Hello Jay: In light of the quote below from today's newsletter, if one is convinced of coming deflation, then one should not own a single gram of gold, since, although it increases in purchasing power, it decreases in real value dollar price; ergo, one should own dollars exclusively to maximize one's wealth/buying power. The oft-quoted example of Homestake Mining indicates that a person should own quality gold producers in a deflationary environment but not physical gold.
I understand it is difficult to predict whether we will have deflation, inflation, or stagflation, and that, in any event, all people should always have some physical gold as a form of insurance. Regarding deflation, I must admit, I somehow can't wrap my head around the idea that a symbolic, intrinsically worthless piece of paper, which is being rather abruptly pumped out and distributed to corrupt elites
(redundant) in the trillions in secret, should suddenly start to gain in value against gold. Is this because the trillions end up with the Rothschilds (of course), and the money supply for the rest of us is actually contracted? But I thought that with each fiat dollar printed, the value of each existing fiat dollar goes down incrementally, regardless of where the dollars end up, since the overall number of dollars in existence has increased. And in the present and future environments fiat dollars will be increasing in the trillions. Best regards, Kim Cochrane, Tokyo
Editor's response: I cannot agree with your statement that one should not own gold bullion in a deflationary depression. The reason I believe that is untrue is because of the concept illustrated on John Exter's inverse liquidity pyramid, shown on your left. During times of a deflationary crisis, like now, the scramble is on for liquidity. Items that became very expensive during the credit expansion are represented at the top of this inverse pyramid. However, when the credit system begins to shrink and implode, as is happening now, the margin clerks begin calling in the debt. A rush develops to sell those most illiquid items, thus causing a collapse in prices. The trend is to exchange illiquid goods for Federal Reserve Notes, but even more so for gold. Indeed, this has been happening of late, has it not? Even as the dollar has been one of the strongest fiat currencies, gold has been gaining, vis -à-vis the dollar! Not only gold stocks have done well; gold bullion, too, has been very strong against the strongest currency.
Why? Because gold is viewed as the ultimate safe haven and the ultimate liquid asset. Even though governments and bankers work very hard to discourage people to use gold as a medium of exchange by taxing its sale, it nonetheless is highly sought after when the financial system comes under duress, as is most certainly the case right now.
With respect to how deflation can actually happen when so much money is being printed, you only need to go back to the 1930s to understand what is once again happening now. With the system expanding with endless amounts of debt, it finally has reached a limit where more debt money can no longer stimulate growth. Why? Because there are few creditworthy borrowers. Logically enough,
banks won't lend to people and companies that cannot pay them back, though there is now totalitarian talk from politicians who would force banks to lend. In fact, not only are banks not lending, but also, credit is shrinking because of defaults and repayments taking place faster than new loans are being made.
You have to remember that in our fractional reserve system, money is always an illusion to begin with. So it doesn't really matter what bank reserves are, if the banks can't multiply the money supply by taking that high-powered money and lending it out. It isn't high-powered money if banks won't lend and people won't borrow. So, I go back to Exter's inverse pyramid to explain what is
happening. As debts cannot be repaid, loans are called, resulting in the forced sale of illiquid asset, thus putting downward pressure on those items. Government can deficit spend, but what I am seeing so far is that their expenditures are not taking place nearly fast enough to counter the enormous wealth destruction that has taken place, especially since the Lehman Brothers collapse in September
2008. Indeed, I think Ian Gordon's understanding of the Kondratieff winter explains it all. At some point during a long period of credit expansion, debt grows and grows, to the point where the system cannot handle any more of it. Repayment of the debt combined with interest obligations simply brings the system down. I think that may very well be where we are now.
But why does the value of gold rise, even as huge amounts of new money are being pumped into the banking system? The reason is that when you borrow money in a currency and then exchange that money for a good or service, you are taking a short position against the dollar. But here is the point. When you reverse that trade as you do in a credit crunch, you are covering your short position.
In other words, the repayment of a loan is bullish for the currency, because it increases the demand for the currency.
Guess which currency has the most debt in the world and thus the largest short position? Guess which currency stands to gain the most in a global deflation? Of course it's the U.S. dollar, which is the world's reserve currency. The strength in the dollar has nothing to do with a vibrant and strong economy. Much to the contrary, it has to do with an imploding economy that is choking on way too much debt.
But again, gold is the optimum liquid and safe asset, because its value is not dependent on someone else repaying their debts. Even the U.S. government has limits on how much new money it can create to repay its debts. Gold's value is not burdened by any such frailty.