Thursday, July 08, 2010

Gold and deflation

Despite all the Administration's and the Fed's frantic efforts, the bearish forces of deflation and deleveraging are biting into the US economy. Although the Administration is practically begging consumers to "spend," frightened consumers are pulling in their horns and thinking of cutting spending or (horrors) even saving.

As for housing, the national inventory of homes for sales has surged to an 8-month supply. The fear among the real estate experts is that the inventory of houses to be foreclosed will shortly envelope the market and drive the price of houses even lower. This is the view of my favorite real estate expert, Bob Campbell, who writes the Campbell Real Estate Report out of Del Mar, California.

All the above is basically deflationary.

On top of that, as I've said a thousand times, Fed Chief Bernanke will absolutely not accept deflation. Even while he's keeping short rates at zero and flooding the system with over 2 trillion of new Fed Notes, the "economic poison" of deflation is creeping into the economy.

What can Bernanke do about it? According to ex-Professor Bernanke, "Deflation is always reversible under a fiat money system." In a speech a few years ago, Ben Bernanke laid out the plan -- "US dollars have value only to the extent that they are strictly limited in supply. But the United States has a technology called a printing press (or today, its electronic equivalent) that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those good and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."

Think of it. What Bernanke is telling us is that the government can create inflation simply by continuing massive quantities of dollars, the euphemistic "quantitative easing."

And in the event that quantitative easing doesn't create the desired inflation, the Fed has another trick. The Fed can buy all manner of debt including foreign debt and use it as collateral. In other words, Bernanke sees no limit to what he can buy in order to jack up the Fed's balance book.

Shrewd gold-accumulators are well aware of all of the above. As the deflationary and deleveraging forces press on the US economy, the Bernanke Fed is ready to devalue the US dollar in its ("whatever it takes") battle to hold back deflation.

With these thoughts in mind, I'm thinking of buying more bullion gold in the near future, this in view of the current correction in the gold price.

Let's boil the whole thing down to three sentences.

(1)The Fed will not tolerate the growing forces of deflation.

(2) To combat the deflationary forces, the Fed will devalue the dollar by printing trillions more of Federal fiat money.

(3) Once it is realized that the Fed is on the path to devalue the dollar, there will be a panic to buy and own gold.