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TWILIGHT TIME: ARE WE HEADED TOWARD MASSIVE DEFLATION OR INFLATION?

“As night does not come at once, neither does oppression. In both instances, there is a twilight when everything remains seemingly unchanged. And it is in such a twilight that we all must be most aware of change in the air – however slight – lest we become unwitting victims of the darkness.” – William O. Douglas

In America today, economically, politically, monetarily, and psychologically, we are now in the twilight zone. The following article has excerpts from an MIA article we published in April 2002. Much that we forecast at that time has taken place over the past four years. The deterioration in our financial system is accelerating – and the danger to your finances has never been greater. Read and re-read this article carefully and ponder its implications for your personal or family finances, and for the future of our country.

INFLATION OR DEFLATION – WHICH WILL IT BE?

Robert Prechter (The Elliott Wave Theorist), Martin Weiss (The Ultimate Safe Money Guide) and Richard Russell (The Dow Theory Letter) are forecasting a dramatic change in the American economy as we enter a huge deflationary depression. But a deflationary depression is only one of two possible conclusions to the collapse of the world’s greatest-ever credit bubble (mountain of debt). An inflationary depression(hyperinflation) is the other very real threat and opposite conclusion to America’s monetary credit fiasco.

The planning you and I do with our personal finances can be exactly opposite – depending upon whether we anticipate a deflationary depression or hyperinflation (an inflationary depression).

Even likeminded fiscal conservatives with a flair for economic history (publications like The Elliott Wave Theorist, the Dow Theory, Martin Weiss’s Money Guide, and Doug Noland’s Credit Bubble) each come to different conclusions as to the exact course of any future economic outcome.

I thought of the views of financial experts I had recently read as I passed a highway snowplow in a near whiteout snowstorm here in Colorado. The snowplow driver generally does great good – clearing the highway during other drivers’ time of need. However, as I saw the huge blade speed past me as I traveled in the opposite direction, I thought: “I hope he’s careful!”

The huge blade and truck could quickly snuff out my life if either of us was careless or inattentive as we passed. Slight error in judgment could create a major catastrophe – especially at high speed. Today, economic/ financial events are taking place all over the world at very high speed, creating instant change in both reality and perception. An analyst’s conclusion that we will soon experience a deflationary depression could be a disaster – if instead we were to experience an inflationary depression (hyperinflation).

A. SOME CONTRARIAN THOUGHTS ON WHY HYPERINFLATION IS THE INEVITABLE CONSEQUENCE TO AMERICA’S ECONOMIC DISORDER

Robert Prechter (a brilliant analyst in the “deflationist” camp) lists the following conclusions from Elliott Wave expert Hamilton Bolton as a summary of past major deflations:

  1. All were set off by a deflation of excess credit. This was the one factor in common.
  2. Sometimes the excess of credit situation seemed to last years before the bubble broke.
  3. Some outside event, such as a major failure, brought the thing to a head, but the signs were visible many months, and in some cases, years ahead.
  4. None was ever quite the same as the last, so that the public was always fooled thereby.
  5. Some panics occurred under great government surpluses of revenue (1837 for instance) and some under great government deficits. 
  6. Credit is credit, whether non-self liquidating or self-liquidating.
  7. Deflation of non-self-liquidating credit usually produces greater slumps.

Number 4 above is the focus of our discussion: QUESTION: What’s the difference this time? ANSWER: Just about everything! Because mankind does not stand still. There is, in every part of the world, a huge movement and expansion in both the speed and intellectual capacity of what man does. No matter where you look, people and their actions and responses are a work in progress – always changing and a little bit different each time. So judging America on past performances and responses, as we try to look ahead, will prove erroneous.

B. DIFFERENCE NUMBER ONE

The “old-fashioned” definitions that many newsletter writers and economists use are “out the window”! Investment bankers’ creativity during the past decade has turned both “money” and “credit” into the same thing. Both are a “socially accepted medium of exchange” (i.e., from the use of simple credit cards to complex multi-level derivatives and swaps). Both “currency” and “securitized monetized debt instruments” are accepted equally as “money,” and serve as “a value storage and final payment.”

