In the modern fiat world, a deflationary-style stock market collapse isn’t supposed to happen. And yet that is exactly what Greece has already experienced and I don’t think it’s over yet. Here’s a modified chart any real bear has seen before: the first half of the 1929-1932 Dow Jones Industrial Average stock market bear, which saw a total loss from top to bottom of 89% (chart stolen from chartsrus.com, a great site, and modified):

This isn’t the whole bear market – the eventual bottom in the Dow was 40 in 1932, and the above chart only goes thru part of 1930. Now, here’s the rhyme: a chart of the Greek stock market using the ATG share index over the past 5 years (monthly candlestick plot using a linear scale):

The Greek stock market is going to be ground further into the dirt. They are also likely headed for an 89% loss from the peak in late 2007. Why? Simple. The Euro currency is acting as a deflationary straight jacket, strangling the over-indebted Greek nation. As weak and flawed as the Euro currency is, it is too strong for Greece. If Greece doesn’t leave the Euro, their deflationary spiral will continue.

It is with great interest that I read a recent report of Greek people raiding their banks for cash and many subsequently using that cash to buy Gold. One of the hallmarks of a deflationary collapse is bank runs. Cash under the mattress and physical Gold are the items of choice in such a scenario, as you never know when a bank holiday will strike. And because you can guarantee that apparatchiks will do the exact wrong thing in this scenario and find a way to devalue and/or confiscate money held in the banking system come hook or crook, I’ll take Gold over paper in such a scenario.

This is the real secret behind the U.S. deflationary collapse in the 1930s that revisionist history conveniently fails to mention. People wanted the U.S. Dollar because it was almost the only major currency that remained backed by Gold once Britain started the wave of European countries leaving their respective Gold standards. Because the U.S. remained on a “hard” money system (until 1933-34) that allowed free convertibility of paper currency into Gold, the deflationary forces in the U.S. were overwhelming. People wanted Gold, not a piece of paper with a pending broken promise written on it.

Greek Gold demand is at historical extremes precisely because the country is in the midst of a deflationary collapse. It is not the end of the world and things will eventually turn around, but holding Gold in the mean time is the right thing to do for Greek savers. Eventually, the Euro will massively devalue to accommodate the so-called “PIIGS” economies and/or the PIIGS economies will leave the Euro system. In the meantime, the Euro will act as an unbearable deflationary weight upon the weaker Euro economies. Any can kicking at this time won’t buy more than a few months reprieve in the Greek stock market until the next wave down begins.

Gold is money. It has been money for thousands of years. I’ll take that track record over any of the existing fiat currencies currently in use. In fact, I’ll take physical Gold over any asset class until the Dow to Gold ratio hits 2, and we may well go below 1 this cycle. Shiny metal or the filthy paper promises of those whom history has shown cannot be trusted when the storm clouds finally start to release their cleansing rain.

NOTE: I recommend physical Gold held outside the banking system as a significant part of any serious investor’s portfolio. At this stage of the secular bear market in traditional asset classes, I don’t see even a 100% allocation to physical precious metals as unreasonable for those seeking to preserve wealth. For those who also seek speculative returns, I run a low-cost subscription service with specific trading recommendations and more in-depth analysis on markets with a focus on the precious metals sector.

Now I am no expert when it comes to retirement investing so I can’t tell you if annuities or TIPS are adequate or not. What I can tell you is that I am an expert on inflation and that this article is either incomplete or extremely negligent.

How can one talk about beating inflation and not include Precious Metals and Commodities? This is totally asinine. Commodity bull markets go hand in hand with inflationary periods. Yes, Gold doesn’t always match inflation. It rises when inflation expectations rise and not when there is disinflation. And yes, clearly the author and most followers of mainstream publications fail to realize that excessive sovereign debt is a precursor to severe inflation. Bank lending, consumption, etc is not relevant in this environment of impending sovereign bankruptcy, zero percent interest rates and quantitative easing.

Moving along, the author makes the Altucher argument which perma-bulls constantly resort to. Who cares if there is inflation, buy stocks anyway! Ok, fine. But these stock pumping a-holes don’t even consider the right stocks. We know they will never recommend gold stocks. However, you can’t even get them to recommend energy stocks, agriculture stocks or any kind of miners. Instead, they will pick some big conglomerate with a minuscule dividend. Good for dis-inflation but worthless for the kind of inflation that is coming.

Finally, the author fails to even consider emerging market shares or debt, which, although seemingly riskier, will outperform over time. Those economies are growing faster and so to will fiscal improvement. Nevermind that some of these governments are far less indebted than the US, Europe, UK and Japan.

