Inflation or Deflation?

Inflation or Deflation?

An interview with Bud Conrad, Casey Research chief economist

The following interview, conducted by Louis James, a senior analyst and editor with Casey Research, appeared in the March 08’ edition of Casey’s International Speculator.

Louis James (LJ): The first question we think most readers will want to know about is this: if the U.S. is headed for recession – if not already sliding into one – do you really think we’re facing more inflation in the near future, or could falling spending power cause deflation?

Bud Conrad (BC): There are strong deflationary pressures in a credit collapse because as housing prices drop and defaults rise, some of the ability to buy new items is lost. Traditional analysis suggests that we could have deflation such as that which occurred in the Great Depression in the U.S. in the late 1920s, early 1930s. I would point out, however, that in the Great Depression the dollar was linked to gold, limiting the amount of money printing that could be done, a limitation that does not exist today. In addition, with $100 oil it is hard to argue for deflation. My base prediction is that we are heading into an inflationary period.

LJ: If there was any doubt about inflation vs. deflation, has it been settled by the central banks of the world as they responded to last summer’s credit crunch with greater liquidity?

BC: Yes. That is the point. The governments and their central banks have no limit on how much money they can create since there is no tie to gold or anything else. It is only logical to expect them to take the easy road and print money. The result is predictable. New government bailouts for whatever problems arise are going to continue.

LJ: With war spending, ballooning entitlements, a crisis of confidence in the U.S. financial system stewing, along with many other woes, do you think there’s any chance that the U.S. will not try to inflate its way out of its current economic predicaments?

BC: In a word, no. Inflating its way out of problems has become the default solution for the U.S. government, and governments around the world. Consider, the price tag for the wars in Iraq and Afghanistan is now credibly estimated at $3 trillion. The economic stimulus package passed by the U.S. Congress will cost $150 billion, which will come on top of slowing tax receipts due to the recession, confirming that the U.S. budget deficit will jump to $400 to $500 billion this year.

That kind of deficit will put yet more pressure on the dollar due to the expectation that the government will inflate the dollars to pay for the deficits, as well as further bailouts that may be required as the credit crisis continues to unfold. And just over the horizon, it gets worse because of the unsustainable costs of the entitlements due to the 76 million baby boomers now beginning to look to retirement, and for their government medical payments.

As governments don’t actually produce anything, paying for all of this will have to come either in the form of direct taxation, which has well-established limitations past which it becomes counter-productive, or from indirect taxation, in the form of a steady erosion in the value of the dollars that will be used to meet the government’s many obligations. In other words, inflation.

LJ: There’s a view among many observers that U.S. trading partners will have to devalue/inflate their own currencies, or their own economies will be slammed by a loss of competitiveness of their products in U.S. markets. This could spill over to those countries that supply raw materials or labor to the first tier of dominos. Do you think such a “race to the bottom” is likely? Our survey finds almost universal inflation around the world, and it seems to be accelerating in most places. Is the race happening already?

BC: Again, yes. The Asian exporters want to expand trade to keep their workers employed, and are trying to accomplish that goal by supporting the dollar with unwise, outsized investments in dollar-denominated investments like Treasuries. As a result, our foreign trading partners have accumulated $6 trillion of such assets, an unprecedented level of holdings.

This circular investment strategy – in which we buy from foreigners and they reinvest in our government paper – has provided the capital for the U.S. economy that our domestic saving has not been able to provide. In the process, it has kept a lid on consumer prices here in the U.S. for over a decade, essentially exporting inflation offshore, along with our manufacturing. But the net result is that the U.S. has done the equivalent of selling off about 23% of its tangible net worth to foreigners, leaving the system at risk of collapsing.

If there is a positive, it is that we have an environment that evokes memories of the long-standing military strategy of Mutually Assured Destruction, where no one wants to be the cause of collapse. The Chinese have pegged their renminbi to the dollar rather than let it rise, and that has fostered inflation that is over 6%. The Persian Gulf oil states that peg their currencies to the dollar suffer the weakness of the dollar, causing higher internal inflation.

