Tuesday, 17 February 2009

My Thoughts on Deflation

As the inflation/deflation debate rages on, I want to talk about what's happening in reality. What we are seeing today is deflation. How can you argue with that? We have seen house prices tumble, commodity prices plummet, and the bonds of weak issuers disintegrate. These things are all deflationary. Some people will say that will all the money printing going on that hyperinflation will come. They might be right, but they are not right today. Right now, the purchasing power of all the fiat currencies is going up in relation to real things. You can now buy more stocks with your money. You can now buy more oil with your money. You can buy more houses (I wouldn't advise that now) with your money. Everything is cheaper. It's going to continue to get cheaper, too. The deflation (or more importantly credit contraction) is not over yet. You are getting a total de-leveraging of society. People are starting to realize that being totally in debt is reckless and are starting to save instead of spend. Hedge funds are pulling in the reins on their leverage (Having leverage of 30 to 1 is no longer considered prudent). Banks are also doing their thing by not lending a penny to anyone. They are just trying to save themselves. The government is giving banks money and telling them you must lend. The banks are just ignoring them and holding on to it, saying to themselves, “Nobody else is lending, why should we? Why don't we just hold on to it for awhile and see what plays out". What's the end game? Well, prices of things have to fall to their intrinsic values before long term investors will come in. The more the governments keep intervening in markets, the longer it will take to get to the end. But when the deleveraging is over (which I think will be 2014 for stocks, 2012-13 for houses, and 2012 for commodities) you are going to get serious inflationary pressures coming back. The governments of the world are taking unprecedented action to unlock the credit markets in order to save the financial system, but they are not considering what the consequences of their actions will be. It's a policy of "let's just do something, anything, and see if it works. If it doesn't work, we will keep doing more of it." It doesn't make sense to me, but I can see what they are doing will be very detrimental in the long run. Keep in mind the price of gold. It's been going up for 8 years straight and looks like it's going to continue its run. When the deflation is over, you want to have some assets in gold (50% or more, in my opinion). Gold is trading above $960 today for the first time in 7 months. I think gold market is up because people are anticipating the end of deflation (even though it is years away, in my opinion) and know it's going to be terrible for fiat currencies. People aren't even waiting for the end of deflation. The demand for gold right now is ridiculous. There is a premium if you are trying to get the physical, because there is little supply. The only thing backing these fiat currencies is CONFIDENCE because they aren't backed by anything. Gold has been considered money and I think will always be considered money. What do you think will happen if the entire world loses faith in these pieces of paper we call money? They will instantly become worthless, and anyone with real wealth (i.e. gold bars, real estate, machinery/equipment, commodities, "real things") will not suffer the devastation that will come to people who have electronic 1s and 0s in their bank account.

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