Retirees should at least get started by putting a little bit in Precious Metals, Commodities, and Emerging Markets. Hell, these things are actually in bull markets! What a concept. Do that and you can still feel comfortable with your grossly over-sized and wasteful position in US equities and bonds.

Full disclosure, yes I am talking my book. I write a gold newsletter and have been a commodity bull for a while and will be in the future. However, unlike most perma-bull stock pumpers, my book makes money! How about that. If you want real perspective on inflation and how to make a killing during what is coming, then consider a free 14-day trial to my premium service.

Economics / Inflation

By: Nadeem_Walayat

Delusional deflationist right from the Bank of England MPC, to the mainstream press for well over a year have pushed the mantra of ongoing debt deleveraging deflation everywhere, everywhere that is than appears in where it counts i.e. the actual INFLATION indices, where inflation is on the rise right across the world as illustrated in the UK by the persistent failure of the Bank of England to control UK inflation that remains above the banks CPI 3% upper limit. Even Greece that really is in an depression is experiencing inflation at above 3%, whilst the US CPI continues to inflate at a more modest 1.2% as summarised below for key world economies.

Global CPI Inflation Rates

This is leaving aside the fact that the official inflation indices tend to under report real inflation rates as the methodologies have been manipulated LOWER over the decades so that governments can continue to stealth tax the population. For instance UK inflation as measured by the RPI which is the recognised measure for UK Inflation is at 4.8%, with my own real inflation rate measurement coming in at 6%. Whilst the U.S. CPI of 1.2% when measured on the basis of E.U. methodology that ignores Bush and Clinton tweaks comes in at 2.4% Then we have Mr Shadowstats who reports U.S. CPI inflation as being at 8.6% rather than the official 1.2%.

I warned of imminent UK and global inflation mega-trend way back in November 2009 (18 Nov 2009 – Deflationists Are WRONG, Prepare for the INFLATION Mega-Trend ), as deflationists fell into the trap the debt deleveraging deflation red herring, that completely missed the big picture that I attempted to elaborate upon in the 100 page Inflation megatrend ebook of January 2010 (FREE DOWNLOAD) that contained the specific trend forecast for UK CPI Inflation of Dec 09 (UK CPI Inflation Forecast 2010, Imminent and Sustained Spike Above 3%) as illustrated by the below graph against which the Bank of England has continually issued statements that high inflation was just temporary and would imminently fall throughout 2010, the reasons for which I touched on recently upon in the article The Real Reason for Bank of England’s Worthless CPI Inflation Forecasts.

Debt deleveraging deflation completely ignores the fact that we are NOT living in the 1930′s, but in a GLOBALISED world economy that is seeing the CONVERGENCE of REAL GDP’s where the developing world is EATING up the worlds resources at a faster pace then the west is cutting back on consumption thus DRIVING INFLATION HIGHER whilst at the same time the west is engaged in COMPETITIVE CURRENCY DEVALUATIONS in an attempt to GENERATE NOMINAL GDP GROWTH which has highly inflationary implications.

Governments attempting to inflate nominal GDP’s through printing money and near zero interest rates so as to push people towards consumption rather than savings because banks are paying LESS in interest than even the phony official inflation rates. Thus people increasingly seek to hold anything other than negative interest rate paying devaluing fiat currency that can be printed in the trillions at the press of a button. Savers in the UK are realising this as INFLATION EATS a life time of accumulated savings. Workers are realising this as the flow of paper currency raises prices in the shops far greater than the flow of paper into their pay packets that is coming in at an average of 2% against CPI of 3.1%. The paper currency is losing value at a much faster pace than the official inflation statistics, people are waking upto this and will increasingly demand payment in terms of ability to track the price of goods and services not official indices therefore demand wage rises above official inflation indices and thus triggering the dreaded wage price spiral, which as the trend for the convergence of GDP per capital analysis as illustrated by the below graph (Inflation Mega-Trend Ebook Page 54) shows for most people will only be a nominal phenomena i.e. they will not actually be able to purchase more as they will be fighting a losing battle against REAL INFLATION.

The threat of Debt debt deleveraging deflation has INFLATIONARY consequences because the governments will not ALLOW for actual Price DEFLATION because it would INCREASE the real value of government debt therefore increases the risk of governments going bankrupt as the debt interest rises, when the real intention is to INFLATE the real value of debt away. INFLATION is also one of the governments most important stealth taxes on the people whilst DEFLATION acts as a subsidy TO the people i.e. their standard of living INCREASES during DELFATION as prices fall whilst inflation gives the illusion of increasing standard of living as workers are stealthily forced to work harder for less real pay despite increasing productivity.

