Inflation, Deflation or Devaluation?
Posted by Ray on September 24, 2009 under Main | 
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This debate has been going on for some time now with many very bright minds taking one side or the other. However, I think the answer is pretty obvious at the moment. There is clearly no demand in the system, regardless of the rosy picture CNBC paints, because we are still knee deep in tough economic times which means we have deflation right now.
On the other hand, deflation is probably not permanent because of the massive printing the Fed is doing. If you are in the camp that the US is in a recovery then what the Fed continues to do is the equivalent of adding a nuclear bomb to a fire, so clearly we are not even close to being out of the woods yet. I do admit things are better, but you would have to be a fool to say that the banking system is healed because nothing let me repeat that, nothing has changed.
The toxic assets are still there, defaults on all loans are sky high, foreclosures, the so-called catalyst of the problem, are through the roof and unemployment is still increasing. The banking system has not done one thing to reform itself and has done even less to change its ways, I mean come on they got a bonus last year and they are getting record bonuses this year. So, nothing has changed and that is the only reason that none of the trillions of dollars have not hit the peoples pocket yet, but they will eventually.
Even if those dollars do not reach the peoples pocket, it doesn’t even matter because we have printed so many of them and issued so much debt that we diluted the value of the dollar. While that means nothing at the moment, because we consume most of what we produce, the weak currency will eventually impact us in a horribly vicious way. Basically, a dollar devaluation means that you don’t even get the benefit of wage inflation which goes along with typical inflation. You simply wake up one day and your currency is not worth anything, just ask the Russians what it is like.
So, essentially, we have deflation now, but the Fed will screw it up and our government will never control spending, as illustrated by the soon to be voted on debt ceiling increase, which means we the people pay for it at the end of the day through inflation or a devalued currency. Since the Fed has shown it has no interest in defending our currency we might as well get used to the idea of a cheap dollar. At first a cheap dollar will be perceived as a good thing, as illustrated through higher equity prices, but longer term it means higher prices for commodities like food and energy.
Before too long commodity producing countries will demand a new settlement currency if the dollar remains too cheap for too long. What that currency is, I do not know. How long will it take to replace the dollar, again, I do not know, but I can assure you it will happen. However, we are not doomed to this future if the Fed decides to defend the dollar through higher interest rates or our government decides to stop wasting money.
If we take action now then we can remain the reserve currency of the world and fend off inflation or a devalued currency. If we do nothing, the likely course of action, we will head for the above mentioned future. Do not shoot the messenger it is just the way things are and if you think things will work out differently then tell me how. I would just like to remind you that Greenspan, Bernanke and every other expert missed the warning signs of the crisis to begin with and odds are very high that they will miss any real recovery.
In short, all the great minds will likely be right and we will suffer through both phases of deflation and inflation, although I prefer deflation any day. The only way to preserve your wealth through inflation will be through real assets like gold, silver, platinum and palladium. I prefer silver and palladium on valuation and as a recovery play, especially if you think we are already in a recovery, as they have industrial uses. I am not the only one who thinks that we are in trouble with our currency and our debt load, Julian Robertson seems to think, rightly so, that if the Chinese or Japanese stop buying our debt we are facing Armageddon, video below.
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