Gold in a Deflationary Global Economy

Part I: Contrary to Popular Opinion, Gold Shines During Deflation

November 14, 1998

The article began like it was right out of our Forecast '97 and Forecast '98 annual reports:

"A lot of companies are suddenly having to compete in a whole new world-one in which prices are actually falling," declared a recent Fortune Business Report article on the World Wide Web.

Both of our most recent annual forecast reports observed that the world in 1997 and beyond will be a New World, one in which the way the world does and pays for business will be completely different than it was during the past few decades; one in which modern technology and the rapid transfer of capital dominates the investment and consumer markets; one which fulfills our 1990 forecast that this decade will be the Decade of Currency much like the 1970s were the Decade of Commodities and the 1980s were the Decade of Paper; and one in which debt default and deflation ripples across the newly integrating global economy like a tsunami after an earthquake. And, finally, one in which the first decade of the 21st century will likely be called the Decade of Gold.

And an earthquake it has been. 1997 saw the classic signature of the onset of a global deflationary economic contraction seen only once every few generations: a global financial market collapse. As a classic leading indicator to the future course of the economy, severe economic contractions begin with stock market collapses or crashes. The Asian crash of 1997 was a classic sign, but for this generation of investors economic problems are compounded by the fact that the global economy is not on the gold standard. Rather, a fiat currency system-one in which currencies are not backed by monetary commodities-exists in a form that has never existed in past history and that been described by some as a "great experiment to see whether [the world] can fashion a different anchor [than gold or commodities], one that depends on government restraint rather than the cost of acquiring a physical commodity." The link between money and a commodity has been broken since 1971, and in the words of the legendary economist Irving Fisher that departure represents "a curse to the country involved."

The curse, then, has Asia reeling in a financial collapse now ten months long and still spreading. Japan is on the brink of deflationary collapse, and the effects of this second-largest economy will be tremendous. All this has been so close to the collapse of Mexico's financial markets in 1995 and other recent currency-related crises. This is not to imply that currencies are necessarily the cause of financial manias, panics, or crashes, but in a fiat currency system the resulting deflationary debt collapse is exacerbated greatly. And, at this part of a long business cycle decades in length, the collapse of 1997/1998 is more than just the currency-related liquidity crisis that Mexico and other Latin American countries experienced in 1995. In many areas of the world it is the start of a great depression of the magnitude not seen since the 1930s.

This, I must add, is not designed to be an alarmist statement. Rather, it is merely an observation of the severe economic structural damage to the economies of the Pacific Rim area and its expected effect on North and South America, Europe, Russia, and elsewhere-an observation that reveals a reality so far known seemingly only to those in the countries presently involved in economic collapse and so little understood by others (American investors, for example, ignore the plight of Asian investors as if it can't happen in America again). It represents the greatest change in the investment climate in many decades, and it will serve the world with great and massive change, both to those accepting change and to those in denial. But those who choose to allow themselves to embrace these great changes will be empowered, and will have the opportunity to change the world in a positive way.

It is the deadly combination of financial and currency market collapse that spells economic disaster and widespread hardship for the countries involved. It is also that combination that leads to the kind of debt defaults, banking problems, and deflation that changes the global economy forever-fortunately, most of the time for the better in the long run but with much hardship in the short run. And, according to our work and to our forecasts of the 1990s, it is that collapse that will help fuel the greatest precious metals bull market in two decades and that ultimately will lead to a complete reevaluation of the global foreign exchange system and the function of gold.

A great Sea Change is occurring in the global investment markets. The changes that are beginning to occur will affect investors greatly, and will require a reallocation of assets in the typical investment portfolio-both out of opportunity to seek profits, and out of necessity to preserve wealth. For those who do not reallocate investments, severe portfolio damage is likely when the next wave of change takes hold-a wave that will flow once again from the Pacific Rim but will also emanate from the collapse of the U.S. and European stock markets as those two countries emerge from a speculative bubble now in progress and not unlike bubbles of the past, such as Japan in 1989, Asia in 1997, and the U.S. and other global equity markets in 1929.

Yet the average consumer has virtually no idea how to invest or preserve wealth during deflation (some express that they do not know what deflation really is), nor does the average investor know how to handle his or her investment portfolio during deflation, for the current generation has not yet had to deal with it. To top it off, the average consumer is not aware of the true nature of gold and how it truly acts--both as a store of value and as the most important commodity on earth-throughout times of inflation as well as during deflation. This report, then, will likely shatter the belief systems of most investors who read it. Yet the data and the research has always been there for us to peruse, for I am not the first to delve into the statistics deeply enough to factually ascertain gold's true tendencies during the cycle of inflation and deflation that has repeated itself so consistently throughout centuries of history.

WHAT IS "THE NEW WORLD?"

