Inflation or Deflation? Navin Doshi (May 18, 2009)

As I have explained in my book, Saving Us From Our Selves, Nature always creates pairs of opposites every where, organisms and organizations included. As usual, there are two views among economists, while the government is trying hard at getting out of deflationary pressure by injecting trillions into the economic system. It is accurate to say that we have experienced deflation in the past several quarters. The state of the economy can be measured by four indicators constituting of two pairs of opposites tied to the four human attributes, as explained in my book. The four economic indicators are the rate of inflation (CPI), interest rates, GDP growth, and unemployment. We are experiencing deflation because the GDP growth is negative, CPI was about half a percent negative in the first quarter of this year, unemployment is approaching 10%, and the treasury interest rate is being kept artificially close to zero. In essence, the wheels of the economy are slowing down, thanks to the imbalance in the pairs of economic indicators created by government manipulation.

Ben Bernanke, who did his PhD on the subject of the 1930’s Depression, is known as Helicopter Ben. He is known to have expressed his views that the way to resolve a depression is to print the money and throw it from a helicopter. The second group of economists believe that the Fed may not be able to control the rate of inflation, once the inflation rate starts climbing due to the trillions of dollars permeating the system. Inflation can be controlled by increasing interest rate as we saw in 1980’s. But they also believe that the Fed may not do so due to the political pressure and the fragile economy and the banking system.

So are we going to have Zimbabwe style inflation or a Japanese style deflation? In Zimbabwe, the lowest denominated paper note is cheaper than the toilet paper we use and the deflation in Japan has been lingering for the last two decades. Government and Wall Street are trying hard to convey the perception that the worst is behind us. After all, the psychology is the most important factor in navigating markets.

In time, Bernanke should have his way and we should be out of deflation and enter the domain of inflation; no one knows how long it will take. However we need to accept the fact that the old glory days are gone for good as far in the future as we can see. Why? The process of deleveraging has impaired consumers and financial institutions. The trend of the last 25 years of “borrow and spend” is replaced by the old ways of “saving for a rainy day”. The financial system is damaged severely due to the vaporization of virtual banks like hedge funds and insurance companies holding worthless toxic assets. The growth in the domestic demand in western countries will not be as good as in emerging markets. Emerging markets crashed along with the western markets because their exports to the west had dwindled. However they have a great potential in enlarging their middle class.

The trend towards worrisome inflation is here to stay. Nations around the globe have adopted the Keynesian currency printing experiment; we have never seen such unanimity among nations ever in the history to go for Keynesian economic philosophy. There are reputable economists who believe that we can not get out of deflation for years to come. There is another trend developing; for example, China has converted their dollars into commodities like copper, silver and gold, essentially commodities becoming a parallel world reserve currency. Commodities could become a dominant currency only if inflation takes off.

The current economic quagmire, the people at GATA (Gold anti-trust Action Committee) believe, is due to the manipulation of gold and silver prices by bullion banks with the blessings of the Fed and the government. Bullion banks buy, or lease gold from various sources and sell to generate profit. GATA, in essence, is the opposite of the Fed in a nature’s pair and is an education and civil rights organization with a goal to force governments to implement free market for all goods and services, including gold and silver. They also believe that loose money policy always creates market bubbles in due course. Gold price, if traded freely, becomes an alarm signal on the world economy system; it indicates the “nutritional value” of the currency, literally. Gold, in essence, acts as a reference or an anchor to bring balance and stability to the movement of the currency. In the 1970’s when it was freely traded it gave a strong signal of inflation. Fed chairman Paul Volcker was able to bring inflation down, strengthening the dollar. If the gold price was not suppressed by bullion banks in the last two decades, gold prices would have given a strong signal long before the credit bubbles brought the world economy crashing down. The Achilles heel of the bullion banks is the shortage of physical gold and silver.

There are only two possible outcomes as I see it. Either the bullion banks will fail in the end, or the US government will have destroyed what remains of the free market in America. I hope it is the former, but the continuing flow of events from Washington, D.C. and the actions of policymakers suggest it could be the latter.

Navin Doshi (May 18, 2009)
(Mr. Doshi is a financial market trader, philanthropist, and a writer.)

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