by Jaime E. Carrasco
Inflation or deflation? -- that is the question as to how the US financial mess will unravel. It is extremely important that we understand this debate as its outcome will have serious implications for your financial wellbeing.
My observations and conclusions are that the outcome of this mess will lead to inflation. I believe "the deflationists" are wrong. The main arguments for the deflationists are based upon two premises: first, the fact that deflation was the outcome of the Great Depression of the 1930s and of Japan in the 1990s; second the argument that the levels of debt are so big that the Central Banks could never print as much to offset the deflationary effect of unwinding the debt.
A historical study of these arguments reveals that deflation is a rarity. Furthermore, we have the experience of all other financial storms over the past century (apart from The Great Depression and Japan in the 90s) creating inflation. Inflation has been the historical norm. It is important to understand why so that one can make rational investments decisions.
The ability of Central Banks to create money always leads to inflation. This was not the case during the Great Depression as the US Fed was unable to print money because the currency was pegged to the gold standard; thus it was impossible to inflate the money supply.
It is important to understand that deflation is the Central Banks' greatest fear as it is the one thing they cannot control. Furthermore, one must also understand that the Central Banks' sole aim right now is inflation through their monetary control -- an outcome that is easier to control down the road. In this context the Central Banks will continue to increase the money supply and inflate.
The US Debt
The US debt is the last remaining credit bubble and rates have to climb in the future. This is one more good reason for increasing inflation as the US knows that the only way to deal with this tsunami of debt is to inflate the debts away at the expense of their creditors.
It was done in Russia, Argentina and all other over indebted countries. The simplest way to reduce debt owned by foreigners is to devalue the currency, either overnight or over a longer span of time. Which leads one to conclude that the recent rise of the $US is unsustainable and will reverse sooner than later.
Precious Metals
The world would not find itself in this mess if currencies were pegged to gold, as we would never have been able to create debt of such levels without acquiring the necessary gold to back the obligations. Gold allows us to peg the value of money to a constant, so that the financial system does not get into this kind of situation.
In a world where we have endless amounts of money we will have to re-evaluate what things are really worth. I see the changes to take place and from a financial perspective gold will increase as we re-define the value of money.
From a fundamental perspective wealthy individuals around the world have been buying gold and today we find ourselves with global shortages for the physical metal. Once again gold is signaling a very different picture than deflation.
Summary
Going forward we will see the global banking system normalize. The banking system will solve the illiquidity issues through global money creation.
Central Banks now know what deflation means and will do whatever they can to prevent it: they will inflate. And who better at the helm than the inflation expert himself Chairman Bernanke?
The US dollar will resume its decline and within the next three to nine months we will see prices rising and inflation returning to the headlines--this inevitable as the US needs a lower dollar.
Supply destruction of the things we need will have worked itself into the system, further supporting rising prices. Deflation, which always appears prior to an inflationary wave, will be a thing of the past and those who position themselves appropriately will be very well rewarded.
