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INFLATION OR DEFLATION –THAT IS THE QUESTION

This was the title of my essay which appeared in GOLD–EAGLE on the 18th October 1999.

The question is of vital importance to the way we protect our assets and invest for the Future and therefore I have thought it necessary to comment on this issue again.

My feelings and conclusions at the time were summarised in the final paragraphs as follows:

" Inflation has gone as far as it can, the Fed has been forced to start increasing interest rates, and will probably continue to do so - Deflation cannot be avoided "

It seems that my predictions in relation to the events between October 1999 and Now were incorrect. Inflation has in fact continued .

THE REAL QUESTION IS HOWEVER;
WHAT HAPPENS AFTER THE BUBBLE HAS BURST?

It seems that I naively overestimated the Fed's ability to recognize the severe and serious situation for what it is ,and to act in the best interests of the economy . Instead, they have pandered to "City Hall" (i.e. the financial powers that be ) and have recommenced reliquifying the economy in the hope that they can bring about a soft landing, and thereby avoid what both Mr. Schicht and I, and many others agree will be an economic collapse and severe pain for millions worldwide.

Mr. Hans Schicht said in December 1998:

Global credit has reached unbelievable proportions. Financial power has smothered all economic and social reality. The never-pay-back credit explosion has created A potential global inflation of threatening proportions. When the asset bubble bursts and the basic lively hood of millions will be threatened , the only way out for governments and banks will be to resort to hyper-credit and explosive money creation to forestall economic collapse and social unrest. Then stocks bond , fiat currencies will shrivel away and inflation will explode with a vengeance in our daily necessities, commodities and hard assets.

Ever consistent Mr. Schicht has now repeated his contentions (GOLD-EAGLE , 25th February 2001) The never-never-pay-back credit explosion and financial manipulations of the last decades have created a "potential global inflation" of menacing proportions. And once there is an overhang of potential inflation - in this case in the financial paper markets - no force on earth will be able to hold it back for long from pouring down one fateful day in a global deluge into the commodities, wages, services and finally the CPI. Inflation will return suddenly and unexpectedly.

And when the asset balloon bursts, and the basic livelihood of millions are threatened, the only way out left for governments and banks will be to resort to "hyper-credit" and explosive money creation in order to forestall immediate total economic collapse and social unrest. Then, inflation will explode with a vengeance. Then stocks, bonds, fiat currencies and everything else that represents fiat paper will shrivel away, and with them the Dollar as a reserve currency.

The Fed decreased rates twice in January 2001 - each time by 50 basis points .

Expectations are that despite ominous signs of Inflation as seen in Wage, Producer and Retail Indices, the Fed will continue to decrease interest rates - and increase Money supply. And indeed inflation is accelerating.

Sales and profits are dropping. Businesses will continue to hit the wall. Consequently, stocks will continue to fall in value.

It is painfully evident that inflation is not having the desired effect. To be sure the inevitable "Period of Reckoning" is drawing nearer.

THE QUESTION STILL REMAINS
WILL THERE BE INFLATION OR DEFLATION AFTER THE BUBBLE BURSTS ?

Let us try to imagine the scenario which will unfold on that inevitable, fateful day.

This day could happen in any manner of a dozen ways, but for argument's sake let us imagine that we wake up one morning to find that the two Casinos (The Dow and the Nasdaq, so appropriately named by Lance Lewis of The Prudent Bear) and the S & P500 have dropped overnight by say 10-20%.

There will be an immediate global reaction, whose ramifications are difficult to quantify. Nonetheless, let us try to imagine just a few of the more obvious ones.

What are large corporations and businesses likely to do ?

- They would probably suspend any future expansion
- They will also try to sell assets to reduce their interest payments and debt
- Many will close their doors and insolvencies will burgeon
- Production would be reduced and retrenchment commence

What are people likely to do ?

- The majority would firstly fear that they might lose their jobs
- Most would probably try to sell to any stocks they own (and start the panic)
- All current and planned future luxury purchases would be cancelled
- Even current expenditure on necessities will be reduced and savings increased
- Purchasing of all kinds will suddenly diminish
- People will try to sell their mortgaged homes to reduce their interest payments and debt

The above few examples are simplistic, but they serve to illustrate that asset values , goods , services and wages will decline .

What we in fact are seeing is DEFLATION.

If Mr. Schicht is saying that the powers be will increase inflation after that fateful day, then I ask:

Who in their right minds will lend money to credit unworthy companies and individuals? Who will want to borrow when uncertainty prevails, jobs are being lost and loans are being recalled?

I also ask:

Will the Weimar type hyper-inflation happen simultaneously, everywhere throughout the world?

Surely something has been learnt about runaway inflation since Weimar. Will the Europeans and other countries allow this to happen? This is unlikely !

If the inflation he talks about happens only in the US, then will the rest of the world just accept a weakening US Dollar, whilst their exports are adversely affected, and the value of their US dollar investments are eroded? This is also unlikely.

AFTER IT IS RECOGNIZED THAT THE RECESSION IS HERE AND AFTER THE FINANCIAL ASSET BUBBLE HAS BURST, THEN DEFLATION WITH ALL THE HARDSHIPS THAT GO WITH IT, WILL UNFORTUNATELY BE THE ORDER OF THE DAY.

Norman Arcus

"The Backyard Economist"
South Africa

2 March 2001