Debt Interest Spiral Inflationary Trend Towards Hyperinflation

As warned off in November 2008 (28 Nov 2008 – Bankrupt Britain Trending Towards Hyper-Inflation?), the consequences of ever increasing debt mountain is the risk of igniting the debt interest spiral (03 Dec 2009 – Britain’s Inflationary Debt Spiral as Bank of England Keeps Expanding Quantitative Easing), since 2008 the Labour government had bent over backwards to ignite an election boom (03 Jun 2009 – UK Economy Set for Debt Fuelled Economic Recovery Into 2010 General Election), so as to maximise its chances of winning the next election. the New government is attempting to bring the debt interest spiral to an halt but as the recent debt interest analysis (29 Jun 2010 – UK ConLib Government to Use INFLATION Stealth Tax to Erode Value of Public Debt ) concluded the Government will not only not be able to halt the accumulation of total debt during the next 5 years but that official debt as a % of GDP is expected to continue to rise to 72% of GDP as illustrated by the below graph which suggests significantly higher debt interest payments i.e. a significant worsening of the governments fiscal position which means MORE money printing despite a economic growth as total public sector net debt rises by 50% to £1.26 trillion (2013-13) from £784 billion (2009-10).

The Inflation Mega-trends

The official CPI inflation indices illustrate the facts of what has actually transpired during the whole period of deflation mantra for the past 18 months.

The actual trend for the UK has been of one of continuing accelerating inflation, where the great deflationary recession of 2008-2009 even barely a year on has become only vaguely visible as an inconsequential blip along the path of the Inflation Mega-trend. Do you see that little dip right at the very end of the above graph ? Well that inconsequential non event is yet again being taken by the mainstream press and Deflationists to run and cry deflation, just as every single minor downward blip during the past 18 months has been followed by something similar, if this type of reaction is not delusional than what is it ?

Meanwhile, the United States has experienced mild inflation since the Great Recession of 2008-2009 began with little overall change but with a positive trend. However this is set against the mantra of deflation that implies the complete opposite of what actually has transpired despite the worst recession since the Great Depression. So all of the talk of the U.S. being in deflation for the past 18 months has been delusional which does not match the reality of what actually has taken place and given the ongoing multi-trillion dollar deficits look set to feed a trend for a stagflationary economy for the U.S. for many years.

Delusional Deflationists Ignore CPI

Having been wrong on deflation in even the officially doctored CPI for the past year, delusional deflationists IGNORE this and any other indicator that implies inflation by picking and choosing any obscure measurements that implies deflation is taking place such as pricing assets in terms of the gold price to imply deflation is taking place when peoples food baskets i.e. the REAL WORLD show INFLATION is accelerating away from them, or in some cases implying that inflation is really deflation in disguise because of loss of purchasing power, which is the whole point of what inflation IS ! Where prices rise to erode the purchasing power of your savings and earnings! I hear weak economies mean deflation looms, well try telling that to Zimbabweans!

Do a simple personal inflation test, dig out your credit card statements from 1,2,3 years ago and see how much your food and energy bills have gone up and then you will know how much inflation has taken place during a period of perma deflation mantra. Never mind the amount average food baskets are destined to rise in price going forward!

Quantitative Easing / Money Printing

During 2009, Central Banks detonated the nuclear option of quantitative easing, the Bank of England will under the new governments regime seek to continue QE as part of its monetary policy. Central banks also have the bigger nuclear option of starting to charge banks interest on holding reserves at the central bank which would be highly inflationary as it would force banks to lend.

In the United States the prospects for QE2 ahead of the November mid-terms is growing and coming as a surprise to many quarters when it has been obvious since the first print run that once started money printing cannot be stopped whilst large budget deficits exist, which where the U.S. is concerned probably means continuing for the next 10 years at least as the U.S. is going to milk its reserve currency advantage to the fullest. So all the talk by the press earlier in the year that Q.E. had come to an end and would be unwound has been found out to be completely WRONG. Again, as I mentioned right at the start of QE in March 2009, once started money printing cannot be stopped whilst huge budget deficits exist EVEN AFTER RECESSIONS END. Therefore rather than be withdrawn or unwound, given the poor deficits outlook for the UK and US, we can expect QE to morph into a permanent feature of monetary policy.

The bottom line is that the QE already has yet to feed through to the financial system, i.e. UK £200 billion of money printing as a consequence of the fractional reserve system ultimately resolves into total money supply expansion of between £1 trillion and £4 trillion, which is highly inflation and already manifesting in what the Bank of England calls surprisingly high inflation and in the U.S. the $2 trillion of money printing to date looks set to be followed by at least another $1 trillion this year. So the seeds of high inflation have already been sown that will be reaped during the coming years.

