I am new to the Austrian economic philosophy. i am trying to investigate the consequences to the US economy to the Fed policies. In reading Tom Woods book - “Meltdown”, it appears that we are headed for a strong deflationary cycle. If that is true, gold and other hard assets will decline in price. Yet, I have heard a lot of talk from Peter Shiff, et al, that we are headed for hyperinflation and crash in the dollar. What is the short term and long term outlook in this debate? Are we headed for deflation and then inflation? How should we position our portfolios?
Try to perceive “inflation”/“deflation” through the lens of the supply/demand for the US dollar (USD). Over the last few decades the markets have considered the USD to be a safe haven so during turbulent times the USD would go up in value (against everything else, hence, “deflation”). The problem with the latest turbulence (crisis) is that the USD is at the epicenter of it. Being the “lender of last resort” the Fed/USgovt have merely transferred the toxicity of decades worth of malinvestments onto the Fed balance sheets and as liabilities to the US taxpayer. This in turn, slowly but surely erodes the usual USD status as the stable safe-haven – especially for the large holders of USD assets (i.e lenders to the US).
So this throws the markets into one large confidence game. As long as the majority of the market p****erceives that everyone else believes that the emperor STILL has clothes (i.e. USD will be accepted by everyone as a safe haven), turbulence/crashes/crises will be accompanied by USD rallies (hence, “deflation”). It’s only a question of WHEN (and not IF) that this perception violently changes – and that’s the Fed/USgovt’s biggest fear which is why they’re not so much concerned by the USD weakness as they are that this weakness remains “orderly”. That will be the time when the “Big One” hits only then USD going down with it (causing massive inflation). When that happens, gold will be the only safe-haven left (as it has been through human history). The stocks sell-off on Thursday and Friday gave the markets a glimpse of this – stocks were down a lot but a lot of currencies and commodities held their ground in stark contrast to their usual behavior during sell-offs.
Conclusion: Use the current (near term) “deflationary” periods (sell-offs, mini-crashes) to stock up on gold in preparation for the time when this increasingly fragile confidence game collapses (long term).
Z.
There is no way to predict the future. But there is a way to study sound economics (this website). Based on the study of sound economics, one would conclude that the actions the government and Fed have taken to “help” the economy have instead harmed it further. You might find these links useful.
A Case for the Inflation Camp
Short term is a toss up. Long term is inflation. Fannie Mae, Freddie Mac, GM, banks, military, Social Security, Medicare, Medicaid, etc. all combined have unfunded obligations in the tens of trillions of dollars. The fact of reality is that at some point in the future, either the world will run out of dollars to lend the U.S. government or the world will just find better places to invest dollars. Most likely it will be a combination of both. At this point, the U.S. government will be faced with raising taxes to pay for things, cutting services, or printing money. Which do you think they will do?
My bet would be on inflation.
I like Peter Schiff’s strategies. Buy precious metals. Buy stocks in Asia.
Financial Safety Rule #1[derived entirely from Austrian principles] says:
despite many claims to the contrary, no one, not even your favorite economist or investment advisor, can reliably /consistently predict future economic events.
Therefor your long term investment portfolio must remain neutral at all times, and not be weighted so that it is dependent for increases in value on the occurrence of one or two particular supposedly “guaranteed” future economic scenarios [e.g. inflation, deflation, “good times” or whatever] .
Regards, onebornfree.
are you soliciting for business?
Absolutely not!!!
I am a financial adviser looking for information for my clients.
I am concerned about protecting their portfolios in light of the economic turmoil.
The thought of getting business from this sight was never my intention.
I am interested in the academic work and have been trying to "enlighten"myself so I can be a better resource for my clients.
My knowledge in this area is minimal.
I am sorry if you perceived anything different.
My question was to onebornfree blogger…
I apologise for the confusion Hoch
The issue with fractional reserve banking is that fractional reserve loans can only be used to purchase capital goods that produce income. This means that expanding credit only increases the prices of capital goods. Contracting credit will thus only shrink the price of capital goods!
However, while credit may contract or remain stable, the bank balances issued propagate through the consumer economy, and eventually the price of consumer goods must rise to “catch up”. So it is possible that asset prices will collapse while consumer prices skyrocket.
Well, we pretty much have gone through a recession…so now we are logically entering a depression. The decline of the dollar and other currencies is pretty likely. But seeing that many “experts” have foretold such a decline already a couple of years ago it will be interesting to see how everything eventually pans out. Either way, I think it’s time for an asset-backed world currency.
Let me just put out several things to keep in mind.