The world money supply is growing faster than the production of “stuff,” resulting inevitably in less purchasing power for all currencies. How much longer this is sustainable is hard to say, but the odds increase every day that foreign holders of dollars will come to believe that the U.S. government is willing to sacrifice the dollar, and then they will begin to unload dollars in earnest. There are signs of this happening already, with the Chinese and others using their considerable dollar reserves to buy up large natural resource deposits, even shares in U.S. corporations. In other words, tangible items.

LJ: What other factors do you think might mitigate or exacerbate inflation worldwide? Do you think the overall trend will be for increasing inflation that will continue for some time, or are there mitigating factors that might slow it?

BC: The slowing of world economies we expect in the mid-term may somewhat mitigate inflationary pressures. However, as we also expect governments to react as they always do when faced with an economic downturn – namely attempting to stimulate growth through further monetary creation – this will only plant the seeds of much higher inflation over the next decade.

LJ: Do you think robust economies like China’s can handle whatever inflation is likely ahead without too much trouble – or is this a serious worldwide storm that’s brewing?

BC: The storm is worldwide. China depends on Western countries to buy its exports and there will be convulsion from overcapacity in an economic slowing. They are not immune to U.S. slowing. The Shanghai stock market that went from 1,000 to 6,000 has already pulled back to 5,000 with some anticipation of further slowing. The world is not decoupled; it is even more coupled than ever. But on an inflationary view, China has strengths, most importantly goods that the world wants to buy, and that results in a trade surplus.

LJ: Can you think of any countries insulated enough from the spreading loss of value that it makes their currencies safer places to put cash? Switzerland?

BC: I look to the countries that are rich in natural resources to maintain an edge because of the commodity boom. Russia is not a safe country from an investment perspective, but their oil has given them a completely new life. Canada has benefited greatly from the natural resource boom and should continue to do so.

LJ: It’s clear from the research you’ve done that the advent of a pure fiat monetary system in the early 1970’s has triggered a significant increase in monetary inflation, but why hasn’t that caused a greater level of price inflation than we have seen in recent decades?

BC: Well, we have seen it, but most people don’t seem to realize it. The U.S. dollar has lost 81% of its value since 1971. Bad as that is, it would have been much worse, if not for the Chinese and others buying our treasuries. That, in effect, funded our deficit spending and exported our inflation to their shores. Look at the inflation in China: it’s headed higher. Their purchasing our
government and corporate debt was like a vendor financing program for the sale of their exports to us. In effect, they loaned us the money to buy their goods.

We haven’t faced the ominous task of paying off what is equivalent to a maxed-out credit card; and when we do, it could spell disaster for the dollar. We have imported Asia’s computers, TVs and clothes, produced with their cheap labor, keeping our price indexes lower. The bubbles of foreign investment capital went into the pool of financial assets supporting our stock markets and housing markets, which certainly had big price inflation, but which are not included in the common price measures of our inflation like our Consumer Price Index. Just applying the methods used in 1980 for the CPI, before the government adjusted the statistics, would suggest that the dollar of 1971 is worth about 7 cents today.

The Chinese and Japanese have actively supported the dollar to maintain their exports, but should world dollar holders reverse course, a floodgate of even worse inflation could come from too many foreign holders all wanting to exit the dollar at the same time. That almost happened in August 2007. They stepped back from the potential melt-down, but it’s still not safely removed from our future.

The process is on the track for even more price inflation in the future, because more people will be waking up to the sham of tissue paper money.

LJ: General loss of value among fiat currencies is obviously good for the price of gold and the kind of investments we have been recommending here at Casey Research. Do you have any other suggestions for investors who believe that inflation of major world currencies is “baked in the cake”?

