Deleveraging Will Give Us a Bout of ’30s-Style Deflation

A Dear Reader, puts the question to us:

“I’ve read Empire of Debt and considered the current recession long and hard, and it seems to me the question of the century is: will money destruction caused by stock market declines, housing market declines etc., and the concomitant deleveraging, result in classic deflation like the 1930s? Or will Quantitative easing and our reliance on the kindness of foreigners to buy (and hold) our treasury bonds result in a dollar crisis and subsequent inflation? It seems to me that as a debtor nation we are at great risk for a dollar crisis as former buyers of our bond auctions turn inwards, but this morning’s largest CPI decline on record has me questioning that. Do you still favor hard assets and avoiding the dollar?”

The answer is yes. Deleveraging will (and is) giving us a bout of ’30s-style deflation. But, yes, the feds are coming to the rescue – like an exterminating angel. Bernanke has said as much himself recently. They’re going to print money. And Alan Greenspan spelled out what printing money would mean, speaking to Congress back on February 15, 2005:

“We can guarantee cash benefits as far out, and at whatever size you like, but we cannot guarantee their purchasing power.”

We don’t know what their purchasing power will be. Gideon Gono was so successful in avoiding deflation, he got consumer prices rising at 230 million percent per year. We doubt Ben Bernanke will be able to keep up with him.

Still, what seems OBVIOUS to us is that after a period of ’30s-style deflation, the feds will get the hang of inflation…the dollar will fall…and gold will rise.

What makes us nervous is that it seems too obvious. What must happen does happen. The bubble in finance had to burst. It did. Prices have to come down…and they are coming down. Now, the feds have to inflate. And everyone knows it…everyone sees it coming.

Everyone is now saying: stick with Treasuries during this down leg…switch to gold, TIPS, stocks, or other asset classes when inflation turns up.

This trade is too crowded for us…too obvious… What could go wrong?

We can think of two possibilities:

1) It could take too long. Every major downturn produces at least one major rally on the way down. If the rally lasts long enough, investors could forget what’s behind it. They could begin to think that the rally is a new bull market…that inflation really is under control…and that have no need to protect against it. They may feel that the rally is their only hope of getting their money back…and they may be loathe to give up on it. Then, when inflation finally does hit, they will be unprepared for it.

2) It could happen fast. If China, for example, were to panic out of the dollar…the greenback could collapse. Treasury bond yields could double…and triple…almost overnight. Gold could pass the $2,000 mark in a few trading sessions. This could all happen like a blitzkrieg, paralyzing investors who wait for a correction before they take action..

Best bet: Stick with the formula – sell dollar-based assets on rallies… Don’t wait for a clear signal that inflation is increasing. And don’t be misled by a sustained countertrend – if we ever get one.

Bill Bonner
for Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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