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Elliott Wave Trading

Mr Denninger and Gold or Why the Dollar-Deflationists Are Wrong

Commodities / Gold and Silver 2010 May 30, 2010 - 01:48 PM GMT

By: Gordon_Gekko


Diamond Rated - Best Financial Markets Analysis ArticleThose who know Mr. Denninger know that he, well, for lack of a better word, hates Gold. It only goes to show the level of disinformation and ignorance prevalent in our society when even smart people like Karl fail to get it. From what I hear anybody even mentioning the word Gold runs the risk of being permanently banned from one of his "forums". In a recent commentary entitled "Ten Things for 2010" he was at it again bashing Gold. Here is what he had to say:

We're not looking at hyperinflation folks, in my view - we're looking at a deflationary collapse…If you fear hyperinflation do not look to Gold, instead buy a small (5% of your total portfolio) position in far out of the money LEAP CALLS on the major indices, spread across them.  Why?  Because (1) the tax structure on gold is unfavorable, (2) gold has never performed well on a contemporary basis .vs. inflation and (3) you can't eat it.  If you try to get around the tax man structure you're going to get creamed; governments can and WILL prevent that from working.  My recommendation thus is to buy insurance against a hyperinflationary event using instruments that do not try to evade the formal financial structure, are levered (to get around the tax hit) and are defined risk (so as to avoid losing your ass if you're wrong.)

Really Karl? LEAP Calls? In a hyperinflation? That’s a good way to lose 5% your portfolio. I’m assuming you know what hyperinflation is - in a hyperinflation the currency becomes worthless, as in toilet-paper. Why would anyone want to get paid their "winnings" in a worthless currency, assuming there are stock indices and counterparties left who can pay off these worthless winnings when countries collapse?

And the tax structure is FAR more favorable for Gold than ANYTHING else, if only you are not in the habit of bending over. Buy cash and keep your mouth shut – it’s very simple – or just move to another country where the government is not as intent on raping its citizens. I know privacy is a foreign concept in America these days, but still. All your other assets, including stock market profits, are fully open to the government and there is nothing stopping them from taxing them to the hilt. Trust me, when it all hits the fan Gold in your personal possession will be your best friend.

Which brings me to my favorite part:

gold has never performed well on a contemporary basis .vs. inflation

Poor Gold. The thing gave an instant 75% profit when Roosevelt confiscated it in 1933 and rose 24x (yes, that’s 24 TIMES) from $35 to about $850 in a space of 10 years from 1970 to 1980. And even during the past decade from 2000-2010 it has risen 5x outperforming ALL asset classes. Overall, from 1933 till date it has risen about 60x. That is, if you simply held Gold since 1933 you would be now 60 times richer, at least in nominal terms. Yet nobody remembers all that. All they remember is the lousy 20 years from 1980-2000 when the full force of the derivatives market was brought to bear upon it to suppress it’s price (well, that’s a topic for another post), as is being done even now absent which it would have easily crossed 10x (from the 2000 low) by now – which it will at some point in the future as the market cannot be suppressed forever. Indeed, the longer the suppression, the more forceful the eventual price rise as happened when the London Gold Pool collapsed during the late sixties soon after which Gold shot up 24x during the next decade. If you’re not that devoted a disciple of Karl I suggest you hang on to your Gold for a little while longer. In my humble opinion, it will outpace all gains in all other asset classes since the creation of the dollar – in not only nominal, but real purchasing power terms.

And then there was this again:

The last time I checked they didn't take 100oz bars at WalMart, but they sure do take $100 bills

And the last time I checked Karl, they weren’t taking stock certificates and bonds either. Also, there was a funny thing I noticed: there was NOTHING stopping me from getting dollar bills, euros, yen – you name it – for my Gold. In fact, everytime I sold some Gold I got even more paper tickets than the last time – which meant that I could buy even more stuff with the same amount of Gold. How surprising, no?

Well, Karl was definitely surprised:

Precious metals will not be a safe haven: Clean miss.  Gold and silver have both performed well.

And talk about reaching wrong conclusions:

Discovery that the metals market has been "polluted" to the point of irrelevance would mean that those around the world who had bought and were holding alleged gold bars that in fact aren't gold had tendered good money for nothing.  This would be a monstrous deflationary event - after all, the definition of deflation is the destruction of money, and that's exactly what would have happened, just as if you took a stack of $100 bills and burned them in your back yard.

