Deflation; where is it?

I’m going out on a limb here.

Deflation is doing what it usually does except that this time it is manifesting itself in the price of gold rather than in the value of a currency. In other words, it looks like we’re about to lose one or more currencies along the way….

A bon entendeur….


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8 Responses to “Deflation; where is it?”

  1. James Says:

    Yes, sovereign purchases and physical delivery have been stepping up over the last two years, but I tend to think – and granted, I am not anywhere near as engaged in the markets as you seem to be – that a lot of what is pushing gold up now is speculation and fund investments (as bonds are both weak and somewhat risky and stocks are volatile).

    Maybe why you didn’t understand me is that I think there is a difference between gold price benefitting from deflationary pressure and gold “assuming the role of currency”, and my comments, even though I couldn’t have stated it as such, were coming from my emphasis on the latter. Now, with that in mind…

    My original question had been – and please correct me if I am misguided – how can we tell at this point whether gold is showing deflationary pressure or if it is simply being driven by increased short-term investment being funneled to it at this time? For your theory to prove correct as I first read it (before your response), would we not, in addition to simply a rise in price or even a combination of price rise, sovereign purchases and physical delivery, also need to see a concurrent drop in stock prices and rise in bond yields?

    Forgive me if I make no sense – I am no economist, nor am I particularly market-savvy. It just seems like those things should go together if we are truly seeing deflationary pressure in the price of gold.

    As for your reply, your point that “gold is assuming the role of currency” certainly would give credit to your deflation theory, so long as that assumption of role continues and intensifies.

    On another note, would you explain the following: if all the major central banks are engaging in QE at roughly the same pace (just for discussion let’s assume that), why would some countries’ currencies be headed for destruction? Would they not all be inflating at comparative rates and therefore be able to float the whole fiasco for some time yet, until the individual debt burdens became unbearable or the people demanded change? I know that initial factors such as creditworthiness, debt-to-GDP, bond yields and purchases, etc., would play a part, but wouldn’t they all be able to inflate together?

    • guidoamm Says:

      Thank you for taking the time to reply. I assure you I am not an economist either. My only claim to fame is an interest in history and a sense of observation from which I derive my investment strategy that I hope help me make a living and allow me to set something aside for my old age.

      Gold has traditionally been a safe haven investment particularly during times of credit/currency stress. Personally, judging from the last thirty years alone, I don’t see that gold has ever been an inflation hedge. If that were the case, gold should have gone through the roof throughout the 80s and 90s when deficit spending really got going and sovereign debts exploded. A better inflation hedge would have been the stock market and, indeed, people like Warren Buffet have greatly benefited from inflation in their investment strategy.

      Whether gold is rising on speculation or investment really makes no difference. Both the stock market and the real estate markets had been rising for exactly the same reasons for many years. Investment and speculation are always looking for the next vehicle because nothing goes up forever. Just in the past twenty years we have moved from technology stocks to the real estate market; and the pattern is always the same – you start off with investors that invest due to fundamental reasons and then you have the speculators that move-in till they become the only and ultimate drivers. Thus, the next vehicle is such because circumstances change. Otherwise we would all keep investing or speculating in the same vehicle forever. And although I grant you that there may be speculation in gold, I tend to think that we don’t really have excessive speculation till your average cabby or secretary is talking about making money trading gold and gold mining company shares.

      My central thesis is that inflation conforms to the law of diminishing returns thus is limited mathematically.

      My observation is buttressed by various metrics such as the Money Multiplier or Tobin’s Q Ratio or any ratio of Debt to GDP.

      Keeping in mind the logic inherent in a fiat monetary system, I contend that as the monetary authorities find it progressively more difficult to generate inflation the inverse result is ever closer sovereign bankruptcy hence the need for ever more creative financial gimmickry.

      Now! Unlike a bout of deflation during the overarching inflationary cycle when the purchasing power of the currency would increase, deflation at the end of the inflationary cycle brings about the destruction of the currency.That’s because as inflation loses traction (increase in GDP) the authorities employ ever more intensive strategies in an attempt to reflate (i.e. bailouts and Quantitative Easing). But inflation pushing the limits of its “beneficial” effect, both bailouts and QE fail to stimulate credit expansion thus there is no demand thus no production. Inversely, what bailouts do at this stage, is increase overcapacity whilst QE encourages investment in sectors that don’t need it. Hence the reason that most QE ends up as excess bank reserves; i.e. it is money sitting in banks rather than being borrowed by economic entities for productive use. As this dynamic develops and accelerates, the currency suffers and economic actors progressively move into vehicles that allow them to preserve if not increase their purchasing power.

      In my opinion, whether the purchasing power of gold increases due to deflationary pressures on the overall economy or due to currency destruction is the same thing.

