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Inflation vs Deflation

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  • Mon, Jun 06, 2016 - 02:47am

    #11
    Paul DeGiere

    Paul DeGiere

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    Same question as above: “How To Keep $?”

I don't think anyone knows for 100% sure if it will be deflation, hyperinflation, or deflation then hyperinflation, or another combination of some sort, and in exactly what order. Valid arguments for all the different scenarios have been made by people like Schiff, Maloney, Dent, and Martenson. No one knows for sure how this will play out, and only time will tell who was right. The point is to prepare for all simultaneously, and keep a close eye on things so that if one scenario begins to manifest more than the others you can then reposition accordingly.

Thus, going back to the "How To Keep $?" question that was never answered, I think this is the critical question and I would love to see a good answer to it. If we are to hold a good chunk of cash for possible deflation, that can be risky if it is in the banking system and the banking system collapses. I'm therefore concerned as to what to do as obviously keeping a good chunk of cash at home is also risky. If you are lucky enough to live near private vaulting services that are out of the banking system then that is maybe an option. Maloney describes using this option for himself in his "Silver Shortage: The Breakdown with Mike Maloney" YouTube video, however he seems to only be doing this for a small amount of emergency cash funds and not for larger investment "dry powder" cash. 

I believe Chris says he will put out a warning if the banking system is flashing red, so that we might pull funds out in time. I think he used the example of Greece, where he stated those citizens had plenty of warning (years?) before things went bad, yet most failed to act and the rest is history. For us in the US following Peak Prosperity, once we have that level of concern here, in theory we can take action as well before our wealth is potentially destroyed. Although I would like to believe Chris is right that we will surely receive this advance type of warning, I don't trust that this might not be a overnight thing where one day things are fine but the next day you're screwed if your funds are in the bank and it's too late to act. I'm going to assume there's a chance we might not get this advance "warning" and that it would be prudent to take some sort of action now.

Therefore what is a good recommendation to do some preparation for deflation but simultaneously not risk it all being lost to banking collapse? In my personal situation, the answer to this is important to me as I'm looking to fund a future housing purchase in the Bay Area. Obviously with the insane housing bubble we have here right now I'm looking to wait for that next housing correction / bubble pop first (which will be deflationary), and I'd like to have the comfort of knowing my cash funds (my "dry powder") will likely be there when the moment comes where I'll want to access and deploy these funds.

  • Mon, Jun 06, 2016 - 10:02am

    #12

    davefairtex

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    keeping your cash safe

My answers, in order of my sense of safety, during a deflationary storm:

  • physical cash, along with proof of where you got it, with copies stored elsewhere, so you can sue to get it back if the police confiscate it.
  • short/medium term AAA corporate debt in a company with a very strong balance sheet in a "necessities" industry – avoid manufacturing.   (probably best to "rate" the company yourself; default rates during 1932 on "investment grade" corp debt was about 9.2%.  No AAA company defaulted during the Depression).  If in a brokerage account, make sure your broker isn't engaging in trading activities.  Margin account is probably a bad idea too.  Own actual bonds, not a bond fund.
  • short term US sovereign debt, owned directly by you: Treasury Direct.
  • checking account at a strong local bank

Avoid: muni or state debt, long term govt debt, long term corp debt, accounts at TBTF banks, money market or bond funds or ETFs, esoteric instruments, accounts at any organization that engages in prop trading and/or derivative writing.

Fun paper on historical default rates: http://instructional1.calstatela.edu/jrefalo/fin331/Lecture%20Notes/Historical%20Default%20Rate%20Study%201920-1996%20(Moody's).pdf

I know the ratings organizations are whores these days, but a first cut of corporates rated AAA can then guide you to a quick look at the balance sheet and – just sense if the business provides a product that is a must-have (like soap – consumer staples) or a would-be-nice (like an iphone – consumer discretionary).  Right now, there are only 3: Johnson & Johnson, Exxon, and Microsoft.  Of those three, I'd pick JNJ.  JNJ earned 17 billion last year, and has 26 billion in debt outstanding.  That's Aaa: not likely to default.  Example: JNJ has a 5 year bond yielding 1.67%.  5 year Treasury yields 1.23%.  http://quicktake.morningstar.com/stocknet/bonds.aspx?symbol=jnj.

Armstrong suggests this time around it will be the sovereigns that fail; in a sovereign debt default, there is typically no "recovery" while with corporates, assets are sold and bondholders do get something back.

In a real depression, cash will be king, because everyone will be desperate to pay down debt.  All assets will be sold to make this happen.  Debt gets harder to pay every year in deflation.