No Karl, the bills still exist – in the bank account of whoever was paid to obtain the said Gold. It is the Gold which is discovered to be no longer existing, thus causing the apparent supply to be further reduced and spiking the price.

Karl thinks he’ll be safe watching these “fireworks” from the sidelines. Not so Karl. By not buying Gold (and holding dollars), you are smack in the middle of them. You are not simply “missing out” on some investment gain but stand to lose everything as the purchasing power of the dollar is decimated. This is why those advocating holding only paper cash as a “safe alternative” are in fact harming those who listen to them.

Now don’t get me wrong - I agree with a lot of what he says in general – he’s a good reporter (which is why I keep him on my “must read” list) - but when it comes to Gold, Karl simply doesn’t “get it”. First of all, when you talk about deflation you have to ask the question, “In terms of what?”.  Most people ala Mish, Prechter, Karl et. al. when they talk about deflation are referring to deflation in terms of the dollar, i.e. they are, in fact, “dollar-deflationists”*. One can’t really blame them since the dollar is considered by most people as “money” today and is therefore their frame of reference. But this is a critical error of perception that will prove fatal to those who hold their life’s savings in dollars when it all finally implodes.  The dollar today is just another fiat currency created at will out of thin air by bankrupt and corrupt governments and their Central Banks. It is an illusion of money, not money; which brings us to the question of:

What is money?

This is a topic which can fill an entire book, but I’ll just quote the best one I found (Mises):

In the marketability of the various commodities and services there prevail considerable differences. There are goods for which it is not difficult to find applicants ready to disburse the highest recompense which, under the given state of affairs, can possibly be obtained, or a recompense only slightly smaller. There are other goods for which it is very hard to find a customer quickly, even if the vendor is ready to be content with a compensation much smaller than he could reap if he could find another aspirant whose demand is more intense. It is these differences in the marketability of the various commodities and services which created indirect exchange. A man who at the instant cannot acquire what he wants to get for the conduct of his own household or business, or who does not yet know what kind of goods he will need in the uncertain future, comes nearer to his ultimate goal if he exchanges a less marketable good he wants to trade against a more marketable one. It may also happen that the physical properties of the merchandise he wants to give away (as, for instance, its perishability or the costs incurred by its storage or similar circumstances) impel him not to wait longer. Sometimes he may be prompted to hurry in giving away the good concerned because he is afraid of a deterioration of its market value. In all such cases he improves his own situation in acquiring a more marketable good, even if this good is not suitable to satisfy directly any of his own needs.

A medium of exchange is a good which people acquire neither for their own consumption nor for employment in their own production activities, but with the intention of exchanging it at a later date against those goods which they want to use either for consumption or for production.

Money is a medium of exchange. It is the most marketable good which people acquire because they want to offer it in later acts of interpersonal exchange. Money is the thing which serves as the generally accepted and commonly used medium of exchange...

(All emphasis mine)

Money was created by the markets; by humans trading goods and services amongst themselves; by the need for indirect exchange. This is one of the major misconceptions of the dollar-deflationists - that money is what the government says it is. Although Governments do their best to convince people otherwise, including putting a gun to their collective heads via legal tender laws, they cannot dictate what money is – not for long periods of time anyways – which is why whereas Gold has been money for thousands of years, you’d be hard pressed to find a fiat currency that has existed past a few decades. The present period is one such short period of mass delusion where the majority has been convinced – including, apparently, Mr. Denninger - that the colored pieces of paper being printed by various men behind the curtains is, in fact, money.

Gold is the commodity that humans chose to be “money”- the most marketable good. It didn’t happen overnight, but over thousands of years of evolution. Billions of trading decisions over centuries made by free men of their own volition – the collective wisdom – installed Gold as money. It needs no government violence to enforce as money because the force of nature that is the market chose it to be money. Indeed, it was the governments who hijacked the free-market commodity money of Gold into “backing” their various fraudulent paper money scams using fractional reserve systems. Why? Because the power to create money is the ultimate power. It is not for no reason that Mayer Amschel Rothschild said:

Give me control of a nation's money and I care not who makes her laws.”

And why do we know Gold is still money today? It’s simple – Gold has the highest stocks to flow ratio of any commodity i.e. its total above ground stockpile is very large compared to its annual production which is NOT the case for other commodities. The reason for this is that while other commodities are primarily mined for consumption, Gold is not consumed but hoarded. Its primary function is that of a store of value – a wealth reserve. Why do you think the Central Banks keep Gold on their balance sheet even today? Right. Even the Gold jewellery demand in countries like India is, in fact, investment demand in disguise – hidden firmly behind veils of religion and culture to protect their real wealth from the depredations of various rulers and governments that have pillaged her over the many thousands of years of her existence.