Given the structure of the western economies, all that quantitative easing will do is to boost asset prices and emerging market economic growth and give an extra lift towards feeding the inflation mega-trend for many years.

Negative Real Interest Rates

At the end of the day the current situation of negative real interest rates is NOT deflationary it is INFLATIONARY as witnessed by official inflation indices that range between +2% to +4% rather than -2% to -4%.

Why ?

Because negative real interest rates erodes the confidence of people to hold fiat currencies. Workers are more eager to spend, savers are definitely more eager to seek escape from an obvious theft of value when banks are paying 2% against CPI of 3.1% and RPI of 4.8%. They are more likely to SPEND and invest in assets other than fiat currencies which is defacto reduction in the confidence of a population in holding the countries currency.

That’s the reason why Gold is above $1200 rather than $600 that prominent permanently deluded deflationists have been espousing these past few years as to what ‘should’ happen.

The Myth of Japanese Economic Depression and Deflation

Deflationists in the mainstream press and BlogosFear constantly perpetuate the myth that Japan has been in a Deflationary depression since the housing and stocks bubble burst in early 1990. One would imagine that the Japanese economy is perhaps 30% smaller with prices 30% cheaper given the repetitive mantra . But what about the facts ? The facts are that the Japanese economy has NOT crashed by 30% i.e. in depression during this time period but grown in virtually every year up until the 2008 global recession to stand at a GDP of some 20% higher than where it was when the bubble burst.

Price Deflation ? – Another myth. Despite the fact that innovation and increases in productivity should drive prices down, Japan’s consumer prices have have not fallen but are in fact marginally higher than where they were in early 1990. Therefore what Japan has experienced is stable prices NOT DEFLATION.

Yes Japanese asset prices, namely stocks and real estate have suffered greatly, however this is as a consequence of the bursting of the bubbles that saw prices TRIPLE during the preceding 5 years that turned safe assets such as houses into over bid gambling casino chips that were priced to discount a perpetual never ending boom. Therefore prices fell to reflect reality such as that it was ridiculous for the city of Tokyo in 1990 to be priced to have a greater value then the whole of the United States!

So when you hear about the US following a Japanese style deflationary depression, what you really need to understand is that it is for one of low economic GROWTH with STABLE prices. However the USA is NOT going to follow that model as the USA does not have the demographics of a shrinking ageing Japanese population which really SHOULD result in DEFLATION and a contraction in GDP which Japan through continuous innovation has NOT suffered. If there are far less workers generating MORE economic output then is that really an economic depression?

Commentators have been pointing to Japanese Debt soaring to now stand at 200% of GDP as highly deflationary when the OPPOSITE is true, as when the japanese debt bubble bursts which it surely will, then it will be highly inflationary if not hyper inflationary as Japan is forced to wipe out the value of its debt

Japanese the Real Gold Bugs

Whilst in the west buying gold for wealth preservation has yet to impact on ordinary people to any significant degree, ordinary Japanese recognising their ever growing debt mountain would ultimately destroy the Japanese currency were buying gold nuggets from their local gold dealers in preparation for hyper inflation 5 years ago! Needless to say despite that not having happened to date, the Gold price rising to $1250 reflects the increased global risks of debt bubbles bursting into high inflation.

Bottom Line - There has been no Japanese Deflation or Economic Depression. Western countries such as the UK and the USA are NOT Destined to follow the Japanese experience as their demographics are primed both for greater nominal GDP growth and price inflation.

Delusional Deflationists Point to Treasury Bond Market to Illustrate Deflation

Deflationists point to imminent deflation and a double dip recession by pointing to the treasury bond market yields plunging towards the credit crisis lows whilst at the same time continuing an 18 month mantra of the stocks bear market rally whose end is always imminent with the most recent plethora of commentary concluding that it has ended (again) and the bear market has resumed.

However the facts are that it is bonds and not stocks are in a bull market that is coming to the end of its life and entering the final manic stage that tends to see markets go parabolic. I am sure in recent weeks you have heard at length as to why bond investors are smarter and thus why the bond rally will go on and on, to me that sounds a lot like the tek stock investors during 1999, they too saw themselves as very smart just as the bubble popped. Every bubble participant thinks its different for them than every other bubble that’s popped before, however it NEVER IS! The bond market investors are in total denial of the fact that the U.S. is firmly on the path towards bankruptcy because the US has given NO SIGN that it intends on bridging the forecast $200 trillion fiscal gap between future revenues and liabilities, a gap that can ONLY be filled by printing huge amounts of money triggering very high INFLATION, which will DESTROY the real value of bonds as in purchasing power terms they will just become confetti paper. Against this stocks that consistently pay high dividends can be expected to retain much of their purchasing power, where my focus is on dividend paying stocks because it is more difficult to engage in corporate fraud Enron style if a company is actually making dividend payments.