In our day, the financial universe has been expanded by hundreds of trillions of dollars of new and accepted “money substitutes.” Both the control and creation of “money” and credit left the confines of central government and the banking industry decades ago. Adam Smith’s books on the “money game,” written 20 years ago, gave us an inkling of the explosion in creative new “money substitutes” that have been expanded and are now created in many trillions by private and semi-private (quasi-governmental) enterprises such as the GEs and GSEs of America.

“Imaginative money (or currency) creation is America’s number one business!” The currency we use today is not “money” – money is dead! “Money” today is only an electronic impulse created by some person’s everexpanding imagination – to be instantly recognized and accepted in an exponentially expanding world of “digital currency.”

C. WHY DOES TODAY’S TOTALLY FIAT CURRENCY/DEBT SYSTEM KEEP WORKING AND EXPANDING?

Today’s “greed” level is probably the highest it has ever been in the world. America fostered the belief that everything of value can be measured in dollars – everything has a “digitized value.” So far, almost all of the world’s peoples envy our success in the creation of a new system of never-ending growth, entertainment, prosperity, and consumption. Why not? An information society informed by TV makes America look very, very good! But outside our borders, Third World nations are restless and question our prescribed value structure. Change is in the wind. Amazingly, other nations of the world each have leadership systems and financial structures more politicized and polluted than ours. So the question is often asked, “where is it any better than in America? Where would you go if you didn’t like the American game?” And the answer is always the same: “America, at least for now, is supreme.”

D. HOW DOES BOOM TURN TO BUST?

“What triggers the change to deflation?” Bob Prechter writes: “A trend of credit expansion has two components: the general willingness to lend and borrow and the general ability of borrowers to pay interest and principal. These components depend respectively upon:

  1. The trend of peoples’ confidence, i.e., whether both creditors and debtors think that debtors will be able to repay.
  2. The trend of productivity, which makes it either easier or harder in actuality for debtors to pay.

As long as confidence and productivity remain steady or increase, then, the supply of credit tends to expand. The expansion of credit ends when the desire or ability to sustain the trend can no longer be maintained. As confidence and productivity decrease, the supply of debt contracts.”

Now (April 2002) we would argue these definitions and anticipated actions of both creditors and debtors (the “old fashioned” relationships described above) are incorrect, or obsolete.

1. FOR BORROWERS – A total breakdown in past standards makes “anything possible.” Many Americans today perceive a system that allows them to have “everything now” for their enjoyment, with little responsibility attached for any future repayment of debt.

Current credit and default rates and the creditworthiness of a high-level cross-section of individuals show an amazing, rapidly increasing irresponsibility in Americans’ use of debt. Borrowers could “care less” about future obligations. “If GM, FNMA, or a local furniture store will give me zero interest, no down payment, and no monthly payments for a year on my ‘loan’ today – I want it!”

2. CREDITORS (THE LENDER) – Banks, corporations (like GE, GM, Ford, and Sears), and “sub-prime lenders” (like Americredit and Metrix) have discovered one thing: There’s more profit in lending (interest rate payments) than there is in producing a product. America’s growth industry is the creation of new imaginative ways to lend money, and to reap exorbitant interest rates. For a producer, the creation of new debt makes the sale possible.

For the lender, the “securitization” of new debts by investment bankers or GSEs (Government Sponsored Enterprises) immediately takes any future risk of default off the original lender’s hands. The more loans you make (and securitize and pass on to the next guy like a “hot potato”), the more profit you can make and report to shareholders – at least for now (today).

When both the lender and the borrower feel no responsibility in the future repayment of a loan, and in fact both the borrower and the lender instantly benefit in the creation of new questionable loans, it is hard to see any “psychological restraint” in the expanded creation of debt.

The borrower says: “If you’re dumb enough to lend it to me, I’ll take it.” The lender says, “I make a profit today when a product is sold and debt is created (origination fees and possible future interest) – I’ll lend to anyone as long as my loan portfolio expands and I can securitize my loan portfolio and quickly (‘lay-off’) pass the ‘paper’ to someone else. Then future collections are their problem, not mine.”

Today, both lenders and borrowers benefit from every new questionable loan that is made. If there is no strong personal responsibility for the obligation of future debt repayment for either the lender or the borrower, then it’s easy to see how the American momentum of debt will get larger, and larger, and larger. The rapid securitization of debt instruments into readily accepted “currency” ensures that “perception is reality,” and our only limits to growth are the limits of our imagination in the future esoteric creation of debt “instruments.”