While gold promoters like to say that "gold is money", it really isn't, and that will become apparent during severe deflation.  Across the economy, gold will get tossed right off the lifeboat if people are forced to choose between gold bars and the debt underpinning the house, the car, or the family business.  Cash of course can always be used to repay debt, so it is zero risk during deflation.  With an ounce of gold, you have no idea how many payments you will be able to make next month, but with cash, you know exactly, and it will never change.  Risk tolerance goes to zero during big deflation.

Gold did well during 1930s because it was exchangeable by law for a fixed amount of cash.  Gold was money – by law.  It no longer is, and so price fluctuates with demand.  A lot of supply will come on the market in a deflation.  People will simply have no choice.  Gold price will drop as a result.

Of course – during the reflation phase, gold will do very well.

If you are clever and nimble, you can hold the "cash" assets during the initial deflationary wave, and then switch out to hard assets before the reflation occurs.  Timing might be challenging, to say the least.  🙂  An asset allocation is probably a strategy that would help you sleep better at night.

You might also go short junk debt.  That will be the first thing to blow up in a real deflation.  But that's more of an adventure too.

  • Mon, Jun 06, 2016 - 02:12pm

    #13

    KennethPollinger

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    Gracias Dave

Excellent post above.  Your assistance in all these matters is outstanding.

Yet, a question.  Wouldn't it be better to wait until a solid market correction/collapse happens to buy those three recommended stocks, that is JNJ, XOM, and MSFT.  Same for metal miners, senior and junior.  I know they are down quite a lot but surely in such an event, they would go down further, no?  And how much further?  Who knows?  Maybe just have "dry powder" ready for that moment?  It's the timing question, I guess.

Again, many thanks for your detailed and careful analyses and comments.  Ken

  • Mon, Jun 06, 2016 - 04:37pm

    #14

    davefairtex

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    bonds, NOT stocks

Ken-

DO NOT BUY STOCKS.  Buy bonds.  Extremely high grade corporate bonds.  They are better than bank deposits since they are backed by a real company with real assets and real earnings.  And you are higher in the food chain with those bonds than you are at some bank with your bank deposits.

And if worst comes to worst and the company blows up – which never happened during the worst year for bonds ever, 1932 – you'll get something out of the bankruptcy.  It won't be a total loss.

The question was, "where do you store your cash during deflation?"  The answer: high grade corporate bonds.  BONDS.  In addition to actual cash, short term treasury bills, and some amount in a local-bank checking account.

  • Tue, Jun 07, 2016 - 07:16pm

    #15

    Eannao

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    Gold in Deflation

Dave, 

If a major deflation occurs, given that central banks cannot tolerate deflation wouldn't they act to re-price gold at a higher price to 'break' the deflation?

E

  • Wed, Jun 08, 2016 - 05:11am

    #16

    davefairtex

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    reflation

Eannao-

If a major deflation occurs, given that central banks cannot tolerate deflation wouldn't they act to re-price gold at a higher price to 'break' the deflation?

Well first, the question was, how do we preserve cash during deflation.  Gold isn't the way.  If a real deflationary wave hits, gold will drop.  If you have gold, you will have to grit your teeth and hang on during deflation phase, possibly cursing the goldbug writers who promised you that gold would somehow be a great refuge when prices of everything was dropping.  No doubt they'd blame "manipulation" while the price of gold tracked all the other prices lower.

Its during reflation that gold (and anything else real) will do well.  But there are lots of ways to reflate without going back on the gold standard (i.e. "revaluing the dollar against gold.")  Keen's debt jubilee is one way.  Real helicopter drops of money are another.

If you listen to what they're saying, they've already prepped us for a reflation-by-helicopter-drop.  I see that as the most likely reflation mechanism.

Renewing the gold standard gives a storybook ending to the goldbugs.  When was the last time "the system" did something to make us happy, except as a side effect?

Also, a gold standard takes a huge amount of control away from the central planners, while a helicopter drop leaves the current system in place.

Gold will still do well during the helicopter drops, plus its a great way to retain wealth that's also portable, which is very helpful if your local government starts to get really repressive.  You can't move your house out of a high-tax jurisdiction, but you can easily move your gold.  Related: there is no property tax due on a gold bar.

But I don't think we're going back on a gold standard.  Not unless confidence in the currency (and the government) completely snaps.  And if that happens, I think they'll try to swipe our gold first (or they'll levy a 50% "gold windfall profits tax")  because they have no interest in giving us goldbugs any sort of reward for being right.

China might do it, after their debt problem is fixed.  They seem to be pro-gold.  But only after that debt problem is fixed.

Just an opinion, informed by recent history.

