Today In Silver

Gerry, a gentleman with whom I have corresponded in the past, has written a smart commentary on the present monetary tug of war.

I call this uncertainty about inflation versus deflation “indeflation”.  It is a combination of the two words but it is also a play on the word indecision.  The fact is that most people (many economists included) do not understand what inflation really is.  I define inflation as the increase of money and credit in excess of the growth in productivity.  Deflation is the opposite … a decrease of money and credit.  Inflation is not a general increase in the level of prices … which is merely a symptom of true (monetary) inflation … as most financial “experts” would have you believe.  The fact is that the world’s fiat currencies have been centrally managed by the various world central banks since the early 1970’s and one could argue that this process has occurred since 1944, 1933 or even 1913.  The most influential currency manipulator during this period was the US Federal Reserve (Fed).  In the past 40 years the Fed has increased money and credit greatly in excess of any increase in productivity in the US economy.  Since the US dollar is the world’s reserve (fiat) currency this led to inflationary pressures in the US but even more so in the rest of the world.  This increase in money resulted in increasing prices of all goods and services but especially so for commodities which saw a top in prices in early to mid 2008.  Since that time we have been seeing falling commodity prices.  How can that be since the Fed has continued to increase its monetary base since then … even more than doubling this monetary base over that period?  Many financial gurus were calling for prices and wages to explode upward in an inflationary spiral reminiscent of the 1970’s.

The reason for this discrepancy is that the fall of Lehman Brothers and the bailout of AIG in the fall of 2008 resulted in a massive de-leveraging of the world banks and shadow-banks which is ongoing today.  Remember that I said above that inflation is the increase of money “and credit”.  It is the function of our banking system to take the monetary base created by the world central banks and lever (or “gear”) this money many times over through bank credit.  Since the 1990’s this process went completely out of control and the banks geared to unimaginable levels using both legal and illegal methods.  This has now reached a point where the banks have created so much credit that the world is awash in debt.  In fact there is now so much debt in the world that the world income base cannot support the interest payments required to service the debt … let alone try to pay off the principal.  This has resulted in a period of destruction of credit which by my definition above is deflation.  However, this deflation has not yet resulted in a general decrease in the level of prices and wages.  Why not?

Although the Fed has more than doubled its monetary base since the start of 2008, this new money has largely been quarantined or sterilized on the Fed’s balance sheet.  In addition it is highly likely that the amount of new money created by the Fed during the past year (although massive) has not kept pace with the destruction of credit that we have seen during that same period.  As a result, prices of most assets (housing, stocks, commodities and consumer discretionary goods) have either fallen (sometimes drastically) or remained flat.

I actually don’t think credit is contracting at this point so much as the availability of credit is decelerating. It was the acceleration of credit availability that fueled much of the world’s (not just in the U.S.) discretionary spending. All we’ve had is a mere stall in credit so far yet it has opened up a fearsome economic chasm. Should we get a meaningful contraction in credit there would be little debate about deflation vs. inflation given the number of people soon selling pencils on the street corner.

It will probably be a while before discretionary spending comes back (those of you who think it will never come back, please save your breath as we’ve all heard the argument before) and that could realistically reduce global GDP by 10%. A large portion of this reduction would probably be offset by government discretionary (stimulus) spending at least until governments were unable to borrow any more because they have displaced or crowded out all borrowing in the private sector. That is when (and only when) the odds of a hyperinflationary or deflationary monetary collapse will approach 100%.

Will food, energy and health care prices continue to rise in the meantime? I’m not entirely convinced. It is possible that the cost of such necessities will be rangebound during the next few years at elevated though not continually rising levels. Readers of Metal Augmentor know I’m talking about the model recently advanced by trader George Slezak. In such a model oil could trade around $50, corn at $5, silver at $15, etc. with periodic sojourns up or down but prices would eventually return to the mean. Hardly exciting but such price levels would be profitable for all but the most marginal producers (I’m looking at you, most of the Canadian oil sands) and this would be quite an accomplishment given the difficult economic conditions. In such a scenario gold and silver would have great potential for price rises and price spikes but the timing would not be certain. There would probably be substantial downside risk for leveraged gold and silver traders, speculators, explorers and miners.