Moreover, even though most people don’t realize it, even today the dollar is only acceptable as money because it is indirectly “backed” by Gold (via the derivatives market) i.e. you can get Gold in exchange for paper dollars on the open market. The proof of this lies in the fact that were, for some reason, the convertibility of Gold into dollars suspended today [on the open market], the dollar would instantly collapse.

Gold IS Money – not the dollar, not ANY fiat currency. Period.

As the king of banksters J.P. Morgan himself testified before the Pujo Committee in 1913:

“Gold is money and nothing else”

The Fiat Money Scam

Throughout history no fiat currency has survived – ever. There is a reason for it. Paper money is inherently a scam – a scheme to loot the people who actually produce the goods and services in the economy. Just because it is legalized and its perpetrators hold fancy government titles does not mean it is not a fraud. The issuer can create unlimited pieces of paper – or computer bits today – at essentially no cost and use them to appropriate real goods and services in the economy. So whereas you and I have to actually do real work to procure it, the printers of the currency can basically print whatever they need. This is why there is a constant inflation of money supply under a fiat money regime as has been the case since the Federal Reserve was established in the US in 1913, as constant theft requires constant creation of new money. The evidence of this inflation is the annihilation of the dollar’s purchasing power since then:

The Dollar's Purchasing Power Since the Creation of the Federal Reserve in 1913

This is why we have legal tender laws making the unconstitutional Federal Reserve Notes legal tender with the monopoly of the private banking cartel (i.e. the Federal Reserve) enforced by the courts enabling the banks and the government to essentially enslave the populace. This is also exactly why the founders of America prohibited anything except Gold and Silver to be used as money, and why the governments go to great lengths to suppress their price. Indeed, America today is the very antithesis of what its founders intended.

The fraudulent money system today is the source of all the rottenness. The various scams in progress today - the entrenched corruption - can be all be traced back to it. The rot is at the very top of the pyramid from which the fountain of fiat money emanates. It is indeed telling that the two World Wars occurred right after creation of the Federal Reserve. Further, no amount of prosecution will fix the system because the prosecutors themselves have been corrupted. As Ayn Rand said:

"When you have made evil the means of survival, do not expect men to remain good. Do not expect them to stay moral and lose their lives for the purpose of becoming the fodder of the immoral. Do not expect them to produce, when production is punished and looting rewarded. Do not ask, 'Who is destroying the world? You are.”

It is too lucrative a scam to be given up voluntarily by those owning the printing press while the going is still good. It is like expecting a thief to stop stealing while not only being immune from any sort of legal prosecution, but actually having the power to create laws. The system cannot be fixed - the only way this will stop is a collapse of the existing system so that a new one can be built – and we are in the middle of it right now.

Deflation in Terms of Gold, Hyperinflation in Terms of the Dollar

By its very nature, due to economic control being concentrated in a few hands and fraudulent creation of money out of thin air, the fiat money system creates massive misallocations of capital and resources throughout the economy. The economy under a fiat money system is no different than a centrally planned one, such as the Soviet Union.  Moreover, since the entire world is on a fiat money standard today – with the various fiat currencies themselves being “backed” by the fiat dollar - misallocations of capital have occurred throughout the world resulting in malinvestments. These misallocations are both material and human, as exemplified by the skyrocketing unemployment rate. The malinvestments now need to be liquidated i.e. converted to the most liquid form – “the most marketable good” or money - so that the capital can be reallocated to more productive uses. Loans are called in as they can no longer be serviced. This results in deflation, i.e. rising demand for money in relation to everything else, and consequently falling prices and increasing purchasing power of money. Moreover, economic uncertainty means that more and more people want to hold “the most marketable good” i.e. money thus further increasing the demand for money.

Now normally – since a lot of debt-money is destroyed in the process and there is a rising demand for money - this would lead to a rising dollar (in terms of purchasing power, not the meaningless DXY), but that would mean that the whole “theft-via-inflation” scam would fall apart. The government can’t tax a rising purchasing power! They simply CANNOT allow deflation in a fiat money regime as it would defeat its very purpose – that of allowing them to appropriate resources from the rest of the economy. This would threaten their very existence.  This is why holes created on the banks’ balance sheets by defaulting loans – which would normally create deflation - are being eagerly filled by the Central Banks. This is why the Fed is now simply printing money out of thin air – both overtly and covertly, with the derivatives market being cleverly used to absorb the excess money creation (so you were wondering why the derivatives monster is increasing exponentially in size?) - to fund the government’s operations as there is not enough money in the market to lend to the government. Hiding under esoteric nonsense terms like “quantitative easing” does not change the fact that it is simply creating money via ledger entries and outright STEALING.

