Tuesday, August 31, 2010

Can Deflation Catch a Falling Dollar

"Inflation is always a monetary event," so sayeth Milton Friedman. Recently Mish and others define inflation as an increase in the money and credit supply. They then point to a myriad of the examples of the deflation they claim that we are in. The crashing of the housing market, the parched riverbed of what once was, the corporate paper Ponzi Stream, the "zero on the velocity" of our money, it being hoarded by the ailing and bailed out banks, and massive mark to market destruction of the capital of a national economy built on hot air. Facing a mountain of evidence such as this, who could argue against it. No one in their right mind. No one in their right mind should miss the bigger picture.

Swirling around outside of all of the narrow definitions of academics and investment advisers is an undeniable reality to which they turn a blind eye. The federal reserve note is crashing against gold. A glance at the chart makes this reality as undeniable as it is untenable, for us all.

Despite the disparaging remarks against the old relic, the banks and currency traders all know that gold is the origin, the precious metal around which the values of all currencies fluctuate. So, as the dollar goes against gold, so goes the dollar. And that federal reserve note goes not so well.

If gold is the origin, then it is not rising against the dollar, rather it is the dollar falling in intrinsic value. To be sure this is not a monetary or credit market event. To be sure this is an independent, and ubiquitous event. It affects all of us who spend, the legal tender counterfeit. All of us.

And even as the counterfeiters who brought us the bubbles prime the pump and push out mountains more of their waisted toxic by product, an angry nation turns away and says, "we have had enough".

There are various theoretical reasons given for the liquidity trap, but let’s just focus on what is happening now and what is likely to happen in the years ahead. Presently, excess reserves are not inducing lending for several reasons, and adding to them further will not make much difference.

  • First of all, banks are capital constrained, not reserve constrained.
  • Second, interest rates could not fall far enough during this business cycle to enable troubled debtors to refinance their way out of trouble, so now banks remain worried about the volumes of bad debt they are carrying and how future loan losses will impinge on earnings and capital.
  • Third, deflationary expectations are beginning to work their way into banks’ loan evaluation process on a micro level; in more and more areas, loan officers are looking at households with shrinking incomes and firms with deflating revenues.
  • Fourth, the private sector has too much debt, and many households and firms are trying to reduce debt, especially as more of them worry about deflation in their own incomes or revenues.
But through it all intrinsically, the dollar falls. Why? Devaluation against gold is not a monetary event, it is acknowledgment that the world no longer has confidence the confidence scheme.

For now the dam is holding, but if that damn should break, the tsunami would be greater than the biblical one. Will it break free? The answer to that is about a monetary event. Will the dollar recover against gold, i. e. will the price of gold go down? No one can foretell the future, but the words slim, and none, come to mind.

Can any deflationist explain why in the midst of historic deflation gold is near it's historic high, has any deflationist noticed? Unlikely. For them it seems enough to cherry pick events in the economy and pick their definition to suit it. But it is precisely in the crosscurrents of events outside of the banks and credit markets that the dollar's destruction lies.

Rising gold is not a signal of inflation, it is undeniable proof of dollar devaluation. Period. That earning dollars is like running on a treadmill. The assault began with the federal reserve act in 1913, when the true US dollar was defined to be one 20th and ounce of gold. That is, gold was $20 an ounce. With the federal reserve note is $1248.70 an ounce. Think that hasn't transferred to higher prices? Think it won't transfer to higher prices? Let's see.

In 1913 a spec of gold, and a fraction of a penny bought a cup of coffee. Today that cup of coffee is two federal reserve notes, or the same spec of gold, that is, a couple of coffee is $2 in today's dollars. What about tomorrow's dollars? Suppose we wake up tomorrow in a world where Starbucks has decreased the price of coffee to one dollar, but gold has quadrupled to $4000 an ounce. Someone who buys that coffee with the federal reserve note that rolled off the press tomorrow morning pays more than someone paying with today's dollar bill.

The price is cut in half, the dollar is cut to a quarter, you pay twice as much for a cup of coffee whose price was cut in half. Not Zen, just comparing apples to apples. And as deflationists remain blissfully unaware, the guy with gold pays with half the size yellow spec, he is unencumbered. Remember Gold is the origin.

Deflation may push down prices of the day denominated in dollars of that day, but rising gold is pushing the value of all the dollars is down. All Fiat currencies die. The Federal reserves note is on its deathbed. Debasement and deflation will be with us for years, and years to come. Unless gold crashes. Any takers?

So, standing here in the chilly twilight of Ponzi finance, the question we ask is, which one will win? Will the supersonic death spiral of the currency force hyperinflation, or can deflation catch a falling dollar?

No comments: