bobbyw24
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The Gold Report: People are hearing and reading about the potential for deflation. On its surface, paying less for everyday items seems like a good thing, but please paint us a picture illustrating why we should all fear deflation.
Michael Berry: I want to point out that deflation isn't foreordained; it just looks likely. Given the history over the last two or three years, where there's been a lot of money printed, some people have assumed that we would hyperinflate. But when you look at the macroeconomics in the U.S., you see almost 10% unemployment and in various groups it's much higher. It really looks like we're not going to pull out of this, and then you have the overhang with respect to debt. There's a lot of potential for deleveraging, for a higher dollar, as dollars are sought to deleverage.
People fear deflation because basically, nobody's really experienced it since the Great Depression. Central bankers think they can do something about inflation; Paul Volcker did in the early 1980s, but central bankers don't really have tools to deal with deflation. Deflation occurs when the money supply shrinks; prices tend to fall in a deflationary environment, and there's not very much you can do except let it run its course. This is very painful.
The other aspect of a deflationary environment is that if you have a lot of debt, either public debt or corporate debt, deflation works against you. On the other hand, inflation works for the debtor; deflation works against him. In that kind of environment the system wants to deleverage, and consequently asset values fall, demand for dollars rises as the system deleverages. The value of the dollar increases; interest rates tend to fall. Basically, the bond market strengthens but not the stock market. It also introduces a completely different investment scenario for individual and for institutional investors.
TGR: If such a scenario did occur, how long would it last?
MB: That's really a tough question, but a very important one. If you talk to some of the top economists, such as Professor Krugman, who believe that we're going to head into a deflationary spiral, the consensus is two to five years. We're probably a year into that now. When you look around and you see what's happening with Greece and the European banking system, the overhang on growth is significant. You're going to witness significant austerity programs in Europe; growth is going to be restrained. And perhaps the only place on earth right now that wants to continue fiscal spending is Washington. Of course, if you look at the Japanese situation, starting in about 1990, they've never really been able to inflate out of their problem. Deflation can last for a very long time if bankers don't get hold of it.
You remember back in 2002 then Fed Governor Ben Bernanke said we could cure deflation because we have a printing press, meaning that we can print dollars. They've tried to do that and it's failed. The fiscal programs they've put in place really have not worked to restore growth, and it does not look as if they're going to.
TGR: Given what you said about deflation being a problem for those carrying debt, it seems deflation would be have a larger impact on the U.S. than other nations.
MB: That's an interesting thought; actually, because we have the world's reserve currency, we can continue to borrow for a while. But at what point does the rest of the world say, "No, we're not going to bank the dollar anymore?" Then, the level of deficit and the debt to GDP ratios become very, very large and serious. No one knows when that tipping point in the U.S. is; that's the problem.
TGR: What would happen to gold in a deflationary environment?
MB: I am not sure. Most people would say that gold works well in an inflationary environment, and it appears to, because it holds its value well; at least some gold stocks did well in the Great Depression. I think there's another rationale in this particular environment we're in now; gold isn't necessarily being viewed as either a deflation hedge or an inflation hedge, but more likely a flight to safe currency or real money. In other words, gold is becoming money because of what people are finally beginning to understand. People distrust the euro. They really don't trust the yen. They don't trust the Chinese yuan; and people are slowly but surely losing trust in the U.S. dollar. I think under a nascent deflationary environment that we have now, where gold is around $1,200, it's more a flight to safety than a hedge against deflation.
TGR: In July's Morning Notes, you refer to having precious metals exposure in an ever-weakening economy as another leg of the survivor stool. In your view what's the best way for investors to gain precious metals exposure?
MB: I think it's pretty critical that you look at what's happening with fiat money. We've only been on fiat money since 1971, thanks to President Nixon. That's 39 years now, and you know fiat money is going the way of the wind. I think you've got to have precious metals, either silver or gold, preferably gold, and you need to have some in-kind. I think you need to own coins or, if you can afford it, some bars and also some exposure to some top-quality stocks. For instance, Goldcorp Inc. (NYSE:GG; TSX:G), or Kinross Gold Corporation (TSX:K; NYSE:KGC) or some precious metal stocks like that. Silver stocks as well, such as Silver Wheaton Corp. (NYSE:SLW;TSX:SLW), Endeavour Silver Corp. (NYSE:EXK; DBF:EJD; TSX:EDR) or Coeur d'Alene Mines Corporation (NYSE:CDE; TSX: CDM).
TGR: Yes, you're big believer in silver.
MB: We've spent a lot of time analyzing silver. I was involved in a big gold-silver find a few years ago, which was Penasquito, and that is now over a billion ounces of silver. I think silver is undervalued. Silver was the original money, if you will, that was used in the ancient days. The Greeks used silver from Laurion to defeat the Persians and restore democracy in Athens in the fourth century BC. When FDR sponsored the special silver purchase in 1934 some academics believe he broke the back of deflation. I think silver is very much undervalued, and it will be pulled along with gold. It's very wise to have silver exposure, and with silver you can actually afford to own it in-kind. You can own silver coins. We've seen silver go from $4 maybe eight or nine years ago to about $18 today. Silver hasn't performed quite as well as gold, but it's moved up well.
Chris Berry: Silver's one main difference from gold is that silver is an industrial metal as well as an investment metal. It sort of depends on your view of where you think the markets are going, but the "poor man's gold" is certainly one way to accumulate hard assets and protect against some of these geopolitical hiccups.
TGR: Going back to Michael for a second, what are the other legs on that stool?
http://www.marketoracle.co.uk/Article21111.html
Michael Berry: I want to point out that deflation isn't foreordained; it just looks likely. Given the history over the last two or three years, where there's been a lot of money printed, some people have assumed that we would hyperinflate. But when you look at the macroeconomics in the U.S., you see almost 10% unemployment and in various groups it's much higher. It really looks like we're not going to pull out of this, and then you have the overhang with respect to debt. There's a lot of potential for deleveraging, for a higher dollar, as dollars are sought to deleverage.
People fear deflation because basically, nobody's really experienced it since the Great Depression. Central bankers think they can do something about inflation; Paul Volcker did in the early 1980s, but central bankers don't really have tools to deal with deflation. Deflation occurs when the money supply shrinks; prices tend to fall in a deflationary environment, and there's not very much you can do except let it run its course. This is very painful.
The other aspect of a deflationary environment is that if you have a lot of debt, either public debt or corporate debt, deflation works against you. On the other hand, inflation works for the debtor; deflation works against him. In that kind of environment the system wants to deleverage, and consequently asset values fall, demand for dollars rises as the system deleverages. The value of the dollar increases; interest rates tend to fall. Basically, the bond market strengthens but not the stock market. It also introduces a completely different investment scenario for individual and for institutional investors.
TGR: If such a scenario did occur, how long would it last?
MB: That's really a tough question, but a very important one. If you talk to some of the top economists, such as Professor Krugman, who believe that we're going to head into a deflationary spiral, the consensus is two to five years. We're probably a year into that now. When you look around and you see what's happening with Greece and the European banking system, the overhang on growth is significant. You're going to witness significant austerity programs in Europe; growth is going to be restrained. And perhaps the only place on earth right now that wants to continue fiscal spending is Washington. Of course, if you look at the Japanese situation, starting in about 1990, they've never really been able to inflate out of their problem. Deflation can last for a very long time if bankers don't get hold of it.
You remember back in 2002 then Fed Governor Ben Bernanke said we could cure deflation because we have a printing press, meaning that we can print dollars. They've tried to do that and it's failed. The fiscal programs they've put in place really have not worked to restore growth, and it does not look as if they're going to.
TGR: Given what you said about deflation being a problem for those carrying debt, it seems deflation would be have a larger impact on the U.S. than other nations.
MB: That's an interesting thought; actually, because we have the world's reserve currency, we can continue to borrow for a while. But at what point does the rest of the world say, "No, we're not going to bank the dollar anymore?" Then, the level of deficit and the debt to GDP ratios become very, very large and serious. No one knows when that tipping point in the U.S. is; that's the problem.
TGR: What would happen to gold in a deflationary environment?
MB: I am not sure. Most people would say that gold works well in an inflationary environment, and it appears to, because it holds its value well; at least some gold stocks did well in the Great Depression. I think there's another rationale in this particular environment we're in now; gold isn't necessarily being viewed as either a deflation hedge or an inflation hedge, but more likely a flight to safe currency or real money. In other words, gold is becoming money because of what people are finally beginning to understand. People distrust the euro. They really don't trust the yen. They don't trust the Chinese yuan; and people are slowly but surely losing trust in the U.S. dollar. I think under a nascent deflationary environment that we have now, where gold is around $1,200, it's more a flight to safety than a hedge against deflation.
TGR: In July's Morning Notes, you refer to having precious metals exposure in an ever-weakening economy as another leg of the survivor stool. In your view what's the best way for investors to gain precious metals exposure?
MB: I think it's pretty critical that you look at what's happening with fiat money. We've only been on fiat money since 1971, thanks to President Nixon. That's 39 years now, and you know fiat money is going the way of the wind. I think you've got to have precious metals, either silver or gold, preferably gold, and you need to have some in-kind. I think you need to own coins or, if you can afford it, some bars and also some exposure to some top-quality stocks. For instance, Goldcorp Inc. (NYSE:GG; TSX:G), or Kinross Gold Corporation (TSX:K; NYSE:KGC) or some precious metal stocks like that. Silver stocks as well, such as Silver Wheaton Corp. (NYSE:SLW;TSX:SLW), Endeavour Silver Corp. (NYSE:EXK; DBF:EJD; TSX:EDR) or Coeur d'Alene Mines Corporation (NYSE:CDE; TSX: CDM).
TGR: Yes, you're big believer in silver.
MB: We've spent a lot of time analyzing silver. I was involved in a big gold-silver find a few years ago, which was Penasquito, and that is now over a billion ounces of silver. I think silver is undervalued. Silver was the original money, if you will, that was used in the ancient days. The Greeks used silver from Laurion to defeat the Persians and restore democracy in Athens in the fourth century BC. When FDR sponsored the special silver purchase in 1934 some academics believe he broke the back of deflation. I think silver is very much undervalued, and it will be pulled along with gold. It's very wise to have silver exposure, and with silver you can actually afford to own it in-kind. You can own silver coins. We've seen silver go from $4 maybe eight or nine years ago to about $18 today. Silver hasn't performed quite as well as gold, but it's moved up well.
Chris Berry: Silver's one main difference from gold is that silver is an industrial metal as well as an investment metal. It sort of depends on your view of where you think the markets are going, but the "poor man's gold" is certainly one way to accumulate hard assets and protect against some of these geopolitical hiccups.
TGR: Going back to Michael for a second, what are the other legs on that stool?
http://www.marketoracle.co.uk/Article21111.html
