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Inflation or Deflation, What to Do and When to Act

Economics / Inflation Apr 25, 2010 - 01:40 AM GMT

By: Gary_North

Economics

Diamond Rated - Best Financial Markets Analysis ArticleHave you ever seen a documentary where the herd of zebras is at the river's edge? The lions are behind them. The crocodiles are in front of them. What's a wise zebra to do?

Most of them wait. Then, without visible warning, they either run like mad or else plunge into the river.


Sometimes the lions win. Sometimes the crocs win. Most of the zebras survive: the ones in the middle of the pack.

This phenomenon is also known as regression to the mean.

It is easier to move forward than backward. Monitoring the lions at your rear is important mainly to know when to take your chances with the crocs.

What you should be looking for is a place in the river where there is a shallow land bridge. You can get across faster, and the crocs will have a harder time grabbing you.

The trouble is, you can't get onto the submerged land bridge fast enough if you're in the middle of the herd.

INFLATION OR DEFLATION?

You need to investigate the logic of price inflation, which rests on the logic – mostly political – of monetary inflation.

Those who predict price deflation argue that the politics of monetary inflation will be overcome by the size of the debt. The debt will become so gargantuan that the central banks will not be able to prevent massive bankruptcies, default, and bank runs. There will be a rush for liquidity. Prices will fall.

I do not think this argument is correct. I have offered my reasons elsewhere. But the logic of deflation rests on an assumption: the triumph of free market leverage over central bank monetary inflation and the monetization of debt. Deflationists do not argue that central banks will adopt a policy of deflation.

Inflationists argue that central bankers will adopt policies of monetary inflation, and these policies will be successful in preventing the collapse of banking and money.

I am in the camp of the inflationists. I regard today's stable consumer prices as the joint product of central bank monetary inflation to save Fannie Mae and Freddie Mac and thereby save the largest banks, coupled with the individual, uncoordinated decisions of commercial bankers to deposit their banks' excess money with the Federal Reserve, thereby sterilizing the more than doubled monetary base.

If you cannot make up your mind, do nothing.

Why do I say this? Because whenever you make a decision to buy anything as misunderstood as gold, you should do so based on your understanding of why gold rises or does not rise under inflation or deflation.

You must then decide which scenario is more logical: inflation or deflation.

Then you must decide which form of gold to hold, and why.

Then you must persuade your wife.

This is not easy. Yet it is mandatory for anyone who wants to act responsibly. You can never possess exhaustive knowledge, but you can possess accurate knowledge. It takes time. It does not take much money.

Is price inflation associated with the crocs or the lions? Find out. That is your #1 assignment.

I think inflation is the lions. There are more of them. They are easier to see. The crocs are limited to the river. They are difficult to see. I think you should pay attention to what is more common.

When inflation starts moving up, you can make your move. Right now, consumer prices are flat. We are caught between the lions and the crocs.

Gold will help you fend off lions. Long-term U.S. bonds will help you fend off crocs.

CONFLICTING STRATEGIES

"Inflation is inevitable. Buy gold."

"Deflation is inevitable. Buy gold."

"Inflation is behind us. Buy stocks."

"Inflation is behind us. Buy bonds."

If I wanted to spend a couple of hours, I could provide you with links to articles proclaiming all of these positions. You would not read most of them, so I have decided to save a couple of hours. Why should you buy gold if deflation is inevitable? The argument is convoluted because it's wrong. I won't bore you with it here. I have dealt with it elsewhere here and here.

My point here is more limited. There are hundreds of thousands of people out there who have bought gold on the assumption that one of these arguments is correct. These arguments cannot both be correct.

Some percentage of these people cannot make up their minds about which argument for holding gold is correct. They bought some gold. Then they write to me. "Will it be deflation or inflation?" I always send the same answer:

"Please post all of your questions on my website. Thanks."

Why do I do this? First, it's a polite way of saying, "I am tired of providing free lunches to cheap people like you, who want me to tell them what to do with their life savings, free of charge." Second, out of 1,000 letters, as many as three people will actually join my website. So, I'll make a few bucks. Then there are the other people. They really cannot decide which it will be, inflation or deflation. They don't know whether to buy gold or not. They send me an email asking me what I think. They get the same response.

It is all over the Web what I think. I think there will be price inflation . . . for a time. I think there will be mass inflation . . . for a time. I do not think there will be hyperinflation and currency collapse. But, if there is, I will be in far better shape than most people. That is because I have adopted Ludwig von Mises's investment strategy. When asked what inflation hedge he had, he replied: "Age." This is the one hedge that works equally well in both inflation and deflation.

People buy investments for lots of reasons, but careful logic is not the main one. They feel the drive to buy. It may be gold. It may be an annuity. It doesn't matter. People have heard about it, and they want it. They go looking for reasons.