The Global Bond Market Bubble

The key drivers for the global bond market over the past 20 years has been China and other emerging markets such as India exporting deflation abroad as they industrialised and produced ever cheaper goods and services to drive down costs thus enabling prices in the west to fall, this has now reversed where China is exporting inflation abroad as its workers now start to demand a higher standard of living and the country increasingly looks towards domestic consumption to generate economic growth. On top of this we have the ever expanding supply of bonds that no matter what the central bankers state is not going to diminish (pay down the debt) for either the UK, USA or most of the developed countries during the next 5 years at least.

The 30 year treasury bond market graph shows a clear long-term uptrend punctuated by several speculative spikes higher amidst’s a so called dash for safety during 2008 and at the present time though there is no Lehman style crisis on the horizon, that just as 2008 resolved towards a swift plunge back towards the long-term trendline so will the current bond market rally just as the mainstream media becomes most vocal in its commentary for bonds being a safe haven destination for investors. If the 20 year bull market trend pattern persists then further upside is limited in favour of a trend that targets a move to $USB 120 to 115 over the next 9 months. So those that have bought during the past 6 months are going to be sitting on losses in about 6 months time.

The 20 year graph for US treasury bonds as a proxy for the Global Government Bond Market bubbles has investors drowning in delusional deflationist ideology that suggests bond prices can keep rising ever higher, when the actual fact is that the bond market is very close to a significant reversal point. This is a manifestation of the reinforcement of belief that this time it is different for this bubble, just as the housing market bubble participants thought that house prices would keep rising for ever because it was different, and before then the dot com bubble could not be priced on the basis of what had gone before because the Internet meant that this time it really was different – IT NEVER IS DIFFERENT!

Off course one of the best inflation mega-trend hedges are Index Linked Government Bonds, and up until recently NS&I Index Linked Certificates, as the new government pulled the plug on these inflation hedges due to the fact that they are paying out 6% per annum TAX FREE, RISK FREE to savers during 2010 and rising to 7% during 2011. Against which the bankrupt tax payer bailed out banks cannot compete that typically pay less than 2.5% that is TAXED at 20% or 40% depending on ones tax band. For 50 pages on how to protect your wealth Download the FREE Inflation Mega-Trend Ebook

The Bottom Line – The global economy is not contracting it is growing by a decent 4.1% this year with similar 4%+ growth for 2011, the emerging markets are more than picking up the slack for the weakly growing western economies as a consequence of high levels of debt AND converging GDP per capita. This ensures that upward pressure on inflation will remain for western economies despite the downward pressure on real wages as the living standards of the east and west converge. For the west this means high inflation as governments attempt to inflate nominal GDP and wages to give the illusion of growth whilst in the east there will be currency appreciation coupled with strong economic growth and higher inflation that will be exported to the west.

What Investors Should Do

The U.S. Fed and the Bank of England are going to keep printing money which is a big positive for asset prices such as stocks. For investors the strategy remains to invest in inflation wealth protection and growth such as agricultural commodities, gold, silver, metals and mining, TIPS, emerging economies such as China, India, Russia, Chile, Brazil, and developed economies such as Australia and Canada as their appreciating currencies will protect your investments purchasing power in sterling and dollars as covered at length in the Inflation mega-trend ebook (FREE DOWNLOAD).

The Protectionism Disaster Scenario

The disaster scenario is for that of one of protectionism to take hold which will fail to stop the trend towards convergence of GDP per capita between east and west, but it will result in a smaller economic pie i.e. global economic contraction, economic depression in the west and price deflation. This means the west would suffer whilst the east grows much more slowly. Protectionism would be a lose, lose outcome for all. The only real strategy the west has is to resign itself towards slow but sustainable economic growth as the emerging markets continue to grow to fill the huge gap in development that still exists between west and east.

Interest Rate Rises To Feed the Debt Interest Spirals

The debt interest payment pressures are set to accelerate as interest rates are forced to rise as a consequence of bond markets baulking at ever increasing supply of debt and rising inflation, UK short-end real rate interest rate of -2.6% is just NOT sustainable. Over the past 18 months borrowers have become drunk on extremely low interest rates (even if the banks are not fully passing them on) whilst inflation has started to rage in the UK during 2010 punishing savers and rewarding borrowers to entice them to take out even more debt.