BC: Watch out for agriculture price rises. A situation you might call Peak Food is developing. We have the lowest supplies of grains ever compared to usage. The prices of wheat, corn, soybeans and rice are all double from what they were a year ago. Dangers of energy shortages leading to food shortage are growing daily and are not widely enough understood. Rising food prices will be important additional drivers of inflation across the planet this year.

LJ: May we ask what you’re doing with the cash in your own portfolio?

BC: I am, not surprisingly, overweight in precious metals.

LJ: Any final comments?

BC: I usually confine my analysis to economic measures, but the world political situation is extremely important and intertwined with the economic consequences. As we look at Asian ascendance, and their expanding importance on the world scene, we should be aware of the dependencies of their claims on our assets.

Similarly, the competition for resources is likely to continue, and the worries over peak oil probably have much to do with our presence in the Middle East. How these unravel is a bigger discussion than we have time for here, but I urge watching the international landscape almost as much as our own internal actions, as the outside forces will direct our future as much as the decisions at home.

***

Bud Conrad, chief economist at Casey Research, is a regular contributor to the International Speculator, Casey’s monthly flagship publication. The International Speculator focuses on undervalued junior exploration companies in the gold and precious metals sector that provide the very real possibility to generate double- or triple-digit returns within 12 to 24 months.

You can try it now risk-free, by taking advantage of Casey’s 3-month trial subscription with 100% money-back guarantee. Click here to learn more.

Recession, GDP and Inflation

Recession, GDP and Inflation: Conventional Wisdom or Data

By Bud Conrad, Casey Research

 That we are moving into – or already are – in a recession is practically a given. But what will it be: inflationary or deflationary? Casey Research’s Chief Economist Bud Conrad weighs in with his findings…

 The debate is coming to a head over whether we will see inflation or deflation. Will the coming recession bring deflation from the housing-related credit crisis in which many forms of debt are disappearing in default; or will the lack of confidence in the dollar and the government stimulus bring us inflation?

 The consensus of economic opinion is that the recession that is just starting could lower demand and thus bring a lowering of prices. “It’s just like Japan! Credit collapse is like the Depression! Those were deflationary!” say many respected practitioners of the dismal science.

 Some deflation! Crude over $100; wheat hitting $25 a bushel; gold at $970. What is going on? Yes, housing is dropping 7% in price, and the stock market is back and forth going nowhere. So which is it? Inflation or deflation?

 I always say “Let’s look at the data.” I have been looking at previous recessions to see what happened to gold and gold shares in the last two issues of BIG GOLD. Here I just look at the Real Gross Domestic Product, which is the biggest measure of how well our economy is producing wealth, to compare to the inflation level. I use the most quoted government inflation number, the Consumer Price Index (CPI).

  During periods of recession, the GDP was falling – no surprise there, as that is sort of the definition of recession. But look at the inflation. It wasn’t falling during recession, it was higher. In two of the seven recessions someone might argue whether or not it was higher, but it wasn’t noticeably lower. It is amazing how convincing a look at history can be.

 We have been describing the “Rock and a Hard Place” problem for the Fed, in that if they lower interest rates, the dollar collapses and eventually inflation appears; or if they defend the dollar with higher rates, then the economy collapses. This analysis shows just how serious the bind is. Historically, when inflation jumped, mostly spurred by the big oil shocks, we saw both big recessions as well. At the time, it was acknowledged that the commodity shock caused the recessions by driving inflation and interest rates higher.

 So the stagflation is really not so new or rare an occurrence. I have been predicting this for a long time. We are now there. Bernanke’s performance has been lackluster and not inspiring confidence, to say the least. He might as well have said “Let the dollar be dammed, full speed ahead with the helicopters.” Instead of a determined, cigar-smoking disciplinarian like Volcker, he just looks weak.

 To some extent history has already predicted the result, so it is really beyond one man’s attempt to push a lever behind the curtain. Really, there’s not that much for him to do but watch the dollar collapse and the U.S. economy to slow. Stagflation.

