest money, to get some real wealth on which you can rely without to depend on the willingness and trustworthiness of nobody, i.e. gold and silver.


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