Wednesday, April 3, 2013

Is It By Fire or Ice?

No, not climate change.  Does the economy get destroyed in inflationary fire or deflationary freeze?   This is probably the one aspect of the coming nastiness that the fewest people agree on.  There are strong, vocal advocates for both hyperinflation and complete deflation.  I've been studying this for a decade and writing on it for the 3 years I've been here, and I'm not convinced one way or another. 

In comments to last night's post, a comment by Taylor proposed the idea that it's by deflationary collapse.  It's worth reading the whole thing.  Grabbing a few key points:
The inflation that people fear is coming due to The Bernank's actions is a one step logical assumption. If things are denominated in dollars and dollars become more available, it will take more dollars to buy something. And this is a point.

You have to go a step further and think how logical people will react in that environment.

See, as people we learn over time and react to our surroundings. Over time people will see prices ever increasing as more and more money works its way into the system. Eventually a point is reached where people will not take any amount of dollars for a thing of real value. Instead they will demand something of equal or greater value in exchange.
I would start by saying inflation is here now.  The collapse is going on right now, albeit in slow motion.  Both smaller packages of products at slightly higher price, and same sizes at much higher prices, too.  Here's something I wrote on this back in 2010.  Shadowstats estimates current inflation at close to 10% per year.   But hyperinflation isn't just bad inflation.  As Gonzalo Lira put it, also in 2010:
If we think that hyperinflation is simply inflation on steroids—inflation-plus—inflation with balls—then it would seem to be the case that, in our current deflationary economic environment, hyperinflation is not simply a long way off, but flat-out ridiculous.

But hyperinflation is not an extension or amplification of inflation. Inflation and hyperinflation are two very distinct animals. They look the same—because in both cases, the currency loses its purchasing power—but they are not the same. 
In fact, hyperinflation is just another flavor of collapse. 

Taylor is absolutely right in this statement, too:
The sudden loss of faith in the currency has a hyper-deflationary effect as the market tries to find a new medium of exchange and barter markets emerge...both of which cause transitional illiquidity of the market.
It's worth noting, though, in the latest hyperinflationary disaster, Zimbabwe, they switched over to US dollars, as the one thing they could trust.  If I'm recalling correctly (lazy!) the same was the case in the Weimar Republic of Germany.  There probably won't be a dependable currency for us to fall back on.  I don't think of gold as a reserve of wealth in this case, just a very dependable barter medium - as will also be silver coins, beans, bullets, band-aids and, yes, skills.  There's a historical number that I wrote about right after Christmas 2011, on whether the US could go back to a gold standard,
It has been said that an ounce of gold buys today about what it did at any point in the past.  Stephen Harmston, former economist at Bannock Consulting, wrote that “across 2,500 years, gold has retained its purchasing power, relative to bread at least” which is seemingly proved when one considers that “It is said that an ounce of gold bought 350 loaves of bread in the time of Nebuchadnezzar, king of Babylon, who died in 562 BC” which is roughly what it buys today, a stretch of 2,500 years.  With some judicious selection of the exact brand of bread, you get remarkably close to 350 loaves (and I'm sure there was some variation in what a loaf of bread cost even in King N's day).  Likewise, you'll hear that an ounce of gold would buy a good toga and sandals in pre-Christian Rome, and buys a well-tailored suit and shoes today, or you'll hear that a $20 gold piece bought an 1851 Colt Single Action Army revolver, and today buys a good grade 1911.
In 2009, they said that in Zimbabwe 1 gram of gold would buy 10 loaves of bread.  There's 31.1 grams in a Troy ounce or 311 loaves of bread.  When something has been a dependable trend for 2500 years, it's not crazy to think it will continue, so I think gold will still make good barter material.  It's more crazy to think you know better than 2500 years of history, Dr. Bernanke.   The problem with gold will be how dense in value it is.  A 1oz gold coin will likely be the kind of thing you'd buy a car with.  My good handguns or rifles will not be for sale at any price. 

I think in today's fiat currency, that's a pile of 90% silver, $2 bills. 


