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Deflation, Depression & Gold

Gold has tripled in 6 years. Yet the world economy has enjoyed a huge boom right alongside...

OVER THE YEARS I have read a multitude of articles and books with one extreme point of view or another regarding impending economic doom.

   Now I see that everything from impending goldilocks prosperity to imminent 1930s depression is floating around in bookstores these days. So which is it?

   The deflationists argue that when debt is issued at increasing levels, there comes a point when we cannot service the debt. Eventually we resort to selling everything we have – bonds, stocks, houses, cars – to raise dollars to pay debt.

   In this scenario, deflation occurs as money aggregates shrink by debt repayments, people hold off purchases – knowing goods will get cheaper – and workers are laid off as there is no demand for their product.
   Five years ago, back when Dow was 8,000, I talked to Mr. Ian Gordon. He based his 1,000 Dow target on this deflation premise. Buy Gold, he says, because it's the ultimate money during times of world depression and deflation.

   Well, he was wrong on the Dow. But he was right on gold, if only for the wrong reason.

   Gold rises in tandem with rising fear of price inflation, not fear of deflation. Gold and deflation simply do not go together. Why would you Buy Gold when your Dollar is appreciating in value?

   Deflationists and Depressionists are often the same crowd. They eagerly anticipate some specific back-breaking straw, an event that triggers the implosion of debt, with the world blown back to the Dark Ages and streets filled with riot and violence.

   I like to bring two contrarian points to this view:

  • The worst possible event that could trigger debt implosion has already occurred, with demand for the multi-trillion US mortgage debt market suddenly and completely dried up. Yet the world has gone on with business as usual.
  • In the last four weeks, we have witnessed the worst financial event in the US over the last 50 years. The subprime mess shook the US financial system to the core, as it directly affected the marketability of the $30 trillion+ US debt market.

   Would you touch beef – or in this case, US debt – again knowing there is a significant quantity of mad cow disease – here meaning subprime – going around?

   The significance of this dwarfs the recent events of 9/11, LTCM, the bubble bursting or the more distant events of the 1987 crash and the 1970s oil embargos.

   To avoid the default of 10 million households and the systemic collapse of major banks such as Countrywide, the Fed and US government had no choice but to bail out the markets.

  1. For lenders and investors, central banks are lending unlimited amount of money to troubled outfits on renewable terms with faulty mortgages as collateral. Fannie May and Freddie Mac are buying increase mortgage purchase to troubled outfits.
  2. For borrowers, Mr. Bush is working with banks and set to "forgive" certain amount of mortgages. The Fed is lowering interest rates to lessen the burden despite oil and commodities prices reaching all time high.

   Investors see such an inevitable and destructive path for the Dollar that it should be no surprise gold has broken through $750 and oil has reached a new high above $87.

   But can you honestly see Safeway running out of food or corporate America such as McDonalds or 3M stop growing? The world is forever going forwards, not backwards.

   Remember, debts are man-made features, existing in a virtual world, serving to facilitate the transfer of ownership of real assets. While debt implosion may cause localized social instability, the disruption does not affect technological or intellectual capacities, or the existence of hard assets. All the houses, cars, planes, and technologies are still here regardless of the fate of the Dollar.

   What I am saying is that people outside of the United States hardly noticed any difference with the US debt implosion taking place in full view. I was in Thailand for a three-day break and the immigration lines at the airport where full of mainland Chinese. What subprime problem do they have?

   In my view, the Dollar losing its reigning status would affect the global economy mildly and swiftly, as the loss of purchasing power in the Dollar merely facilitates the transfer of wealth from Dollar holders to other fiat currency holders – as well as the owners of hard assets.

   If the party has to end for the Dollar, it just means that the party is starting somewhere else.

   This topic, linking gold to prosperity, deserves a long discussion on its own. Here let me point out that the Gold Price has risen from $250/oz to $750/oz in six years while the global economy has grown the fastest since WWII according to The Financial Times.

   This goes to show that a gold bull and prosperity can happily co-exist without a doom and gloom outcome. With an increasing global middle class and ever-expanding fiat money aggregate, I don't see the rising gold and economic trends reversing anytime soon.

John Lee, CFA is an accredited investor with over 2 decades of investing experience in metals and mining equities. A Rice University graduate with degrees in economics and engineering, Mr.Lee is the Chairman of Prophecy Development Corp.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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