Let’s start with an economy which is still using a commodity money without banknotes. In such a society, the supply of money is limited by the production of the commodity. In the case of gold, it is limited by the extent to which gold can be mined. The demand for money (cash balances) along with the supply of money determine the “price” of money. But money is different than any other good in that the prices of all other goods are determined in terms of money and so can naturally be compared, through monetary calculation, with one another. If a hamburger is $3 and a pair of shoes is $27, then a pair of shoes is 9 hamburgers. But what is a dollar worth? You could say 1/27th of a shoe or 1/3rd of a hamburger but that’s not much help because then we’d have to denominate the price of a dollar in terms of everything for which it could be exchanged and we run into the CPI problem of “what is a representative basket of goods?” But there is one way to measure the “price of money” and that is real production of the monetary commodity itself. As the price of money increases, production of the monetary commodity will increase. Hence, changes in the level of gold mining (if gold is the monetary commodity) correlate with the price of money. Guido Hulsmann discusses this here.
Inflation in a commodity money economy is the result of one of two events - an increase in the supply of the monetary commodity (mining, in the case of gold) or a decrease in the demand for money. Deflation is the result of the opposite situation. When the stock of the monetary commodity is much larger than the production capacity of the monetary commodity (as in the case of gold), fluctuations in the demand for money swamp fluctuations in the supply of money, so that a small change in the demand for money (uncertainty) is much more significant than a large change in the supply of money (mining).
In a paper money system, a secondary level of inflation and deflation are built on top of the underlying fluctuations in the supply and demand for the monetary commodity. In the case of gold or silver banknotes, this means that that prices for real goods in terms of the monetary commodity can be going up (inflation) while prices in terms of the banknotes are going down. The demand for the commodity money can be decreasing (or supply increasing), causing production of the monetary commodity to go down (prices denominated in the commodity money are increasing), even while demand for the banknotes is increasing (prices denominated in banknotes are decreasing). To move this analysis forward to fiat money, this is why it is not automatically a good idea to buy gold during an inflationary period… if both gold and the fiat money experience inflation (reduction in demand), both become less valuable to hold than real goods. While paper money and commodity money, on the long term trend, are negatively correlated, they are not absolutely negatively correlated. The long-term inflationary behavior of fiat money is the consequence of its expansionary nature and its legal tender status which means that betting against it holding value, in the long-term, is always a winning bet. But in the short term, both fiat and commodity money can experience simultaneous inflation or deflation.
The most general analysis, then, of capital safety, IMO, is the expected relative appreciation of any asset - you buy anything with your savings, the question is determining which things will appreciate the most (or depreciate the least, if you’re a glass-half-empty type). Depreciation isn’t so bad as long as your capital depreciates less than everyone else’s… it’s like losing 10% in a bear market where everyone else lost 50%. No big deal, in fact, it’s a victory. But I think this is the most general problem facing everyone who saves even a penny… by virtue of saving at all, you have become a capital speculator… no matter where you leave your money, you are speculating, even if not intentionally. If you leave it in dollars, you are implicitly saying, “I expect dollars to be the most appreciating/least depreciating asset”. If there are other assets which would have better preserved your capital, then you have made a mistake. Of course, hindsight is always 20/20 but the essence of capital preservation is learning from the past those lessons that are applicable to the future.
Hope these thoughts are useful to you!
Clayton -
Addendum to my reply to Hoch577:
The general advice going around in the Peter Schiff/Jim Rogers/Doug Casey/et. al. “perma-bear” investment circles is to just stay out of stocks (at least, US stocks) completely. Here is a good article which makes the argument that the US government needs a global stock market collapse (to keep demand for US dollars high, while the Fed is printing them up by the cargo-ship load). If I had money, I think I would be following Jim Rogers at the present, and buy ag commodities. He believes that they are cheap, on the fundamentals (I’m just repeating Rogers here, I’ve done zero footwork on this), and that we are likely looking at a collapse in food supply due to malinvestment brought on by the dot-com and real estate booms, which will, of course, send ag commodities to the moon. He also is purchasing ag stocks and investing in China.
Paradoxically, the more bad news there is on the front page and in the business section, the better the dollar will do. So, dollar holdings represent a bet that there will be lots more bad news than there has been so far sending investors back into dollars. This is not a bad bet, given the coming wave of commercial real estate defaults and the shenanigans that have been pulled with the toxic assets program that will eventually get exposed. Gold holdings are a bet against the dollar, primarily. While this is a good bet, long-term, it may be a bad time to buy, which is Rogers’s position. Though, it does look as if gold is undergoing a short-term correction. I wish I had some money.
Basically, you want to buy anything that you think has been underinvested due to the inflationary boom. This means there will likely be a shortfall in production as demand surges, driving prices up. Agriculture, generally, fits the bill but with some imagination, I’m sure there are many real goods in other categories which will be experiencing similar supply problems going forward.
Clayton -
It makes me nervous that Timothy Geithner agrees with you. Any representative money can be gamed. An “asset-backed world currency” just brings us back to the days of the so-called “gold standard” which was inflationary. An improvement, but not exactly a real solution.
Clayton -