3. DOES THIS CONTINUE ON FOREVER? – With the U.S. government advocating that Americans “keep borrowing until it hurts” (saving is taboo), and with the U.S. Treasury and Federal Reserve now just obscure midgets in the explosive “currency creation process,” this does look like it will never stop – until the dollar (U.S. currency) is trivialized into oblivion! For you and I to plan ahead, we have to answer one question: How does America always solve a default or confidence crisis?

ANSWER: Government sponsors and supports the creation of more currency and credit to solve any short term problem as “lender of last resort.” So we have come full circle to our beginning question, What is next?

When “it” finally arrives, will it be a deflationary depression or an inflationary depression (hyperinflation)? With our knowledge of every government response to financial crisis over the past five decades and our current understanding of America’s dynamics of debt creation, there can only be one answer. America, in any future economic crisis, will choose to inflate our way out of crisis through instant creation of more currency, credit instruments, and loan guarantees. The only way to avoid an internal economic revolutionary disaster in America is to “hope” in the future to pay off today’s mountains of debt with cheaper dollars. If a thousand dollars of debt created five years ago is now only equivalent in “real buying power to $200 today,” there’s always hope the debt could be repaid – even if it never is.

Inflate or die is the only practical answer to today’s credit bubble. Gargantuan debt will never be paid back with real dollars, and a true depression (i.e., a deflationary depression) would be the end of America as a world power and is therefore unacceptable.

E. PERSONAL FINANCIAL PLANNING ALTERNATIVES

We begin with two choices as a possible conclusion to our inflationary credit bubble of today: a deflationary depression, or an inflationary depression. If you were anticipating a deflationary depression, it would infer that putting your savings in T-bills, triple A Munis and cash would be your best plan in preparation for future events. Like 1930-33, in a deflationary depression the dollar (money) would be king.

But “what if” money isn’t money any more? Then in an inflationary depression anyone who had prudently saved dollars (money) would quickly see inflation or currency devaluation (see Argentina today) quickly wipe out the real purchasing power of any accumulated savings. The U.S. dollar would quickly be devalued in terms of “real things” (i.e., food and energy) that people need to live.

In a deflationary depression, savers of money (dollars) would prosper – to get to buy bargains at bargain basement prices as debt defaults drastically shrank the available money supply, and a debt collapse caused a real shortage of dollars. But “what if” America’s Treasury and Federal Reserve officials continue to encourage or facilitate rapid monetary and credit expansion?

As each larger crisis in credit speculation is papered over with last minute promises from the world’s “lender of last resort,” our monetary walk toward higher inflation (accelerating creation of currency and credit) will quickly become a stampede to monetary excesses – and hyperinflation. And finally, a “run on the dollar” is inevitable.

At that time, dollars saved by prudent conservatives will be “trivialized into oblivion” – utterly worthless. Read your history! This has happened before, with small and great nations alike. With both history and current events as our guide, a person could assign the following “odds” to the possibilities of deflation and inflation in our future:

DEFLATION: Only a “severe” accident could cause this to happen. And even if the accident happens, the rush to physical dollar bills will only prove momentary. Odds are 1 out of 10 it will happen.

INFLATION: After a 20-year bear market in “real things,” with increases obvious now in the CRB, precious metals and gold share prices, the odds are 8 to 1 that high inflation will happen. Rapid credit expansion and today’s creation of new money substitutes make inflation appear to be all but a certainty.

