kidmercury

Venture capitalist Albert Wenger recently had a good post debating whether we are entering an inflationary or deflationary depression. He argues deflationary. Myself, as well as all those who come from the Ron Paul/Peter Schiff/gold freak mentality, are on the inflationary side of things.

Before I get to why I am betting strongly on an inflationary depression, let us first clarify what we mean. Inflation means money supply is going up, deflation means money supply is going down. We can extrapolate this further to say that inflationary environments are characterized by rising prices, deflationary ones by falling ones. Falling prices may sound good -- until you remember that that means the price of your wages as well. Deflationists are concerned about the falling value of assets (money is hoarded, there is less production); Inflationists are more concerned about devaluing of currency (your money buys you less tomorrow than it does today).

In reality we will see elements of both inflation and deflation. For instance, both inflationists and deflationists generally agree we will see US financial assets fall in value. In the Austrian school of economics, we can think of this as those investments that were made because the money supply was artificially expanded and thus seemed lucrative (but actually would not have been had the money supply been more appropriate) will now need to be expelled from the market. Those asset classes -- which, in this depression will most notably be housing and financials -- will decline. I would think most inflationists and deflationists would agree with this assessment.

Now for why I believe inflation is the greater concern.

It's All About The Default Risk

Inflationists look at the US economy and see one thing: debt. Lots of it, and more on the way. The American society, both its people and its government, are addicted to credit. We have a budget deficit (government spends more than it takes in) and a trade deficit (imports greater than exports). This scenario, known as a double deficit, is at the heart of the problem, as it fuels credit addiction.

Any real solution begins with understanding the importance of cutting spending, which in turn will decrease reliance on credit. We do not see this happening. Instead, we see the government spending more than ever before, taking on more debt. The market is beginning to wake up to what is happening, and is forecasting an increasing likelihood that the US will not be able to pay back its debts. The default risk on 10 year government debt is now greater than the default risk that was on Lehman Brothers (which did default). With each bailout, the US government increases its spending obligations, which increases both its demand for additional debt and the likelihood of defaulting on existing debts. This is why inflationists freak out at the bailouts and call them inflationary; they increase the likelihood of a default, at which point the printing presses get turned on, dollars get printed, and we go inflationary.

It's All About the Chart

I am a currency trader who focuses on technical analysis, so I always rely on price action in charts to tell me WTF is going on. Below is an 8 year monthly chart of the EURUSD exchange rate. Note the upward sloping diagonal line that the rate has not been able to break. Technically, I view this as a key trendline; so long as this trendline is not broken, I have a tough time thinking the 8 year trend of dollar devaluation is broken. Other indicators, like the monthly moving averages, also suggest the trend of dollar devaluation is still intact. Ongoing weakening of the dollar means an inflationary depression.


It's All About the New World Order

Deflationists tend to live in a different political reality. Put another way, inflationists tend to be conspiracists. As such, inflationists tend to view central banks like the Federal Reserve as inherently inflationary -- that is what they always do. See this article, and then this one.

It's All About Argentina (Not Japan)

Deflationists tend to argue that the United States is heading down the path of Japan, which did have a deflationary depression. Japan, however, did not run a double deficit; they were not addicted to credit, had real savings, and were a lender -- not a borrower. Argentina, like the United States, was hooked on credit, and borrowed as much as it could. When each economy experienced a depression, Japan went deflationary; Argentina went inflationary. The US mirrors Argentina more closely than it mirrors Japan.

It's All About Peter Schiff

Here's a short interview with Peter Schiff where he explains how we are going inflationary, not deflationary. I view Schiff as the real deal and agree with him on pretty much everything related to the economy. It's worth noting that Schiff's track record is stellar; he correctly called both the housing crisis and the run up in gold prices.


Buy your gold, your foreign currencies, your foreign assets....anything but US dollars. Inflation is here, and more is on the way.