Wednesday, February 24, 2010
How We Get Out of a Deflationary Debt Spiral
Simple. Default (refuse to pay/declare bankruptcy/re-negotiate debt) and/or debase/devalue the currency (a "subtler" form of default). Don't forget the end game when you're watching the daily squiggles. In the 1930s, contrary to what you will read if you study mainstream economic texts or the current paperbug clowns (a la Krugman), the federal reserve (which is not a part of the government and does not have any reserves) made heroic efforts to stop the deflationary slide. People argue that they didn't lower interest rates fast enough, print enough new debt, or turn some other economic knob at the right time.
OK, perhaps this is true. In fact, I'll say that it is true. Because central planning of an economy doesn't work well over time (ask Russia) and can't work even with a star quarterback at the helm (and Bernanke is no star, trust me). If we gave Paul Volcker the reigns right now, the same thing would occur that is going to occur under Bernanke's stewardship of our unconstitutional central bank. In our current fiat system, printing money means printing more debt. But more debt makes things worse in the current setting when debt cannot be paid back. Of course, this won't stop everyone "in charge" from trying.
More job programs that don't work, more "stimulus" that causes only a greater stupor, more wars that only serve to increase our enemies' strength at the expense of our own, more government control over the economy that ensures it will stay weaker for longer than it needs to, and more welfare for anyone deemed less fortunate than the average Joe. Forget common sense. It won't be back for awhile.
And when things are worse five years from now than they are today, the cause will again be misdiagnosed and economists will be "surprised" as "no one could have seen it coming." The blame will also be laid on those who are long gone and no longer beholden to "the people." But the final trump card will be available and will be used at some point during this cycle, make no mistake about it.
This trump card is currency destruction. There are those who say we cannot devalue our currency in the U.S. because we have no one to devalue against as the world's reserve currency. Those who say this cannot see the forest through the trees and won't until the game is already over. If what's left of the global free market will not devalue the U.S. Dollar despite reckless government policies designed to do just that, then the trump card gets played.
This trump card has been played for centuries, whether via abandonment of a Gold standard (a la every major global economy in the 1930s), an announced devaluation of paper currency (a la the recent actions in Venezuela and Vietnam), decreasing the metal content of coins (a la Roman times and the U.S. in the middle of the 20th century) or introducing an entirely new monetary system (a la the Euro). The only lesson Bernanke learned from the 1930s is to try to devalue the currency quicker and as fast as possible so a new cyclical false inflationary boom can begin sooner rather than later! The devaluation of the U.S. currency in 1934 (i.e. Gold peg changed from $20.67/oz to $35/oz) brought back a multi-year cycle of inflation without delay. Any consequences after a few years are handed to the next group of politicians, so why concern oneself with longer term analysis?
I suspect the bankstaz have no plans to go back to a Gold standard unless bloody riots force it upon them. I am not holding my breath for such an outcome, as the level of monetary ignorance among even educated and intelligent citizens of the world is generally higher than seems remotely possible to those who have crossed over to the other side of the matrix. This leaves three outcomes in my mind that are most likely, though there may well be others.
First is a super-sovereign currency a la the Euro, whether on a Western basis (i.e. something along the lines of the Amero but with a different name) or via something from the IMF. The second possibility is a coup by one or more of the emerging economies of the world, who could introduce a hard asset-backed currency in an act of economic warfare. Such a plan could help explain why China is the first country using a paper debt-backed monetary system in a long, long time (ever?) to openly encourage its citizens to buy silver and Gold.
Finally, there is the possibility of the paper masters of the world fostering a Gold bubble. As Soros said, the ultimate asset bubble is Gold. By encouraging Gold prices to go higher, the declining value of paper money is overtly exposed to market participants and can become self-sustaining. Of course, most Gold bulls believe that this will happen with or without government assistance and I agree. Governments cannot change the primary trend, but they can distort it and current distortions serve to slow the Gold bull market down rather than speed it up.
Regardless of which of these "solutions" are chosen, and none are fair or reasonable from the point of view of we ants of the world, a debt default thru repudiation or currency defilement will economically destroy those who hold their life savings in U.S. Dollars. Don't worry, though, mommy government will take care of you after the deed is done. And, no, this unilateral policy action will not be openly discussed, voted upon by the public or announced in advance.
Because of where we are in the economic cycle, stocks are likely to lag whatever inflationary jolt can be achieved by destroying the paper promises standing behind our transactional money. This is why Gold does well during a Kondratieff Winter. The lack of confidence in the economy and government behind it leaves few good investment choices. Prechter believes the reason Gold didn't tank in the 1930s (if I understand him correctly) is because Gold was linked to the U.S. Dollar. I think he has it backwards. The reason Gold didn't soar higher in the 1930s was because its price was fixed and thus Gold was not allowed to find its true market value.
The bearishness in the retail Gold crowd is palpable right now and misplaced in my opinion. No one can predict the short term with any consistency (though it is fun to try!). Sentiment and interest in the Gold patch are at indecipherable lows despite $1000 now acting as a floor for the Gold price instead of the ceiling. Now that a four digit Gold price is cemented in market participants' minds, the only important question is related to what number will be the first of those four digits when the secular Gold bull market comes to an end. I don't claim to know, but here's a hint: it ain't the number 1, although this may be the magic number for the Dow to Gold ratio when the Gold bull peaks.