The End of Gold, Part Two

February 01, 2009

I have read that the risk of stagflation is greater than deflation. I have also read a lot of reasoning along these lines: “what the government has done already will cause inflation and if deflation gets really strong, the government will do more of it so that will cause inflation.” In other words, even deflation is inflationary?

First, we were in stagflation as recently as this summer and we have fallen through it into deflation. The recession started in the winter of ’07 and in the summer of ’08 oil was $140 a barrel, most commodities were through the roof (including gold) and the dollar was at or near all-time lows against almost all major currencies. Recession plus a bubble in prices equals stagflation.

Second, the Fed's money injections have failed to bring back lending. Most importantly, consumer credit growth is negative, as you can see in the latest Fed data. With consumer spending representing about 70% of GDP and a significant portion of that spending done on credit, the risk of inflationary spending seems remote, considering that, according to influential analyst Meredith Whitney “we expect available consumer liquidity in the form of credit-card lines to decline by 45 percent."

And we are unlikely to find ramped-up spending from industry. Consider the following, from the GE conference call as reported here:

Deflation is out there and we’re seeing that in our raw material purchases.

Deflation is accelerating and we’ve got fewer people and less spending.

When we came into the fourth quarter ’08 businesses [were] looking at a little bit of inflation. We’ve been working with the sourcing teams to actually turn that into deflation.

[and]

… Our loss estimate of $10 billion has an average assumption of over 9% unemployment.

9% unemployment? We’ll be lucky if we don’t see 15%. 12% is a mortal lock in my view. And as Ms. Whitney noted in the article I cite above, the credit card is the second key source of consumer liquidity, the first being jobs. And the issue of jobs – unemployment – is the key fundamental in the deflation scenario.

Take a commenter on my last posting. He was objecting to my line: “cowardly business ‘leaders’ throw layoff gasoline on the deflation fire.” Let’s call him “Joe The Businessman”:

Businesses are not laying people off because they have no guts. They are laying people off because they either do so or they fail! Businesses do not want to get rid of trained employees. They have to cut cost! Where do they go? My business is short of cash. I have not been able to get a loan. Production loan has expired. My current choice. Cut cost or fold! What will I do? Guess. I may have no choice.

Joe is not alone in this “no choice” thinking. A friend of mine has been a management consultant with some of America’s top firms, advising some of the biggest corporations in the world. His expertise is finance. When I asked him whether CEOs and managements couldn’t be persuaded to consider the macroeconomic implications of laying off large percentages of their workforce at exactly the same time so many other corporations were doing the same he said: “No. There’s really no mechanism for taking in external considerations like that.” Was there no recognition of the effect of *collective* action? Didn’t businesses understand that deflation is economic mass suicide? He said: “What do you want from me? That’s just the way it is.”

“Have no choice.”

“Just the way it is.”

Does America now have a “can't do” attitude? When American business people – the most powerful economic actors in human history – think themselves powerless, there is a serious problem. Specifically, deflation. More specifically, about 90,000 layoffs at major companies announced just this week. Deflationary behavior has not only set in, it has been firmly embraced by American business. Think of it this way: the financial stuff is the technical, but unemployment is the fundamental valuation metric when it comes to deflation. Our business leaders have already decided we are going to see massive unemployment. As for the American financial community – do I really even have to get into that? Those fraudsters aren’t even trying to do business. They are spending all their time trying to hide from the results of their misdeeds and to drag as much taxpayer money as possible down into the deflationary sinkhole they have dug for us all.

Nobody makes much money in a deflation. It’s that simple and that grim. With a negative mentality firmly in control of the American economy, the only way you make a good profit is to find something to go short that deflation hasn’t hit yet - like gold.

Could gold see a second bubble? Sure. Would I bet on it? No.

What do you want from me? That’s just the way it is.

Disclosure: no positions

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