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Roostercogburn · Forum General Joined: 29 Feb 2008 Posts: 1557

Article From USA Today

Q: I'm constantly hearing warnings that vicious inflation is coming and investors need to be ready. Are the fears legitimate and how can investors prepare now?

A: Everyone is afraid of inflation. Maybe they should be more afraid of its reverse: deflation — a sustained decline in prices, including prices of assets like homes and stocks.

Consumers and businesses are suffering debt-induced indigestion after years of borrowing to buy stuff they couldn't afford. Much of the debt has been transferred to the federal government, to backstop the financial system and prevent a further collapse in asset prices. The government has pumped money into the economy by borrowing itself.

This isn't the right place to discuss whether the government was wise to shoulder the debt. That's for economists to debate, for decades. Here's the problem for investors: The more money pumped into the economy, the greater the risk that each dollar is worth less (supply and demand). That's a textbook definition of inflation and what most investors, like you, are afraid of. But as I'll explain, deflation may be the greater risk.

First, understand that the level of borrowing by the government has been staggering. According to the U.S. Treasury, the current federal debt is around $11.8 trillion, as you can see here. And that total is growing as budget deficits continue to yawn. To put the $11.8 trillion in perspective, consider that it's getting close to equaling the $14 trillion annual gross domestic product of the USA, that is, the total output of all goods and services.

But wait. Didn't I say the danger may not be inflation, but its scarier cousin, deflation? That's the conclusion to draw from the highly regarded fixed-income money manager, Jeffrey Gundlach, chief investment officer of money-management firm TCW.

First a bit on Gundlach. His record predicting the economy's twist and turns and the performance of its mutual funds has been dead on. You can see here how one of his bond funds has performed.

It's also important not to paint Gundlach as partisan. He says Republicans and Democrats alike, as far back as Ronald Reagan, are responsible for the government's irresponsible spending. He says the nation's problems are due to politics and government, and that includes both parties. You can read more here about Gundlach.

Gundlach says smart investors aren't just worried about inflation. That's too simplistic; it results because many of our parents suffered through inflation and warned us of its dangers. "We're all suckers for inflation," he says. Inflation is just one of three possible outcomes of the government's spending spree, and perhaps not even the most likely.

The first possible outcome of the mounting debt load, and perhaps the most remote, is that the government will curtail spending and bring down the debt. Gundlach, who says he can't help but be an optimist, hopes politicians snap out of their spending spree and realize they need to start paying off our enormous debt. This option, of course, comes with dangers to citizens including higher tax rates and reduced benefits.

What if the government just rolls over the debt? The common thought is that government will simply print more money. The result: Inflation. Gundlach says this isn't the most likely option, because politicians and the Federal Reserve know how dangerous inflation is. Inflation is unpredictable. For that reason, Gundlach is thinking government will likely avoid this option.

If the government doesn't pay down the debt and doesn't print money, what's left? Here's where it gets interesting. And Gundlach is very unusual in his thinking. He suspects the government has a strong possibility of at least partially defaulting on its debt.

The default may start in 2013 or beyond as Social Security obligations start to hit, he says. At that point, the government will need to renege on its financial promises to the elderly who paid into the system. And when that happens, the public will demand that the nation's other creditors, including foreign investors, also suffer. That would mean default, something that's been unfathomable for decades.

What happens if the U.S. government defaults? Gundlach says in this scenario, deflation is the big danger. And in a world of deflation, dollars will be scarce and extremely valuable. Again, this is contrary to the worries of those who are terrified of inflation and its rising prices.

What can investors do to protect themselves in case deflation hits? They need to own dollars. And Gundlach isn't talking about dollars in a savings account, which are just lights on a computer screen. He's talking about actual, paper $100 bills. Benjamins in your physical possession. Also bars of gold or precious gems.

Gundlach isn't throwing out this scenario for shock value. He says while many investors are selling dollars, he's buying dollar-denominated assets and investments. The dollar, he says, will show that it's really one of the only safe places for investors to store money, relatively speaking. It's not as strange as it might seem. In fact, the value of the dollar spiked in March, when the financial crisis was at full boil.

Will Gundlach be right? It's hard to say, but his comments are valuable for investors who are blindly buying into the inflation story and investing in overseas assets. And Gundlach says he's prepared to acknowledge he's wrong if the dollar falls below the lows set in 2008.

Even so, "the market will wake up to the reality soon," he says. "When you live on debt, it will end badly. Risk is not going away."