 Bud Conrad is Casey Research’s chief economist and a regular contributor to BIG GOLD, a monthly advisory for the more conservative resource investor. BIG GOLD focuses on large-cap gold producers and near-producers, gold mutual funds, ETFs and much more.

 With gold now up over $970 an ounce, the investing masses will soon catch up to its timeless value as an inflationary hedge. When that happens, BIG GOLD subscribers will already be well positioned to benefit from the incoming tide. Sign up for a risk-free trial subscription with 100% money-back guarantee today and take a full 3 months to decide whether BIG GOLD is for you…

 Click here to learn more.

Stock Market Down – Need Short Ideas?

The Stock market is heading down. Losses anyone?

Now is definitely the time to be shorting certain stocks or even the market as a whole, but who knows what to do?

Casey Research has a team of experts, and it isn’t just precious metals stocks and resource stocks that they know. Casey’s own Bud Conrad gave us some timely shorts of stocks like MBIA and AMBAC last fall.. before their fall!

In the just released issue of International Speculator, Bud gives us another short tip; one that performed well today for those who took his advice right away (up 8.5% just today!).

How Will Gold Perform In A Recession?

Will Gold Crash in a Recession?

By
Bud Conrad and David Galland, Editors

BIG GOLD from Casey Research

From the 1990s until today, Americans have maintained their life style by borrowing.
As the American consumer is about to find out, the bill for that life style is coming due.

 

So where will that lead the U.S. economy? Simply stated, surveying the landscape of current events, many of which are a direct consequence of excessive debt and an inevitable slowdown in
consumer spending, we expect stagflation ahead. Loosely defined, that term refers to a general economic slowdown – a recession – but coupled with rising prices triggered by massive infusions of liquidity into the market.

That liquidity can come from governments – witness the billions upon billions now being thrown into the fray by the world’s central banks – or it can come from, say, some percentage of the 6+ trillion in U.S. dollars held by foreigners coming home to roost. On that latter point, in recent weeks there has been almost daily news about foreign corporations and sovereign wealth funds unloading their greenbacks in exchange for shares in some of America’s largest financial institutions. Doug Casey has correctly pointed out that it is when the trade deficit starts to shrink, which it recently has, that you need to look for cover… because, among other things, it means the tide of U.S. dollars is beginning to wash back up on U.S. shores.

Our view that the stagflationary scenario is the most likely is supported by a steady stream of data. For instance, despite an obvious slowdown in 2007 holiday season shopping, the Bureau of Labor Statistics reports that producer prices in November increased at the fastest rate in 16 years.

Rising prices make a stagflationary environment positive for gold, if for no other reason than that investors reallocate depreciating paper-backed investments into tangibles with a demonstrated ability to float as the intangibles sink.

So, our view remainsthat we are headed for a stagflation. But what if we are wrong?

What happens if the global economic crisis gets so bad that it trumps any and all inflationary influences and we enter a straight-up deflationary recession? That is, we are sure, a question on the minds of many gold investors.

Some quick thoughts…

Gold in a Recession

Traditionally, gold has been a safety net against inflation. Inflation is good for gold, a case we don’t need to make again here. But, in a typical recession, the demand for everything slows and the prices of many things fall. The knee-jerk reaction of most casual market observers, therefore, might be that if inflation is always good for gold, then the opposite is always bad.

Historically, however, that is not the case. The chart below shows the price of
gold overlaid against official periods of recession as defined by the National
Bureau of Economic Research. As you can see, about half the time gold actually
rises in a recession.

(Note: this chart uses monthly averages, so you can see that current prices are, in nominal terms, higher than the 1980 high, based on those averages.)

 

Simply, there isn’t a specific historical precedent that demonstrates that gold will fall during a recession. But could we have a general deflation, one that might tip gold into one of the down cycles? Of course.