In any case, those are my thoughts on “indeflation”. The odds of the situation continuing at the present level of uncertainty for several years are frankly not very high but it is entirely possible that we will have a temporary, partial and weak recovery a few months ahead followed by renewed economic decline and another weak recovery and so on and on. That might very well look in retrospect like a prolonged period of “indeflation” and it could also explain the prices of essential commodities trading at elevated levels without necessarily embarking on a new bull market (while not being in a bear market either).

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Jim Willie of Golden Jackass fame has discovered, according to his latest Gold: Musings and Peptalk, the not-so-secret but totally-ignored-by-analysts tool that the Federal Reserve used to prop up the dollar and U.S. Treasuries late last year. In Fed Reveals Meaning of “Other”, I had discussed how around 40% of the increase in the Fed’s balance sheet had not gone to U.S. banks as generally believed but rather to foreign banks under the Fed’s Central Bank Liquidity Swap lines. Although I don’t always agree with Jim Willie, in particular with his more outlandish calls, he does offer a highly valuable perspective that attempts to simplify and connect the convoluted and complex global financial and monetary system. He often even succeeds and for that reason I recommend that his writing be heeded (although as is the case with mine, it should be taken with a variably-sized, usually big, grain of salt). In any case, check out the “Treasuries and CB Swaps” charts in his latest piece and mine from the beginning of February — all I can say is imitation is the sincerest form of flattery.

silverax Monetary Links

Nibbling at the Edges of the Power Structure
Bron Suchecki
September 29, 2008

I have called Professor Antal Fekete’s monetary recommendations a “Prosperity System” because they seek to maximize economic well-being given the mental constraints of human nature and the physical limits of Mother nature. In his insightful critique, Mr. Suchecki puts a finger directly on the very core of the Professor’s approach and crystallizes many of the reasons why I personally came to believe — but only after reading the Professor’s works — that monetary gold (and silver) lies at the very heart of the redemption of civilization. Here are some excerpts from Mr. Suchecki:

Scanning my bookcases my eye fell on two books: one I have read - Paul Hawken?s The Ecology of Commerce (1993) ? and one I have only skimmed but been meaning to read - Lewis Mumford?s The Myth of the Machine: The Pentagon of Power (1970). What these two books share with Antal?s work is a strong moral sense, specifically that there is something wrong with the way society works, and a focus on making it better. The best gold advocates (I prefer this term instead of ?goldbugs?, which implies emotional irrationality) I feel have this moral element to their work. It takes the form of a belief that fiat currencies, which lack any limits, are detrimental to society. This concept of limits also appears in Paul?s, Lewis? and Antal?s work.

. . .

A key aspect of Antal?s work is the power that physical gold money gives the consumer, the average person, over the monetary system. Without the ability to redeem gold, without the ability to hoard gold, there can be no control on power: ?When a currency is redeemable in standard gold coins, any individual disturbed by the behaviour of the government or banks can attempt to protect himself by presenting for redemption such paper currency as he may command. It is this power of individuals that holds, or tends to hold, banks and government in check.?

. . .

I cannot think of a better description than ?animated individual minds … nibbling at the edges of the power structure? for what gold advocates are all about.

silverax Monetary Links

Has Hedging Killed The Goose That Was To Lay The Golden Egg? - Part 2
September 16, 2008
Professor Antal E. Fekete

The Professor tells the gold mining industry how to treat shareholders. Will they listen?

The challenge to the gold mining industry is enormous, but there are no signs that it is up to it. In retrospect, the industry has been selling gold for the past sixty years at ridiculous prices. It has frittered away the patrimony of shareholders, the top brass has been lining its own pockets and helping government profligacy. Shareholders are confused. They were hoping against hope that higher gold prices would ultimately change all that. Well, higher gold prices have come, but the wasteful exploitation and the rip-off continues. There is no noticeable change in the pittance gold executives dish out as dividends.

silverax Monetary Links

Investing in Chaos - The Storm is Here
September 17, 2008
Darryl Robert Schoon

Darryl doesn’t pull any punches:

This is the end of a system. It is not a cyclical correction. It is not a market pullback and it is not a repricing of risk in an otherwise resilient marketplace. We are witness to the end of an economic system based on credit-based paper money that began 300 years ago in England. All beginnings have endings?and that we didn?t expect it to end doesn?t mean that it wouldn?t.

silverax Monetary Links