| Deflation on the Horizon | ||||||||
| by Jeff Thomas | September 21, 2015 | ||||||||
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For years, a rather pointless argument has been ongoing amongst economists - that of inflation versus deflation.
The principle countries of the world have amassed a
greater level of debt than the world has ever seen and, of course, this
can only end badly. But will it end in inflation or deflation? To me,
this discussion is akin to arguing whether the sun will rise in the
morning or set in the evening.
Those who predicted inflation and those who predicted
deflation will both get to be right. This will be an equal-opportunity
disaster.
Certainly, whenever there’s an increase in the currency
in circulation, there will be inflation. Yet we don’t seem to be
witnessing significant inflation. But, then, the massive money printing
that’s occurred hasn’t been widely circulated. It has, instead, been
pumped into the banks, where most of it has stayed.
Also, there has been inflation in the world in general,
but less so in the U.S., as the U.S. dollar is rising against most
currencies. As a result of these factors, the traditional inflation
before a crash has been limited.
The next major event in the row of dominoes falling is
likely to be a crash in markets. Whilst it’s obvious to anyone who
studies economics that the bond and stock markets are in a bubble of
historical proportions, the majority of people (those who rely upon the
media for their financial guidance) are vainly hoping that political
leaders will come up with an economic aspirin of some sort that will
make the debt problem go away, eliminating the possibility of market
crashes.
But, now, we’re beginning to close in on the first crash.
It’s within view and is finally giving pause even to the many who had
maintained that it would somehow not come to pass. It’s beginning to
look more real to the average person.
The bellwether has been a significant drop in the stock
market. This drop does not constitute a crash, but neither is it an
anomaly. It’s merely the first downward leg in the overall decline.
There will be a correction to the upside, then another downward lurch,
and so on.
Plan on Deflation Following the Crash
Deflation always follows a crash. The dollar won’t go
down right away. That will happen in the inflation period (more about
that below).
Investors tend to muse that, if a market begins to
decline, they will view the situation carefully and decide whether to
sell some stocks and which ones to sell. Unfortunately, in a crash, it’s
very unlikely to turn out that way. In a crash, the price is heading
south rapidly and there’s little time to ponder the situation. The
investor is likely to find that his broker has made the decision for
him.
When the equity in a brokerage account falls below the
maintenance margin, the brokerage issues a margin call that forces the
investor to either pony up more cash, or have his portfolio sold off to
make up the loss. This may come as an unwelcome and badly-timed shock,
but there’s worse to come. The greater downside is that the broker is
not obliged to contact the investor prior to the sell-off. The broker
may decide to sell any of the stocks he chooses in order to save
himself. So, not surprisingly, he may well choose to sell those stocks
that are not headed south, as it will be easier to find buyers for them.
Plan on a Drop in the Gold Price
Many investors maintain in their portfolio a percentage
of precious metals stocks “just in case.” They consider this to be a
diversification, an insurance policy. If the stock market heads south in
a significant way, there’s every likelihood that this will drive up the
price of precious metals. But, of course, in a crash, even a moderate
one, this position will be the easiest one for the broker to sell. The
investor may discover that, overnight, both his more conventional stocks
and his insurance policy have diminished or disappeared.
In addition to the above, those who hold physical gold
as an insurance policy against stocks may find that, if they depend
upon the stocks for income, they cannot afford to pay their bills if
stock earnings suddenly disappear. Something will have to go. Maybe it
will be the family boat, or that beloved Harley in the garage. Maybe it
will be the precious metals.
For these reasons, even the most adamant of goldbugs
should be prepared for a downward spike in precious metals following a
significant crash. And, if the overall crash is a series of downward
thrusts interspersed with smaller upward corrections, it shouldn’t be
surprising if the gold price follows a similar path.
So, does that mean that gold and silver are not a safe haven against stormy economic periods?
Not at all.
It merely means that, in addition to the major cleanout
of the gamblers and traders from the gold market from 2011 to 2015,
there will be a final (and possibly very sudden) cleanout after a fall
in the market. In my estimation, it will reflect the crash - the more
severe the crash, the greater the downward spike in metals.
However, the reverse will be true in terms of its
duration. The deeper the crash, the quicker those investors who still
have cash will jump onto the gold truck. Therefore, the spike could be
very brief and pronounced.
For those who have been prudent enough to exit the market
prior to the crash and still be holding money in their hands, that
would be an excellent
time to buy gold. In fact, it may be the very best opportunity, because,
at that point, it’s likely that gold will have reached its bottom and
will be poised for a historic rise.
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Plan on Inflation, in Addition to Deflation
At this time, or relatively soon thereafter, the central
banks can be expected to fulfill their oft-repeated promise that they
will fight deflation with money printing.
In all likelihood, we will see quantitative easing like never before.
Central banks will print as much as they feel is
necessary to counteract deflation. However, this will have a more
dramatic effect on increasing the cost of commodities than to relieve
the fear of purchasing assets. (The average person will readily buy food
and fuel, but will not buy the boat or Harley that’s for sale in the
driveway down the block.)
Historically, when this happens, wages never keep pace
with the rising prices of commodities, so the situation will worsen -
deflation in asset prices with inflation in costs.
Again, historically, this is a recipe for dramatic inflation that becomes hyperinflation.
To my mind, this is the only uncertainty. Whilst the other dominoes
described above are almost certain to fall, each in their turn,
hyperinflation is the wild card. Hyperinflation occurs when the people
of a country lose faith in the political/economic governance of the
system. If it occurs, no government has ever succeeded in reversing it.
It plays out until full economic collapse occurs.
If and when this happens, precious metals will most
certainly retain their lustre and may provide a soft landing for those
who have held their metals position during the doubtful times.
One caution: Since most of the traders and gamblers are
already out of the gold market and most gold is now held by those who
are long, the window of opportunity will be brief if a spike does occur.
Whatever precious metals are on offer will be gobbled up quickly.
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