Before delving into those facts as presented by centuries of history and into our own conclusions and recommendations, it is important to understand that the late 1990s have truly brought us into a New World. It is a world of falling economic borders, of an integrating global economy in a rapid-fire information age in which capital flows cross thousands of miles with a simple keystroke on a computer in a brief moment of time. Our Forecast '97 report described the coming New World as a world of Change with a capital "C," a high-technology world of accelerating global economic integration, lightening-fast movement of investment capital from one market to another and from one country to another, of corporations gearing up to the new global economy in which domestic economic borders are falling with increasing rapidity, and of new ways to do business and to pay for it.

Computers represent the greatest technological revolution since the invention of electricity, and the Internet represents the greatest change in the way the world does business since the by-products of that invention of electricity. Indeed, it is no coincidence that electricity surged in practical use in the Roaring Twenties, and computers surged in practical use during the Roaring Nineties. Both provided an incredible increase in efficiency and, in turn, economic productivity. It is that increase in productivity-if one had to pinpoint the single-most important economic artifact of a major technological innovation-that is responsible for the magnitude of great business booms of the past, especially the 1920s and 1990s. And it is the typical mishandling of that business boom that inflates the speculative bubble so much that it can do nothing else but burst.

It is the action taken by humankind in response to these great business booms that contributes greatly to the life-style of consumers in the wake of the initial surge in business activity. Unfortunately, humans are a complacent lot and drive themselves to speculative excess in response-excesses that push the business cycle so far away from equilibrium that the next business contraction within that cycle is greatly exacerbated.

As a result, an unfortunate part of the New World environment is that investors have come to expect commodity-style returns in their respective stock market portfolios-20% to 30% returns are expected from mutual fund and stock holdings. Investors now readily jump from one money manager to another to catch the hottest one for the year, unwilling to settle for less than 20% and expecting-not just wanting, but expecting - 30%, 40%, even 50% in a year. Recently they have been able to achieve this expectation.

Yet it is that expectation that will once again cause the average investor to overstay his or her welcome in the stock markets, exactly as occurred for Pacific Rim investors in 1997, and exactly as has occurred in the manias of the past. It is the bursting of the speculative bubble that will exacerbate the deflation that is already beginning and that would otherwise be expected to be mild. It behooves investors, therefore, to embrace Change, 1990s style, and diversify portfolios now. As shown in this report, a key target of that diversification should be in gold, as well as in silver, platinum, and gold shares.

TRANSPOSING SPECULATIVE THOUGHT INTO FACTUAL RESEARCH

In this report I refer fairly frequently to the masterpiece of research contained in University of California, Berkeley professor Roy Jastram's 1976 book, The Golden Constant, which is unfortunately out of print. It is perhaps no coincidence that my months of research into centuries of data, studies, books, and information that undoubtedly would serve to thrust anyone toward the transition from speculative thought into factual information that I discovered that Jastram had set out to do the same thing in 1976. Jastram begins his study by declaring that The Golden Constant sets out to publish centuries of actual statistics in a quantitative study that "was chosen to transpose speculative thought into actual numbers." Since I have discovered in my daily work that a vast majority of investors engage in the dangerous practice of investing based on speculative thought and not actual research, I was delighted to find another who had also set out to "crystallize speculations by the use of quantitative evidence," as Jastram put it.

Of course, this was just one aspect of my research since I have written many a time during the past decade of the likelihood of deflation hitting the global economy during the 1990s and of a bull market in gold after a low likely in 1998. For that I utilize a plethora of research, statistics, economic data and theory, and proprietary indicators. It was in my report 1989 And Beyond that I had postulated in great detail the likelihood that the 1990s would yield to the kind of deflationary debt collapse typical of the Kondratieff Economic Long Wave cycle of debt repudiation (see p. 14), now tracing itself out in classic fashion and spreading from Asia, and that a new world would emerge such that the 1990s would be referred to as the Decade of Currency. Being that both currency and gold have long histories as media of exchange, one can hardly ignore the grand implications for gold as a result of the seemingly perpetual currency collapses of many countries of the world.

I was equally delighted to discover U.S. Federal Reserve Chairman Alan Greenspan's 1966 and 1967 newsletters on gold and his support of the gold standard, reiterated in 1981, and of classic economist Milton Friedman's books, including Money Mischief: Episodes In Monetary History," both of which provide great insight to the theories and research of some of today's most influential economic authorities. Yet at the same time, what I really found is that there is a serious lack of factual information and research on how gold acts during a deflationary economy, and that Jastram's 1976 study-which was performed when gold was at only $100 to $175 per ounce-needed to be continued!

As a result, I have taken all my knowledge to date and combined it with a study in which I continued the Jastram study where he left off in 1976. After all, his study was very consistent with all that I knew before I came across his four centuries of statistics and standardized price indices that allow us to realistically compare commodity prices prior to the year 1800 with today's prices. Commodity statistics that keep the prices of a particular basket of commodities and the relative performance of gold and currencies- across the many different governments and types of economies exist over the centuries-constant over a long period of time are difficult to obtain. The additional proof of my theories about gold in a deflationary economy that I was able to derive by studying data well before the inception of wholesale price indices in the U.S. was invaluable in keeping the study just like gold: a constant.

Nevada accounts for 75% of U.S. gold production.

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