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Economic Deflation in Gold Terms and the U.S. Dollar Collapse

Economics / Deflation Oct 29, 2008 - 06:44 AM GMT

By: Eric_deCarbonnel

Economics Best Financial Markets Analysis ArticleWe have finally gotten to the point where most investors and the media understand the severity of the credit crisis and are expecting deflation. It is a good start, but unfortunately, it still isn't quite right.

Deflation will be in terms of gold, like in 1929


As deleveraging occurs and debt is destroyed, prices of commodities and other assets will fall in terms of real money, which is gold and other precious metals. The price of oil, for example, will continue to fall in terms of gold. (Investors need to start thinking of values in terms of ounces of gold instead of dollars, because that is where we are headed) What this means is that, while it is possible that the price of oil could still increase in terms of dollars, the price of gold will increase to an even greater degree.

There will be no deflation in terms of dollars

Right now, everyone is buying dollars and US treasuries based on the idea of price deflation in terms of dollars. Here are a couple of headlines evidencing this thinking:

Deflation Monster Coming as Credit Losses Far Exceed Capital Injections
U.S. Dollar Has Entered a Multi-year Bull Market

(The US dollar in a "Multi-year Bull Market"? That must the most over-optimistic, out-of-this-world thing I have heard this year.)

I would like to point out that the stock and credit market would already have crashed several times this year to a much greater degree if not for the constant stream of interventions by the fed and treasury. In other words, the results of this housing and credit collapse have already diverged from what happened during the Great Depression due to the creations of trillions of dollars through money printing and government guarantees. While trying to prevent a 1929-style crash, the fed has vastly increased the supply of dollars in relations to the world's limited supply of gold. The dollar's rally due to deflation fears these last three months is therefore based on a false premise.

The US dollar has already its status as the world's reserve currency

The US dollar has already lost its status as the world's reserve currency due to the government's fiscal irresponsibility, especially over the last year. Political and financial leaders around the globe are furious with the US and its financial sector, and they are determined to move away from the dollar. Meanwhile, clever investors who see the writing on the wall are already accumulating physical gold and other precious metal, creating shortages. However, none of these signs are needed to know the dollar time has come. The simple truth is that the value of paper or fiat currencies is determined not only by the quantity in circulation, but also by the financial strength of the government which backs them . The US government is broke and has been living on borrowed time for years (from China mostly). Everyone knows the US is totally insolvent, but they continue to hold dollars because the dollar's collapse is too unimaginable .

With the dollar's collapse being so unthinkable (like the bankruptcy of Lehman), there is no political will to try to prevent it. Worse still, even if the government develops the resolve to save the dollar, it is too late: if the government stops printing/borrowing money and guaranteeing bad debt the US economy will disintegrate (the financial sector is gone in either case).

Not a good time to buy Stocks

Some very smart people, including Todd Harrison at Minyanville, believe we have seen the lows for 2008, I have to disagree. The enormous amount of money being printed to bail out Wall Street will mean nothing once a run on the dollar begins. Since the evidence indicates that the flow of money into gold is already beginning, I doubt the dollar can survive to the rest of the year, let alone a month, before collapsing.

When will the dollar collapse?

The dollar will collapse when demand in the physical gold market overwhelms demand in the COMEX. Either there will be defaults on the delivery of gold for futures contracts, or there will be a government intervention limiting the withdrawal of gold. Either of these events will be a "perception changing event" of enormous proportions. After all, who wants to stay in low interest bearing US treasuries (which are financing all the bailouts) when faced with the collapse the currency? The move out of the dollar could be so violent that it brings down the financial system despite all the bailouts to date.

(if you own COMEX gold, either sell it or request delivery and hope you are one of the lucky ones who gets their gold)

What will the dollar collapse look like?

For starters, there will be a massive exodus out of US assets. Stocks, bonds, treasuries, and anything liquid will be sold so that dollars can be transferred to safer currencies (are there any?) and gold. At the same time, the price of US imports, specifically oil, will skyrocket. With their lifesavings wiped out, I don't know how exactly Americans will deal with 10 or 20 dollar gas, but it won't be pretty.

By Eric deCarbonnel
http://www.marketskeptics.com

Eric is the Editor of Market Skeptics

© 2008 Copyright Eric deCarbonnel - 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.

Eric deCarbonnel Archive

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