Whether they “allow” it or not deflation WILL take place – not in terms of dollars, but in terms of Gold. It’s simply forces of nature – the market – at work. The dollar deflationists expect the dollar to suddenly reverse its 100 year long drop in purchasing power. Ain’t gonna happen. What the government is doing now – i.e. spending raw printed money into a contracting economy - assures us that we will end up with the hyperinflation of the dollar. The only thing they can do is prolong its demise with intermittent bouts of induced apparent “deflation” to keep the inflationary scam going a little bit longer - remember 2008? (h/t Gary). Initially, of course, many people (such as Mr. Denninger) – mistakenly thinking the dollar to be “money” – will rush to its perceived safety causing the dollar to rise.  But ultimately, as more and more people realize that the government will not – indeed, cannot – stop inflating the currency into oblivion, will choose to hold the ultimate “marketable good”, i.e. Gold. This is the reason why Gold is the only asset class at new all time highs. Rest assured, even the big boys are holding Gold in their private vaults, not dollars. Is there any sense in holding something you can create at will?

Ultimately, there can only be deflation in terms of commodity based money such as Gold since it cannot be created out of thin air. Indeed, we have already been deflating in terms of Gold for the past decade. Just look at the various commodities, the stock market, real estate – pretty much anything - priced in Gold – it’s all going down:

 SPX priced in Gold (2000-2010)

As capital goes down the liquidity pyramid in search of the most marketable good, all the money derivatives – including the dollar – will collapse returning all capital to where it came from: Gold; a global reset, if you will, with only holders of Gold left standing when the dust settles:

 Exter's Liquidity Pyramid

You Cannot Eat Gold, But You Can’t Eat Dollars Either

That has to be one of the lamest arguments against Gold – ever. It is the sign of a closed mind. It shows that you don't know ANYTHING about human history, which is not surprising considering the sorry state of our government controlled "education system". You cannot eat FRN’s either – why not just burn them? The function of money is not to be eaten but to be used as a medium of exchange and store of wealth i.e. to get what you want to eat at an indefinite time in the future. And while with Gold you are assured of getting at least something in return in the future, whether it is an edible product or not, it is not so with dollars. Fiat money has a problem in that it lasts only as long as the government enforcing its use does. In times of economic uncertainty, such as today, when the very survival of various governments is at stake (yes, that includes the US Government) do you want to hold Gold or their worthless colored paper tickets? Gold is the only money that has outlasted empires and governments - no fiat currency has. Think about it - what will your dollars be worth when there is no government to enforce it as legal tender? Yup – zip, zilch, ZERO. And to those who say that we will not need Gold (but something else like food or guns) in such extreme circumstances, I say that empires and governments have constantly collapsed throughout history but it did not mean the end of the world. As long as you believe that human society will exist and there will be division of labor, you need money (i.e. Gold) – because:

a)    You cannot store indefinitely all your needs especially perishable items such as food.
b)    You do not know with 100% certainty what you will need in the future.
c)    You cannot produce/manufacture everything that you will need today or in the future by yourself.

Even if the government does not collapse there is nothing stopping it from devaluing the currency at will in a step function thereby instantly appropriating a vast amount of your savings, as has already happened not once but twice with the dollar since the creation of the Federal Reserve. I mean really, the facts are so obvious that you have to be either be in total and complete denial (perhaps due to having already put all your eggs in the dollar basket) or in collusion with the people promoting the paper money scam.

Gold is the currency beyond Governments. It is the most liquid form of money accepted throughout the world – the true reserve currency of the world - whereas Dollars, Yuans and Euros etc. are only guaranteed to be accepted within their own respective countries, and as long as their respective governments last. Why would you want to tie yourself down to the paper currency of a particular nation, especially in times of such turbulence? It points to a very limited sphere of thinking when you advocate that holding only dollars is the best strategy. It is a fallacy to believe that there is no refuge outside the system; that you have to be trading paper tickets all the time to “keep up” with the dilution of your purchasing power or just stand by idly holding dollars while the government rapes you. Gold is your refuge outside the system.