HYPERINFLATION: With tens of trillions of dollars of “uncovered” debt now in America, every crisis creates more gargantuan new government loan guarantees and bailouts (i.e., trillions more in new liquidity). Odds are 3 to 1 that hyperinflation will happen. Hyperinflation is much closer than it appears. So what’s the answer? Deflation, moderate inflation, or hyperinflation? As we’ve said, looking ahead in 2002, all we can do is assign the current odds – to be reappraised in the months and years ahead. What we do know, April 1, 2002, is that the Consumer Price Index (CPI) and Producer Price Index (PPI), as “fabricated” by government, are relatively dormant. Thinking people see only a “propaganda value” to the government’s CPI, since food, housing, energy, and who knows what other basic life needs are excluded from this “headline index.” The CRB (Commodity Research Bureau) Index, comprised of equal percentages of commodities like wheat, gold, orange juice, and oil, has recently bounced up over 200 from the secondary bottom low of 186.30. The 20- year bear market low in commodity prices as measured by the CRB occurred October 24, 2001 at 182.83. For both commodity speculators and investors, this secondary “higher bottom” is a very bullish signal in anticipation of a new multi-year bull market in commodity prices (translated: inflation). [ED. NOTE: The CRB has almost doubled since this was written in 2002.] And finally “gold bugs” and more recent investors have seen shares of gold stocks rebound from secular lows two years ago and double, or triple in price during the past year. Do gold shares anticipate higher inflation? Many people would say when Newmont Mining (the biggest and best run mining company in the world) sees its shares advance from $12 to $28 on the NYSE – after a 20-year bear market in gold – “it’s telling us something.” [ED. NOTE: Newmont has since risen to $62 and even after a sharp correction, is trading at $41 at this writing.]

1. IF WE PREDICT DEFLATION – a balanced portfolio of the following investments would seem appropriate:

a. Cash – money market funds.

b. AAA corporate or muni bonds.

c. Annuities.

d. T-bonds.

e. Predictable high dividend utility stocks.

2. IF WE PREDICT INFLATION – the following investments (with no special priority in order listed) would be included in a balanced portfolio.

a. Gold and silver coin investments.

b. Gold and silver stocks (producing companies).

c. A raw material index fund.

d. Commodity production (farming or mining).

e. An investment (or employment) with “superstar” management may prove one of the best answers. Working or investing through stocks in what people need and use, as we adapt to rapid changes in our own value structure may be one of the best forms of capital (buying power) preservation.

Most importantly, even new investments in “the very best” must be made during times of adversity when the stock price is low. In today’s highly volatile markets, this isn’t as hard to do as it might first appear. Identify true value – then wait to buy when it’s “on sale.”

f. Energy – natural gas, coal, and oil and oil service companies.

[ED. NOTE: Since real estate depends upon both exponential increases in credit and continuing low interest rates, an investment in real estate in America today could only be considered a very, very long-term investment. Neither commercial nor residential real estate fit hyperinflation, and in a deflationary depression and credit collapse real estate prices would most certainly fall.]

F. SURVIVING, INVESTING AND PROSPERING IN THE TWILIGHT ZONE

Investments made today for a deflationary depression will totally wipe out your savings – if you are wrong. Investments made in “real things” in the expectation of inflation will not be totally devastated in value if you are wrong, and will prove a “Godsend” as inflation accelerates.

BEST INVESTMENT RULE: Own today what people will need and use in the future – combined with the best proven management you can find. Even with this advice, it always pays to have a diversified and current investment plan, where the odds of anticipated future success are continually re-evaluated in the re-balancing of your investment portfolio.

1. TWILIGHT PAST – When we look back to the year 2002 which was the beginning of a major secular change in asset valuation and a new investment focus, the results over the past four years are startling:

a) After seeing the initial move in the CRB Index from its low of 186.30 to a little over 200, what followed should be no surprise. Today the CRB has topped 388 – up another 95%. And cyclical commodity expert Jim Flanagan (Past Present Futures, 1-800-545-9331) believes another doubling of today’s CRB Index is very possible in the next year or two, based upon the size of past 60-year cycles. Jimmy Rogers believes the bull market in commodities will run another 10 years or more.

b) The U.S. Dollar Index (the measure of buying power of our money versus all other nations’ currencies) is now at 85 – down from 120 in 2002. This means your dollar savings or paycheck has lost almost 30% of their purchasing power in the world marketplace versus ONM (other nations’ money). On average, all foreigners gained almost 30% (free) in the purchasing power of their currency while the dollar declined.

c) Oil per barrel (a barrel of oil, unlike the U.S. dollar, is measured the same anytime, anywhere in the world), and the exact quantity in a barrel of oil remains a constant. Oil as high as $78 a barrel, tripled in price from $26 oil in 2002, and even after a correction to $54 (at this writing) is still up 207% over the past four years.