The same is true of people who have decided not to buy.

Some people are action-oriented: early adopters. Others wait a long time to act. They are the people who make early adopters rich . . . the early adopters who really did see coming what in fact came.

Most people are late adopters. They sit on the sidelines. They wait to see what their peers do. Their peers do the same thing.

For these people, arguments are wasted. They are not looking for arguments. They are waiting for the herd to start running. They want to be at the center of the herd. That is the safest location to avoid predators.

THE CENTER OF THE HERD

The center of the herd is safe most of the time.

What threatens the zebras in the center is this: The zebras at the front of the herd get the better grass.

We are in an economic drought. It is neither price inflationary nor price deflationary. It is a slow-growth economy in which unemployment remains high. Promotions are few and far between. Raises are rare. Income is slowly falling. Income in the private sector is falling even faster.

I recommend that people concentrate their efforts on their careers.

People are hypnotized by their IRA or 401(k) plans. These plans are down since 2000. An entire decade is gone. The experts who advised buy-and-hold, no-load stock funds have proven themselves utterly wrong. They do not change their advice.

I recommended getting out of stocks, especially dot-com stocks, in March of 2000. That was the week of the top for the NASDAQ. I recommended getting into gold in October 2001 – close to the bottom: under $300.

Did people do it? I doubt it.

Did they stick with their stock portfolios? Yes.

They are still alive. They are not poor. But they have not made gains. If they borrowed on their homes, they have lost their original loan's non-recourse protection. They are liable for all of their mortgages, even if they sell. They must make up the difference. They are trapped.

Nobody warned them, except fringe e-letter writers. They did not read the loan contracts. They did not ask their CPAs, if they had CPAs.

Now they look around them and find that being in the center of the herd gave them protection from the crocs and lions, but the grass is depleted.

The economic drought is going to get worse. If you think I am wrong, read what David Stockman writes. He was Reagan's first budget director. He warned about the huge deficits that would come if Reagan did not cut Federal spending to match his proposed tax cuts. He resigned. He saw what was coming. Now it has arrived. He now warns against the enormous Federal deficits and their anti-growth effects on the economy.

There comes a time to move to the front of the herd. This is especially true when the lions seem distant, and the crocs do not seem close to the water's edge.

Most people do not want to be at the front of the herd. This is just as well, because they could not get there even if they wanted to.

I suggest that you spend your time working on your career before you worry about gold, price inflation, or price deflation. Your main problem is that the grass is getting sparse.

STRATEGIC INACTION

About four decades ago, conservative sociologist Robert Nisbet offered this bit of advice to the Federal government:

"Don't just do something. Sit there!"

This was a variation on the more traditional advice, "Don't just sit there. Do something!" His is far better advice.

The case for doing nothing new is a strong one. As a conservative, he understood this. Most of our lives are routine. We do things today pretty much the way we did them yesterday. This is how we keep our sanity. If we had to re-think everything every day, we would go mad. We would wind up paralyzed.

By assuming that things tomorrow will be pretty much the way they are today, we will probably be right tomorrow. We will not lose time, sleep, or money planning for events that do not take place.

Yet there is always change. Most things do not change rapidly, but some do. Nine-eleven came along, and Bush's Executive was there with Clinton's Homeland Security legislation ready to be implemented. The bureaucrats had planned ahead.

"Never let a crisis go to waste," Obama's Chief of Staff Rahm Emanual has said. This is the radical politician's view of social change. "Be prepared!" Voters are far more ready to surrender their liberties than to fight politically to get old liberties back.

This, too, is the philosophy of conservatism. "Stick to the devil you know." That was Rudyard Kipling's advice in one of the greatest poems ever written: "The Gods of the Copybook Headings."

http://bit.ly/copybook

So, most of the time, don't just do something. Sit there.

Your goal is not to stay seated. It is to give yourself time to read, then think. You need to know what you are facing. This takes time and concentration.

But until you have a sense of what you are facing, it is best to take no action other than reconnaissance.

CONCLUSION

People prefer inaction to action. This is wise most of the time. But sometimes it is unwise. I think we are in such a time.

Pay attention to your career and your job. Concentrate on these if they are not the same.

Think: "How will my career or job do under conditions of mass inflation? Depression? In between?" Think about these effects on your job, nit your portfolio.

People get sidetracked. They think that buying this or that investment asset will save them. What will save them is their ability to stay ahead of the lions and out of leaping distance by the crocs.

It is not your investment portfolio that matters most. It is your career. There are no one-shot answers for your career. You can't write a check and solve the problem.

    Gary North [send him mail ] is the author of Mises on Money . Visit http://www.garynorth.com . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

    http://www.lewrockwell.com

    © 2010 Copyright LewRockwell.com / Gary North- All Rights Reserved
    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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