What to Expect in the Future

The Bank of England WILL RAISE INTEREST RATES AND PRINT MONEY – This is contrary to anything you will hear anywhere else as the consensus view is that QE and Zero interest rates are complimentary, they will NOT be as we move forward! Because the Bank of England Will have no choice but to attempt to DEFLATE PRICES whilst INFLATING the Economy to achieve this it MUST RAISE Short-term Interest rates WHILST KEEPING LONG-TERM interest rates low. To achieve this the Bank of England needs to BUY Bonds and Stocks whilst forcing demand for consumption and wage increases lower. This WILL become the consensus view AFTER the FACT, perhaps in 6 months time ? Just as the mainstream press is ONLY NOW, 9 months on, starting to slowly wake up to the Inflation Mega-trend with the likes of the FT only coming to conclusions on the Bank of England Inflation targeting very recently, something that I came to several years ago!

FT – FT audit casts doubt on Bank’s forecasts – 9th August 2010

The forecasts used by the Bank of England to set interest rates are biased and contain little useful information, a Financial Times audit has demonstrated.

Nadeem Walayat – Bank of England’s Worthless 2% 2Year CPI Inflation Forecasts – 14th August 2008

The Bank of England’s in depth 48 page quarterly inflation report published yesterday concludes with the forecast for UK CPI inflation to be at 2% in 2 years time. Since the Bank of England first adopted the 2% CPI inflation target back in 2003, the Bank has perpetually made the same forecast for 2% CPI in two years time, and nearly always missed the target by a wide margin. Clearly there is something wrong in the banks procedures which appears to deliver the motions of generating paper work such as the 48 page report, followed by pats on the back rather than an effective response to the failure to meet the Banks primary objective.

The full implications of debt and the inflation mega-trend on interest rates as the UK economy recovers will be covered in my next in depth analysis, ensure you are subscribed to my always free news letter to get this in your email in box.

Comments and Source: http://www.marketoracle.co.uk/Article22199.html

By Nadeem Walayat

http://www.marketoracle.co.uk

Copyright © 2005-10 Marketoracle.co.uk (Market Oracle Ltd). All rights reserved.

Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem’s forward looking analysis specialises on UK inflation, economy, interest rates and the housing market and he is the author of the NEW Inflation Mega-Trend ebook that can be downloaded for Free. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 500 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

A move past the 2008 highs would be an important breakout. However, it is important to note that in both Silver and various large-cap gold stock indices, resistance actually dates back to 1980. For the gold stocks we are looking at a potential breakout from a 30-year base, while for Silver, we are looking at a potential breakout from a 29-year base.

Ladies and gentlemen we are looking at the inception of a historic move in precious metals and precious metals companies. Don’t believe me? Consider that at the end of 2009, 0.8% of global assets were in the precious metals complex. Folks, this was above 20% in 1981 and over 30% in the 1930s. Despite what you may read or hear, virtually no one owns precious metals, and those that do don’t own enough.

As you can see from the picture below, folks are rushing for safety in Treasury bonds.

Sad to say but most folks don’t get it. Those that continue to stick with crappy stocks and bonds that aren’t going anywhere deserve their own fate. Those that get involved in the precious metals will be wealthy when its all over.

Debt default is unavoidable. Inflation or deflation doesn’t matter. What matters is that the US, Europe and Japan CANNOT grow their way out of the debt mess. A new currency regime is unavoidable. The worse the economy gets, the faster we move towards sovereign default, bankruptcy, hyperinflation and a new currency. It has happened before numerous times and will happen again. Don’t be left behind. The train is getting ready to depart the station.

Consider a free 14-day trial, which entitles you to future updates as well as updates from our recent past.

And herein lies the rub: if and when the economy ever picks up, and at this point that looks like an event that may well never happen, “Many economists worry that bank lending and monetary growth will eventually surge and, ultimately, cause higher inflation.” The backstops offered by the Fed looks increasingly more brittle: reverse repos and IOER. The longer ZIRP continues, the more aggressive the Fed will have to become if and when the money multiplier finally shoots higher. If prior examples of hyperinflation are any indication, this will not be a seamless or smooth process, which is why aside from the traditional calls for hyperinflation as a result of a collapse in the faith of the monetary system as a whole, many are also calling for this outcome should the Fed, paradoxically, stabilize the economy. And it is about to get worse: the Fed’s balance sheet is likely about to grow by another $2 trillion as soon as QE 2 is announced. Which means that by the time the economy needs to remove excess liquidity, the Fed will need to find a way to remove not $2Bn, but probably double that number. The simple conclusion is that the longer the Fed fights deflation, the greater the likelihood for (hyper) inflation as the final outcome once it ultimately rights the economy. We tend to think that Odysseus was faced with an easier choice.

