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Tuesday, September 30, 2008

Inflation, Deflation, Money Velocity and Gold

From David Rosenberg at Merril Lynch (now Bank of America) today:

"Money supply will increase but money velocity will not

We are getting asked repeatedly these days how it is that the government debt creation we are about to see is not going to be inflationary. After all, aren’t we going to see a boom in the money supply? Well, we’re sure that the money supply is going to increase, but at the same time, we are going to see the turnover rate of that money, or what is called money velocity, decline. This is exactly what happened in that 1989-93 period when the Fed massively reflated. Money velocity contracted 13% and this is the reason why the inflation rate was cut in half that cycle and bond yields rallied 400 basis points, though no doubt that downtrend in yields was punctuated by intermittent corrections – as we’ve seen take place in the Treasury market over the past week."

In Gold, Oil, PMs: More Hedgies Get Whacked I wrote:

“Forget about oil demand from the BRIC countries. The whole globe is grinding to a halt. Believe it.

Forget about inflation. There has never been in the history of the world an inflationary run while land prices were declining. The amount of debt being destroyed as the monster of a debt bubbles implodes will suck down all asset prices and just absolutely collapse the velocity of money.

Factor in some serious de-leveraging by every single kind of market participant, and there is no way commodities can resume their ‘secular Bull market’ for years to come.

Take a look at copper for example. Copper just smashed through a multi-year trend line after putting in a long topping formation. Since 2006 prices have been hitting the same highs and getting rejected. This break down is of utmost importance.

Game over.

I’m firmly in the deflationist camp.”

As soon as the fear and panic subsides, the easy money will be made SMASHING gold short as people finally realize that inflation is what we HAD and that deflation is what we will HAVE.


Anonymous said...

As the venerable Barry Ritholtz has said, bear market rallies are some of the sharpest. The bear market rally in gold over the last couple of weeks is a great example.

Hello deflation, all hail his majesty, the king: cash!

-Mike J

Anonymous said...

I sure hope you are right.
Smart to have 5-10% inflation hedge though.
You never know for SURE whats gonna happen.
Best of luck to all!

Anonymous said...

Can wage inflation be engineered? Check out the stream of news about illegal immigrants round ups and mass deportations. That bound to have an effect on labor availability. Direct loans to automakers – to increase wages.

Another war? Fiscal stimuli of trillion proportions? Free government loans to small businesses. Labor costs in China catching up with labor costs in the US. How about a higher medium wage.

Seems like bankers want their money back by way of government/taxes, since they can’t get it back anymore directly from many individual borrowers, who went bankrupt. That is deflationary because it sucks out cash that could be spent outright on consumption by the multitude and invested in productive undertakings by the government, no? (And I don’t buy the overconsumption story).

Anonymous said...

I would much rather have silver or gold than paper money, thank you very much.

The $USD will continue to decline vs. all real things of value. Paper can be created much easier and in much higher quantities and will be.

Anonymous said...

Isn't the wild card here the risk of greatly reduced demand from our generous partners in the Middle East and Asia for our gov't debt, due to percieved credit risk? Higher interest rates, but also a weakened dollar, no? And in a case of lack of confidence, it seems possible that the risk may override the higher interest rates on offer and crater the currency, no?

Anonymous said...

I agree the nominal price of gold will likely decline, though it will hold up better than all other commodities as it reverts to it's role as money. However, after this brutal fall stock bear leg is over and it's time to go long as a short term trade, remember that gold stocks will shoot to the moon during the bear market recovery bounce and will outperform general equities by a large margin. The bounce should be from late fall to the spring and many gold stocks will double or better from their eventual lows in late fall. For now, gold stocks and gold will get caught up in the deflationary deleveraging and should be a decent short for another month or so (what isn't right now?).

However, I would argue that other commodity sector stocks that are more correlated with the economy (e.g., oil stocks come to mind) are a better short.

See Bob Hoye's work at Institutional Advisors for an explanation of the "real" price of gold improving gold miner's profitability. Gold mining stocks got hit from 1929-1930 but did great from 1931-1933 during the last U.S. deflationary implosion.

Thanks for all your AWESOME work!

Anonymous said...