The developing recession, based as it is on a global contraction in credit, looks to be especially long and deep. Almost daily now we learn of multi-billion-dollar debt defaults. Those, in turn, trigger both a freeze-up in easy credit and a flight from risk.

In response, the government has responded with its predictable “fix-it” tools – stimulus and bailouts. The tools of government stimulus are lowering the Fed funds interest rate, and potential new large-scale bailouts like the Resolution Trust Corporation (RTC) that was put into action to straighten out the Savings and Loan crisis of the 1980s, to the tune of $200 billion. While the Europeans have just unleashed an amazing $500 billion in new liquidity, so far, U.S. Treasury Secretary Paulson and Fed Chairman Bernanke and friends have been surprisingly slow to act. They started with denial and have moved to inadequate band-aids.

In the absence of any concentrated and well-funded program – such as the RTC – to try and keep the wheels on (and, at this point, it is not clear that any imaginable measure will suffice), the deflationary pressures of the housing collapse are winning.

But there is an important, longer-cycle pressure that is not talked about much, although it is increasingly obvious to the American consumer: the dollars they’re spending are buying less. They see gasoline and heating prices rise, but don’t think much about the dollar itself as the underlying source of price inflation.

This decline in the purchasing power of the dollar is extremely important for the price of gold. That’s because the pressures on the dollar seem overwhelming when aggregated: huge budget and trade deficits, wars and retirement demands of baby boomers, unprecedented foreign holdings of U.S. dollars. Watching the prices of internationally traded goods, including oil at $90 per barrel and
wheat at a record $10 per bushel, it is hard to imagine a situation of serious deflation emerging.

Looking for Alternatives

The flight to quality by investors who no longer trust packages of mortgage loans, or anything that is not strictly labeled as government backed, is unprecedented. The interest rate on government-issued two-year Treasuries dropped to 3%, reflecting the demand for safety. Concurrently, other interest rates have risen in response to increasing mistrust and uncertainty.

Gold, of course, provides a different form of safe harbor alternative – an asset that is not only readily liquid but, unlike government paper, positively correlated with the very same inflation that will erode the purchasing power of paper assets.

Right now, gold is not on the front burner, but this is only to be expected because of the state of flux of global financial markets. Like observers of a war of Titans, the market is confounded by the sheer magnitude of all that is going on, from the devastation being wreaked on the world’s best-known and most established financial institutions, to the unleashing of billions upon billions
in experimental new liquidity measures by central banks. As the fog of war begins to clear and it becomes obvious that not only will economic growth be severely curbed, but that the fiat currencies are going to be sacrificed in the fight, some percentage of the funds now sitting on the
sidelines – much of it in U.S. Treasuries – will begin to move into gold and other tangibles. In the face of limited gold supplies, this surge in demand should create strong upward pressure on the price of gold and, for leverage, gold shares.

In sum, even though the relatively sluggish and inept responses from the U.S. government in the face of the current credit crisis could produce a severely slowing economy, creating periods of deflationary fears that put stress on the price of gold, we continue to believe that the most likely case is for massive inflationary bailouts that support a positive outlook for gold.

 

Bud Conrad and David Galland are, respectively, the chief economist and managing editor with Casey Research, publishers of BIG GOLD, an inexpensive monthly advisory dedicated to providing unbiased and actionable research on simple, effective and cautious ways to participate in rising gold markets.

Each month subscribers receive a comprehensive but comprehendible overview on the economy and gold markets, plus detailed recommendations on the best ways to invest, including
producing and near-production gold stocks, mutual funds, gold ETFs, e-gold alternatives and much, much more.

Free BIG GOLD Report
As a special offer for readers, and so you can see the value of this unique publication for yourself – for a limited time – Casey Research is making a BIG GOLD special report available absolutely free of charge. “The Golden Triple-Play: A Gold Stock, Mutual Fund and ETF” contains everything you need to know about profiting from three of today’s best gold investments.

To learn more and to request your copy of this free report, click here now.