Got Gold, Mr. Denninger?

*In general we can state that they are “fiat-money deflationists” since the process of money creation is same in all the countries i.e. money is created as debt and the collapse will follow a similar route. The only caveat in my opinion is that since the dollar backs all the other fiat currencies, it *might* collapse last. Also, to keep things simple, for the rest of the discussion, we’ll simply use the term “dollars” with the understanding that it can be used interchangeably with the general terms “fiat currency” or “fiat money” since it is one itself.

By Gordon Gekko

© 2010 Copyright Gordon Gekko - 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.

© 2005-2016 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Shelby Moore (author of "How Inflation is Deflation")
03 Jun 10, 20:22

You've summarized nearly everything I have been writing at my goldwetrust.up-with forum, including the debate I've had with Denninger and Mish Shedlock.

You only missed a few details, such as that gold responds to negative real interest rates (although you've essentially explained the phenomenon why):

Shelby Moore
03 Jun 10, 20:39
Why Denninger Hates Gold

In my private emails with Karl Denninger, I summized that the reason he hates gold so much is it would enable the crooks to escape the reach of the law. And it would create an inequal society, because all the middle class would be without gold. He said we gold bugs deserve to be incarcerated and worse (I dare not repeat the physical voilence he feels towards gold bugs).

Understand that Denninger is a socialist. He believes govt and laws are a solution. It is very important that people understand what socialism is precisely and that capital is not money:

"Socialism is the redistribution of capital from individual decisions to central managers."

"Financial capital is any form of wealth capable of being employed in the production of more wealth."

As for the people who refuse to buy gold and/or buying it later than the banksters did, well that is going to be a learning experience for them. That is the way capitalism works, it punishes ignorance.

And any other system, one that tries to regulate fairness, as per Denninger's desire, becomes much more unfair and even genocidally fascism at its end.

And besides, there really isn't a choice. Nature is in control and gold will perform its function irregardless of mice and men.

The people deserve what is coming to them, because for decades they have been demanding socialism (something for nothing). Debt is socialism, it takes capital from those who worked and redistributes those who did not work. It centralizes capital in the hands of the most ignorant. And no amount of regulation or laws can change the fact that debt is socialism.

Shelby Moore
04 Jun 10, 12:20
Mish Shedlock debate

I also debated one of the other prominent dollar-deflationalists, Mish Shedlock:

Note Gordon Gekko stated in the above article what I have also stated, that we have had and will continue to have deflation relative to gold. Other than credit saturated assets such as western real estate, we have had and will continue to have high rates of price inflation.

The hyper-inflationary event coming will be caused not by price inflation, but when the public realizes that only 10% of the dollar economy is real:

Shelby Moore
10 Jun 10, 01:28
Natural law applies

Denninger understands most of it, except he fails to respect the natural law (even though he mentions it in support of many of his arguments) with respect to his desire for centralized power of man's law:

Shelby Moore
25 Jul 10, 06:58
Denninger's mistake on deflation

Denninger interview videos linked from my comment:

Denninger says we can't have inflation because there can not be created a bigger credit bubble than the housing bubble that is bursting (this was the same argument presented by Mish Shedlock). The "money supply" (an inherently ambiguous term as I have explained in past) can not be increased (pushing on the string of total credit). He correctly pointed out that govt debt is being increased to offset loss of private sector debt, and the total debt has decreased (but only very slightly, see chart):

I agree but inflation will result any way. What he apparently does not understand is that the govt will monetize entitlements from here forward (and this will not cause a collapse of the dollar relative to other equally bad fiats), and yes total credit may decline and housing and other credit based assets will continue to decline (that is deflation). But this acceleration of social welfare monetization (is mis-allocation of capital, i.e. theft) and will cause a devaluation of the dollar relative to assets that can not be diluted by corruption of central banks monetizing sovereign bonds. Thus will result in inflation in price of everything that is not bought on credit (i.e. energy, food, gold, silver, etc). The govt is printing money to pay entitlements. The totals may have peaked, but the composition is changing RADICALLY, which means an inflation in the price of things that can not be created out of thin air which are not in oversupply. I had written about this:

Essentially what is happening is that the westerners are being drained of their net worth and this is being done with a combination of deflation of credit based assets and inflation of commodities. There is an accelerating transfer of jobs and wealth to developing world so they the world's poor (those that can get a job) can absorb this inflation (because western companies are forced to lower labor costs due to the decline in private sector):

Thank you.

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