d) Uranium metal (nuclear power could be the world’s salvation as all major countries face ever-expanding energy demand and increase their pollution and greenhouse gas concerns) has increased from $10 in 2002 to over $72 today – up 620%. Demand for uranium fuel can do nothing but expand. (Best Source: The Dines Letter, PO Box 22, Belvedere, CA 94920.)

e) And gold (the sleeping monetary giant) rose from $265 (in 2002) to $735, a 277% increase in four years; and even after a strong correction from its May 2006 highs, is still up 245% (near $650) over the past four years.

f) Many energy and precious metals and uranium stocks have appreciated 200% to 600% since 2002. And, coming out of a 20-year bear market and moving into an apparent dollar disaster, the rise in most of these may have just begun (what does a pound of uranium cost when the purchasing power of our dollar drops to next to zero?). Uranium prices go up to infinity. (Lots of zeros.)

2. TWILIGHT PRESENT – A major secular (longterm) change in investment focus, as well as a historic change in the world’s “power elite” and other nations’ impact on how we live is clearly underway. The first tiny hint of what’s to come is the jump from $20 to $50 in the cost of a fill-up at the local gas station. A spectacular reallocation of limited income and savings ensures that a major upside-down change lies just ahead for America. Energy availability has become the future measure of any nation’s wealth or poverty for its people.

a) MASSIVE QUANTITIES OF U.S. DOLLARS FLUTTER EVERYWHERE AROUND THE WORLD LIKE CHERRY BLOSSOM PETALS IN WASHINGTON D.C. IN THE SPRINGTIME. And like cherry blossom petals, the value of fluttering dollars can quickly fade as foreign producers decide they don’t want any more Yankee dollars and say, “No Mas!” A massive regurgitation of U.S. dollars could happen at any moment in a world caught up in emotion and hate – where U.S. debt is over $80 trillion and our credibility and fiscal responsibility is rapidly evaporating.

b) WAR COSTS MONEY – lots of money! In a nation addicted to credit, the multi-year war on terror has provided George Bush, Gates, Congress, and “Homeland Security” with a blank checkbook. Even “tiny” wars have always been inflationary and led to currency devaluation. But, this is the beginning of a very big war! So far, America (not any other country in the world) is paying the bills – with 100% borrowed money!

c) THE HOUSING BUBBLE PIGGYBANK IS RUNNING ON EMPTY – Alan Greenspan’s “secret” was to drop interest rates to 1%, then to throw away the rule book on appraisals, employment requirements, credit investigation, and the future responsibility of lenders to be responsible in a year or five years for the loans made today. A “pot-full” of easy credit and a constant new supply of “free” money from “refis” were ballooned for the past five years by the Fed’s actions to support the world’s greatest housing boom ever.

“Refi dollars” fueled the greatest-ever consumption binge in America’s history. Record low interest rates made possible the most marginal investment speculations that would never previously have “paid out” with normal 4%-6% interest costs. With 70% of American GDP dependent upon consumption (real expanding credit purchases), the risk of a consumer collapse and depression in America (real credit collapse) seems all but certain. The only way out is Fed-led hyperinflation for you and me in America.

3. TWILIGHT FUTURE – World War III seems inevitable – a long-term battle between Muslim desire for world domination and America’s belief in individual freedom. America’s Middle East involvement gets bigger by the day – and grows in scope. With an expanding war and need for our nation’s defense that is very real, and with perhaps the poorest of all tactical choices so far by President Bush and Gates, we are in trouble on three fronts:

a) An understandable decline in our battlefield readiness with both troops and military equipment. (Constant wind, sand, and roadside explosive devices are very hard on everyone involved.)

b) Rapidly expanding cost of war – financed with new debt. You cannot do this forever (see the former Soviet Union) – future American bankruptcy is predictable.

c) Loss of America’s worldwide prestige is ongoing. Bush and Gates really are arrogant and are seen that way by the rest of the world’s nations.

If you really value your freedom and your country; and if you care about your nations’ future – you need to read a book which will give you chills as you compare the authors’ future predictions for America with America circa 2007- 2012. It’s MUST reading! Ayn Rand’s 1168-page novel written in 1956 – “Atlas Shrugged,” might be the best book for any true American to read today. We truly do stand at the turning point in American history – now.

[This article was written by MIA associate editor, Jim Deeds.]

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