From the St. Louis Fed:

The Monetary Base and Bank Lending: You Can Lead a Horse to Water…

In its response to the worsening financial crisis during the fall of 2008, the Federal Reserve took actions that dramatically increased the size of the monetary base (the sum of currency in circulation and depository institution deposits with the Fed) (see chart). Subsequently, the Fed purchased some $1.7 trillion of securities issued by the U.S. Treasury and federally sponsored housing agencies, which expanded the monetary base further. The base more than doubled in size between September 2008 and May 2010. Yet measures of the money stock, such as MZM, M1, and M2, increased far less. For example, M1 increased about 17 percent over these months; consequently, the ratio of M1 to the monetary base (measured by the St. Louis Adjusted Monetary Base), commonly referred to as the “M1 money multiplier,” fell from about 1.6 to 0.84.

Why was the increase in the money stock so small when the increase in the monetary base was so large? The answer centers on the willingness of depository institutions (banks) to lend and the perceived creditworthiness of potential borrowers. A deposit is created when a bank makes a loan. Ordi -
narily, bank loans—and hence deposits—increase when the Fed adds reserves to the banking system. How ever, despite an increase in reserves of
over $1 trillion, total commercial bank loans were some $200 billion lower in May 2010 than in September 2008. Banks added to their holdings of securities, which resulted in a modest increase in deposits and the money stock, but many banks were reluctant to make new loans. Partly this reflected weak loan demand, but it also indicated a diminished appetite for risk on the part of bankers. Further, a lack of equity capital (and a high cost of obtaining additional capital) constrained the lending of many banks (banks are subject to minimum capital requirements based on their outstanding loans and other assets).

Many economists worry that bank lending and monetary growth will eventually surge and, ultimately, cause higher inflation. Minutes of Federal Open Market Committee meetings indicate that Fed officials have discussed possible measures to discourage excessive growth in lending and the money  stock. One option is to sell securities outright or under repurchase agreements, which would shrink the monetary base. Recent experience illustrates, however, that large changes in the base may be necessary to effect the desired changes in bank lending. Another option is to raise the interest rate paid to banks on their reserve deposits, which would raise the opportunity cost of lending and thereby tend to exert upward pressure on market rates generally and slow the growth of loans and the money stock. However, because the Fed has little experience with paying interest on reserves,
it is difficult to predict how much bank loans would change in response to an increase in the interest rate paid on reserve deposits. Hence, the Fed may resort to both options if monetary growth threatens to become excessive.

—David C. Wheelock

The reality is that hyperinflation is first and foremost set in motion and driven by a deteriorating fiscal situation. In fact, significant economic weakness and deflation is a precursor to hyperinflation. Too many analysts believe that there has to be some economic demand or some consumption to stimulate inflation or hyperinflation. Printing money to try and stimulate your economy or excessive credit growth is what leads to inflation. Printing money because you are broke and can’t service your debts is what leads to hyperinflation.

Recently Jim Rickards wrote about how a change in velocity can trigger hyperinflation or severe inflation.

At Mises.org, Henry Hazlitt educates us on velocity:

For example, it is frequently said that the value of the dollar depends not merely on the quantity of dollars but on their “velocity of circulation.” Increased “velocity of circulation,” however, is not a cause of a further fall in the value of the dollar; it is itself one of the consequences of the fear that the value of the dollar is going to fall (or, to put it the other way round, of the belief that the price of goods is going to rise). It is this belief that makes people more eager to exchange dollars for goods. The emphasis by some writers on “velocity of circulation” is just another example of the error of substituting dubious mechanical for real psychological reasons.

Indeed! The focus on velocity may have led you astray over the past 10 or 15 years. Take a look at this chart of velocity from Dr. Lacy Hunt of Hoisington Investment Management.

As you can see, velocity actually increased during a time of disinflation and has been muted throughout most of the bull market in commodities. Moreover, despite in recent years, the sharp drop in credit growth and bank lending in the West, Gold and Commodities have powered higher. We know that Gold has made all time highs against every currency. Yet, take a look at this chart.

Priced in Euros and Pounds, Commodities have rallied back to their 2008 high! Priced against a basket of currencies (ex US$), Commodities are 9% below their 2008 peak. Not bad considering the crash in 2008 and ensuing deflationary environment.