  1. Interesting article.

    Last year the company I work for still didn't have a "Performance Review" plan in place to individually rate us for our raises.

    So, in the interest of being "fair", EVERYBODY was given a 3% salary increase because "That's what the current inflation rate is".

    When they announced it at the all-hands meeting, it got hard to breathe in the room because of all the gasping taking place.

    3%? Yeah, and I've got a nice bridge for sale in New York!

  2. Im honored to be topic of a blog post!

    You make some really good points in your post. First, dont think that I am down on precious metals. They will be a valuable form of barter if the dollar sinks until the market can find a new medium of trade (which wont be PMs, as there simply arent enough in the world). That said, gold and silver are still commodities at the end of the day and are subject to inflationary and deflationary pressures in markets the same as any other good (Hence why one ounce of gold in today's prices will buy 1500 loaves of value brand bread today. Theyre still $.98 at Kroger)

    I guess my point, for those making plans, is dont expect that stash of gold to go as far in a depression/collapse as it does today. The value density you mentioned is the exact problem. If the market is illiquid and all you have is some gold coins, you will probably find that people arent going to give up so much practical value for something that they may not be able to reasonably spend in the near future.

    And as Gray hinted at, have something in a smaller denomination as it will be more fungible for the normal every-day purchases. Otherwise you may find it awkward to try and walk out of the bakery with 350 loaves of bread at a time...

    I dont expect only deflation. If you read the scenario that was quoted carefully, I actually expect a period of hyper-inflation followed by hyper-deflation that mitigates as the market adjusts. its not a straight log graph in either direction, think y=-1/x.

    The reason I mentioned skills as being so valuable is that when you have a skill that produces something of value, you create wealth equal to what the market will pay at that time for the value you created. The practical result being that if you have skills that are in demand, you will be able to get by in the immediate term based on the wealth you are generating in the current market, whether it be inflationary or deflationary.

    Not gonna make you wealthy, but if youre willing to work it will keep you from starving.

    A final thought: One thing is true, we are in the middle of the collapse. Dont be fooled by the slow start though. The world is too interconnected these days. Once we get far enough up the slope, things will unwind quickly and messily. The real tough one is always timing. Its so hard to know if it will be this month, this year, or in this presidential cycle. There are too many factors to know for sure until it is obvious in hindsight.

  3. I think it makes sense to have some precious metals, but IMO it's foolish to put too much faith in them. The price of gold is widely viewed as a barometer for the percieved health of the dollar. If the price of gold starts shooting up too fast, I expect to see our politicians become nervous and start looking for ways to limit that rise. They could go the FDR route and make ownership illegal, but I doubt that's what they would do these days. I think they would try to demonize gold owners the way they did short sellers and pass a 90% or so capital gains tax on gold and precious metals. That would crash the market value of gold rather nicely.

  4. Annon@1:11p you hit it out of the park. That is how most federal law is written because it is one of the few direct powers that Fed Gov has according to the constitution.

    Thus firearm laws are tax based.
    Thus Obamacare is a "tax" (and not a fine).
    Thus drug laws are mostly tax based.

    So if people get arrested for possessing gold, it will be for not paying some sort of transaction tax tied to the buyer.

    When all you have is a hammer...

  5. Whoooh! Hear ye - Hear - ye! The Fed Gov you have today and have had since 1860s has been operating in FRAUD as a Corporation, a de facto Gov't, not a de jure one. I now even hear it spoken on Fox & MSNBC. All the statutes, Titles etc only apply the Gov't worker, officers, elected officials and those living in DC (City of Washington), Guam, Puerto Rico, possessions & Territories of the UNITED STATES OF AMERICA, a Corporation. Go with the Junk Silver at least for the time being!!

    1. As the kids say, SRSLY!

      The Fed.Gov is almost a wholly owned subsidiary of the Federal Reserve Bank. The Federal Reserve Banks have been out-buying China when it comes to buying our own debt, by like 9 to 1! If the Federal Reserve stopped buying our debt and let the market set interest rate, would collapse.