      How can we tell? Personally, I can’t tell and I am unsure anyone can. What I can see is that the purchasing power of gold is increasing to the detriment of all major currencies. But I can also see that gold’s purchasing power is outpacing the major markets AND, most importantly, gold has trounced that most sacred of safe havens, the United States Long Bond that, in terms of gold, today is back at 1980s level.

      Not sure you’ve taken a look at the charts I maintain on stockcharts? Here’s is the link again in case you haven’t seen it:

      Regarding your last question. Both the US and Europe are indeed trying to float the whole fiasco and they have been “successful” for a few years. Success is relative of course. Refer to the charts above. Debt burdens are already unbearable. That’s why we have bailouts and QE. The people are already asking for change witness the Tea Party and witness the social unrest in Europe. It is only a matter of time till the people demanding change will organize in a more effective fashion…. trouble is…. that when society organizes to ask for change it usually spells revolution….

      All governments and all monetary authorities are indeed inflating together… but inflation has a very real limit….

      Gold is telling me that something is about to give… what it is and where I cannot say… but something is to go “bump in the night” me thinks.

    • guidoamm Says:

      … and by the way… I did say I was going out on a limb on this one….

      • James Says:

        Granted, you did. And I don’t think you’re wrong – I guess I’m just trying to figure out where we go from here and for how long prices are going to make it LOOK like you’re right. However, your charts certainly paint the picture.

        Do you know of others who have written about the end of the inflationary cycle in fiat systems? We’ve had inflationary cycles before, but never to this degree with worldwide fiat systems, so this should be kind of a new thing and I just wondered if anyone else had the prescience to see things like excess bank reserves signalling the monetary saturation of the economy.

        • guidoamm Says:

          Most links in my blog-roll will take you to bloggers that offer what I consider constructive observations on where we are, how we got here and where we might be going. Some of the people I link to see an inflationary outcome but offer valuable technical and fundamental analysis nonetheless.

          I am like everyone else. Just trying to survive as best I can. We all see the same technical and economic information but we all draw different conclusions. Sometime the outcome we predict is similar but the path varies.

          Much to the delight of our Chinese friends, we are living in interesting times.

        • guidoamm Says:

          I seem to have missed this FT article of a few days ago about more central banks becoming net buyers of gold:

          A note of caution here. It is always a warning sign when the main stream press begins to catch on to a new trend. Granted this is the Financial Times that is not exactly main stream for the great unwashed and granted too that gold positive news is not yet pervasive even in the specialist press…. yet. But it is a sign of incipient change in attitudes nonetheless. On the Defcon scale of urgency, we are now at Defcon 4 in terms of when we should be bailing out of gold investments.

          By the time you will see popular TV chat shows singing the praises of investing in gold, or popular sit-coms mentioning gold, or you hear waiters in restaurants and secretaries and travel agents or teachers talking about gold investments, that’ll be the time to start reducing your gold investment holdings. By the time gold appears as a steady ticker and the price of gold is discussed hourly on CNBC for a few months you will know we’ve reached the end of the viability of the investment. That will be your Defcon 1 signal.

  2. guidoamm Says:

    Not sure I understand your question/statement

    There is already confirmed evidence of sovereign accumulation – i.e. Saudi Arabia, Hong Kong, China, Philippines and though unconfirmed yet, also Germany apparently.

    Purchases by individuals too have been going at a fast clip as evidenced by lines at coin shops in Germany and Austria and the fact that the Australian and US mints cant keep up with demand.

    Insolvency today has moved from the private sector to sovereigns. The traditional tool of lowering interest rates has reached its limit thus we have entered the realm of Quantitative Easing.

    Quantitative Easing can work as a stop gap provided global demand is still positive. A country that has lost monetary traction can obviate by engaging in QE whilst waiting for its own economy to reset. Japan is the obvious example here. Astronomical monetary injections and a form of quantitative easing throughout the 90s whilst global demand was still positive has helped Japan palliate monetary failure. But now that global demand is tenuous if not absent, the cows are coming home for Japan.

    However, when ALL major economies are engaging in QE, global demand is tenuous to absent and interest rates are at the lowest level in a century, more QE and more bailouts only serve to obliterate the currency.

    If demand is absent and QE results in exploding bank reserves rather than increased economic activity, then you are looking at deflation.

    Deflation would ordinarily show up in increasing purchasing power (goods and services become cheaper ergo the currency appreciates). But lack of demand and gargantuan QE destroys the currency.

    So be it because of safe haven investment, be it because of sovereign accumulation which is safe haven investment too, be it for individual purchases which is too safe haven investment, gold is assuming the role of currency and is benefiting from deflationary forces.

  3. James Says:

    Well, that is surely an interesting take. But so much of the price rise is due to speculation and safe-haven investing; won’t it only last – and your theory prove correct – if that force is significantly joined (or exceeded) by sovereign purchases and physical delivery to individuals?

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