Why are Gold and Commodities performing so well if we are in a deflationary environment? The greater the deflation and the worse the economy gets, the greater the worry about sovereign bankruptcy, which will come via default or hyperinflation.

Certain government bonds are rallying because they are safe-havens relative to other government bonds.

The point is, precious metals are outperforming and commodities to a lesser extent even without a rise in bank lending, a rise in credit growth and a rise in velocity. As we already explained, deflationary forces and a weak economy ultimately exacerbate the ability of various governments to service their ongoing and growing debt burdens.

Hyperinflation is a fiscal phenomenon borne out of a bankrupt state that can’t service its debts. Monetization is a trigger while a rise in consumption and velocity is a psychological effect as Hazlitt notes. After all, if massive inflation is coming, what is the first thing you want to do? You’ll position yourself in hard assets well ahead of thinking that “I need to spend now because this money will be worthless later.”

In our premium service, we have paid little attention to inflation-deflation or money supply or velocity. Instead, we correctly focus on the fiscal health of various governments. As that deteriorates, it brings us closer and closer to the eventual end game, which is a new currency regime. For what it is worth, I do believe we will see severe inflation but note that hyperinflation of the Zimbabwe or German kind is out of the question due to the deep and liquid bond markets that we, Europe and the UK have. If you’d be interested in more clear analysis and how you can reap big profits while protecting yourself, consider a free 14-day trial to our premium service.

Jordan Roy-Byrne, CMT

Jordan@thedailygold.com

http:/www.thedailygold.com/newsletter

M2 “is there” and now the Fed needs velocity to go with it, says Zero Hedge.  I will go one step further and say that they are not likely to get said velocity until the d Boys have convinced everybody that it isn’t coming.

Even then, it may not come domestically here in the good ole’ US of A or more accurately its (monetary) velocity will lead right out of the country, into global resource and economic investments not anchored below the surface by a sublime and unpayable debt burden.

But money supply is there and it is being ramped exponentially and systematically through various methods by very smart theoretical and mad scientists; paper alchemists.  You cannot create limitless amounts of something, unbacked by productivity of any kind, and expect that its value in relation to real things and real productive centers will not erode exponentially over time.

So M2 is there.  The herd will ignore this just as it did in 2008 and the transitional asset of monetary value will benefit first, its miners will gain the famed leverage that gold bugs have lost hope on, followed by resources (commodities) that the productive world needs to function.  Finally, those productive economies that are aligned with the inflationary future will catch the bid as a new global system gets sorted out.

This will probably be a grind – over years – which is why those with short attention spans, a lack of stamina and/or no plan or road map are going to get blown up.  But yeh, M2 “is there” and velocity will probably be more tricky.

Source: http://biiwii.blogspot.com/

The author basically concludes that Gold is a currency and not a commodity because it has followed US Dollar movements closely. Yes, we all know that Gold and the greenback usually move in opposite directions. However, while noting Gold as a currency, the author fails to note that it is a worldwide and universal currency.

Righting America’s national balance sheet would explicitly raise the dollar’s value as investors with money abroad move assets into a more-sound American economy. The selling of euro, yen and pounds would push the dollar higher—and gold lower.

First of all, I would argue that at this point, righting the balance sheet isn’t the issue. The issue is that the US and other nations start growing fast so they can grow their way out of their massive debts. The debt burden won’t become smaller if the US has a balanced budget. In fact, we’d see GDP decline and in turn, debt as a percentage of GDP would rise. If a nation has a low overall debt, then austerity can work. However, when your debt becomes to large, growth is the only answer.

Secondly, the selling of foreign currencies isn’t necessarily bearish for Gold, which has risen against all currencies since 2000. There are many extended periods when both the greenback and Gold moved higher….Q2 and Q3 of 2005, 2001, Q4 2008 and Q1 2009 for starters.

Lastly, the author seems confused by Golds relationship with inflation.

Invest in gold, then, according your beliefs about the future of the greenback. Just don’t invest based on the idea that gold is a proxy for inflation. You are likely to be played for a fool.

Actually, Gold moves in accordance not with inflation but with inflation expectations. In the 1980s and 1990s, we had inflation but since it was disinflation, inflation expectations were kept in check.

Finally, we should note that Gold does well in times of credit stress. Deflation or hyperinflation can result from a tight credit environment. This is why Gold performs well in both deflationary and inflationary environments. Going forward, instead of focusing on inflation/deflation, investors should focus on the sovereign debt picture of western governments. If it worsens, then Gold will continue to rise.

Unlike those who write editorials in the WSJ, we have been following Gold day by day throughout this bull market. Check out our premium service for 14 days and for free!