"Increased velocity of circulation is not, in itself, even a contributing cause of higher commodity prices. It is not even a link in the chain of causation. Increased velocity of circulation and higher commodity prices are joint results of a change in the value of money in relation to the value of goods. When people value money less in relation to goods, they offer more money for goods; when they value it more in relation to goods, they offer less money for goods. Any change in velocity of circulation is likely to be a result of these changed value decisions: it is not itself a cause of the change in value. The value of money does not decline because its velocity of circulation has increased, though the velocity of circulation may increase, when it does so, because the value of money in relation to goods has declined."

Henry Hazlitt

(MV = PT) is so simplistic it has no practical value

// Client #9

Anonymous said...

We just had an explosion in the finacial system and the world has been running towards it (supporting the dollar), soon they will realize that supporting our dollar is also killing their own economy and start running away from the explosion, launching gold into the thousands and this time we will have the worst of both worlds..economic contraction along with massive inflation because of massive printing of dollars.
So Dave, one of the oldest firms in the country just collapsed on your watch with the same kind of thinking and you have the gall to be giving advice to the public? Shame on you. BTW...I'll buy all the gold you want to sell me...idiot.

Anonymous said...

cash is paper, gold is real money. i know you understand this, but there will be hordes of people willing to exchange their paper cash for the very limited amounts of gold as the crisis hits. i am one of those.

i think you are dead wrong on gold deflating and i will buy all your gold (if you have any) to prove it.

remember the difference between now and the days of when your economic theories applied. derivatives swamp todays cash, stock, and bond markets combined. the times of when neat little formulas and complex equations regulated world economies is gone.

when you debauch a currency, you destroy a society. who knows what will happen exactly, but gold is a safe bet. do you ever study what Ron Paul says?

Anonymous said...

Ben. They're printing already. We'll pass 10 trillion tomorrow. It;s too late- bailout or no bailout the plan is in action and it's coordinated. Once US dollars stop flowing back to treasuries it's night night time.

Anonymous said...

"Hello deflation, all hail his majesty, the king: cash!"

i bought a lot of gold back in 2002 as greenspan was busy printing dollars.

sold some of it recently for a few dollars.

i ran out of toilet paper....

good luck with all those 'king dollars' you got there buddy...

scott said...

a strong fiat currency (any and all) would seemingly wreck havoc on trade flows as demand destruction from credit restrictions continues.

i understand your perspective when you reason that cash is king. after this ongoing run for money it will be interesting to see how existing value is stored.

DKenny said...

Gold will do just fine because there is no CREDIT RISK. Silver and gold are the two commodities that most likely will do well, even in deflation. Just look at what happened during the Great Depression. Gold went up and gold equities skyrocketed. I wouldn't bet on gold going down, altho it very well could see weakness in the hedge fund liquidation.

Anonymous said...

Gold is going to $500. Oil is going to $50. Platinum and palladium typically lead moves in other commodities. They are down to less than half of their highs in March.

Deflation is here folks. The banks will not inflate, because inflation would bail out the debtors. When the savers again outnumber the debtors, it'll be time for inflation.

Anonymous said...

Re Gold Silver
Agree with deflation and your bearishnes on commodities in general. We have already started the mother of all depressions. But consider...
1. Comex prices are one thing, but you can't get the real thing at a retail level except at a large premium, if at all. Mint stopped production of gold eagles and buffaloes. This form of rationing is to stifle demand artificially. News from dealers is about unavailability.
2. Prices are already low due to 18 years of CB price suppression. Downside could be limited.
3. Few who have the physical are actually willing to sell. I am one who is not.
4. Goldman Sachs now net long on TOCOM (but could be a smoke screen for a large short pos on Comex)
5. Fed's balance sheet full of crap. At some stage there will be consequences.
6. Agreed there will be times to go short, but due to manipulation of Comex, forget TA. Very difficult to know where/when to go short.
7. You say "when fear and panic subsides". When will that be Ben ? You have a quadrillion dollar derivatives monster. Fear and panic will be a constant.
8. Gold in your hot little hand has no counterparty.

Anonymous said...

"Deflation is here folks. The banks will not inflate"

good call on that one...

Anonymous said...

Just a warning from the other side.
Beware fools gold. When your going hungry and need money for the rent gold won't keep you warm. Golds an illusion and always has been. Good for the secure to decorate their palaces....

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