  • Wed, Jun 08, 2016 - 09:17am

    #17

    Eannao

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    Reflation

Hi Dave,

the idea of re-pricing gold at a higher price to 'break' deflation doesn't involve returning to a gold standard per se. It involves the Fed (possibly in concert with other central banks) supporting a higher price for gold. I suppose in effect this would be a quasi gold standard.

It is an idea that I have read mainly from Jim Rickards (http://dailyreckoning.com/elites-new-case-gold), but it does seem rather far-fetched now that we discuss it. What seems more likely as you say, is Helicopter Money in some form.

As an aside, the recent upturn in gold, oil and many soft commodities could be an indication that we are entering the inflationary phase. Perhaps we won't see the deflationary 'Ka' though it's hard to imagine how we can avoid it considering all of the extra debt we have piled on?

Given the unpredictability, I think the only way is to prepare for both. Gold, cash and patience.

 

  • Wed, Jun 08, 2016 - 11:18am

    #18

    davefairtex

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    what’s the mechanism?

Eannao-

So let's think through the mechanism for "the central banks supporting a higher price for gold."  That would involve the Fed printing new base money, and buying gold with it.  (How else does one "support" higher prices if not through buying?  Wishful thinking won't cut it, neither will cheerleading, at least not for long.  I must say, I definitely support higher prices for gold.  Does anyone care?  Will that affect the price?)

So the Fed prints money and buys gold until gold gets to their desired price of, say, $5000/oz.

If gold drops below their price, they print more money and buy more gold.  If gold rises above their price – maybe they don't care.  Or maybe they sell gold in exchange for dollars – to "mop up" inflationary effects of all that printing.

I have just described what the Fed used to do during the gold standard.

Or, otherwise known as "central bank price support for gold."  Nobody in their right mind would ever sell gold for less than $5000/oz because you could always take your gold to the Fed, and get $5000 for each ounce.

Set the price too low, nobody will sell you any gold.  Set it too high, and you'll see massive inflation.

British had a problem with that – they set it too low during the 20s, and it caused them a lot of trouble.  Gold fled England.  "Sure I'll trade these pounds for gold."

Lots and lots of people would sell their gold to the Fed, take the money, and buy other stuff with it.  Stuff that had not yet gone up in price.  The Fed would end up with a great deal of gold, and a lot of new money would be dropped into the system, driving up prices of everything.

FWIW, I agree – cash, gold, and patience.

  • Mon, Jun 27, 2016 - 08:45pm

    #19
    adamlh

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    When the hyperinflation is about to hit…

If it is clear to us that hyperinflation is going to hit (whether it is preceded by a deflation or not) would it make sense to use all of the borrowing power you have to buy hard assets? Like should I have a home-equity line of credit all ready besides signing on the dotted line, and use all my credit cards or anything else I have available to borrow with and buy – gold, silver, ammo, food – knowing that selling an ounce of gold will be enough to pay off all my debts?

Is this crazy talk? I mean I realize there is risk to being wrong. But let's say it was super obvious. Is there a flaw in this plan?

  • Mon, Jun 27, 2016 - 09:39pm

    #20

    General

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    Inflation vs Deflation

Having physical gold and silver is a really good idea.  Gold will start becoming more difficult to buy in the near future.  Paper money has no backing, expect for the word "trust" on it.  Once folks lose trust in their governments, Feds, and their ability to make proper decisions (our leaders), money can instantly start losing value.  Our Fed is hiding 4.4 Trillion in debt on their balance sheet with only about 58 billion of assets…not good!  No way for them to pay it off.  That's just a beginning!  Gold will go straight up soon.  I'm not talking about 1,400/oz; I'm talking well over 10,000/oz…maybe even up to 50K/oz.  The Fed can set a gold price of lets say 10K/oz with buy and sell at 10,200 and 9,800/oz respectively and go back to gold back currency.  It's the best way to create instant inflation in our current deflationary (depression) environment.  All nations are in a pickle (Feds) at zero to neg rates (bad deal, neg rates).  There is no way to increase off of zero rates…a constant loop.  Raise rates and the markets crash, lower rates below zero and you have serious problems also.  We are stuck at ZERO interest RATES…and will never get off.  With zero rates comes low growth, which we have in spades, so going back on the gold standard is their best way to get off some.  Will it work…yes, but either way, we're in serious trouble.  Most folks will lose everything they have in savings and 401Ks.  The Feds have screwed us, so…a Brexit.  Have some gold and silver also.  The dollar will eventually tank and you'll lose the majority of buying power.  Gold and silver will help to protect your assets.  When the above happens, SSAN, retirements (esp govt retirements) and savings will become almost worthless…just saying.

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