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We have enough youth.
How about a Fountain of Smart? ~ Rooster

flyupsidedown · Forum General Joined: 16 Feb 2007 Posts: 1895

Certainly India's divestiture of billions of USD for gold does'nt bide well for the deflationers. If deflation's prospect were real they would sell gold and buy dollars. But why would they? What is backing the dollar to supposedly drive its value up? We are already in debt around 80% of our GDP, and the GDP is a figure much maligned by gov't manipulations to make us seem richer as a country than we are so they can convince and sell debt to foreigners. Wonder why he recommends buying Gold and Dollars? Hmmmm . . . sounds like he is hedging his strategy just in case. Here is another take;

September 30, 2009

Inflation Is Our Future
By Puru Saxena

At present, there is a lot of confusion amongst the investment community and opinion is divided as to whether we will witness inflation or deflation.

On one hand, the deflationists are claiming that given the extremely high debt levels in the West, further inflation is impossible. On the other side of the argument, many proponents of inflation are calling for Zimbabwe style hyper-inflation. In this business, everyone is entitled to their opinion; however it is my contention that we will get neither deflation nor hyper-inflation. If my assessment is correct, once business activity picks up, our world will have to deal with high inflation.

Although I have great sympathy for the deflation crowd, given the reckless attitude of the central bankers and their ability to create debt-based money, I do not believe deflation (contraction in the supply of money and total debt) is very likely.

For sure, in this post-bubble environment, American consumer debt continues to contract – but this is being more than offset by the expansion in federal debt. Over the past year alone, federal debt in America has surged from US$9.645 trillion to US$11.813 trillion. In other words, during the past twelve months, American federal debt has risen by a shocking 24.47% and it now stands at 83.52% of GDP! Now, given the ability of the American establishment to essentially create dollars out of thin air, I have no doubt in my mind that it will be able to inflate the economy. However, this will come at a huge cost – and the victim will be the American currency.

In fact, the recent weakness in the US Dollar is a sign that central-bank sponsored inflation has started to dominate the private-sector debt contraction in the West. Furthermore, over the past few weeks, various governments have issued US Dollar-denominated debt and this suggests that the carry-trade is back in vogue. In a startling move, Germany recently announced that it plans to borrow money in US Dollars!

Now, given the ongoing federal debt accumulation, sky-high budget deficits and competitive currency devaluations, the macro-economic environment has never been better for precious metals. Yet, both gold and silver continue to frustrate the bulls by moving up slowly, with large corrections.

So, what is going on here? Have we already seen the end of the precious metals bull-market or are we about to witness an explosive rally? Before I attempt to answer this question, I want to make it clear that even though gold failed to better its all-time high during last autumn’s panic, it was the only asset (apart from US Treasuries) which stayed relatively firm. And looking at the various markets today, gold is the only asset which has beaten its all-time high. So, whether you like it or not, gold deserves some credit for fulfilling its role as a safe haven.

Now, unlike some of the die-hard gold bugs, I don’t believe that gold is the ultimate asset to own at all times. Without a doubt, there have been times in history when gold has proven to be a lousy investment. For instance, between 1980 and 2001, the nominal price of the yellow metal fell by an astonishing 70%. This horrible price action spawned an entire generation which grew up hating gold and, up until a few years ago, the vast majority considered gold a barbaric relic.

However, during other periods in history, when macro-economic uncertainty was high and inflationary expectations were running out of control, gold turned out to be a fantastic asset to own.

If my take on the macro-economic situation is valid, then we are in such a period now and gold must form a part of every investment portfolio.

You may remember that over the past year, central banks have injected trillions of dollars into the banking system and it is only a matter of time before inflationary expectations start spiralling out of control. Up until now, this ‘stimulus’ money hasn’t permeated through the economy in the West – but once money velocity picks up, prices will start rising, and the investment community will become very concerned about inflation. When the deflation scare abates and people start protecting the purchasing power of their savings, capital will start to flow towards precious metals.

Long-term clients and subscribers will recall that about two years ago, I highlighted gold’s tendency to rocket higher every other year. Figure 1 captures this trend perfectly and you can see that since the outset, gold’s bull-market has been punctuated by lengthy consolidations and the yellow metal has surged to a new high every alternate year.

Figure 1: Is gold about to shine?

So, if gold remains in a bull-market and its trend consistency is intact, its price should surge over the following months. Remember, however, that certainty does not exist in the investment world and savvy investors should remain open to all outcomes.

Given the uncertainty in the world today and the ticking inflationary time-bomb, my view is that gold will soon embark on its north-bound journey. So, I suggest that investors hold on to gold and the related mining companies, which will probably continue to perform well until next spring.

As far as silver is concerned, it has always been a high-beta play on the direction of gold. If the next up leg in gold’s bull-market materialises, the price of silver should also head towards the heavens. Accordingly, investors may also want to allocate a portion of their investment portfolio to silver bullion and silver producing companies.

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Blessed happy, fortunate, prosperous and enviable is the man who walks and lives not in the counsel of the ungodly (following their advice, plans and purposes) . . . Ps 1