-- Posted Tuesday, 13 January 2009 | Digg This Article
| Source: GoldSeek.com
Rick’s Picks
Tuesday, January 13, 2009
“Phenomenally accurate forecasts”
A couple more years of deflation, then a hyperinflationary tsunami? That’s the scenario envisioned by a reader from South Africa, Eelco Lodewijks, in response to yesterday’s commentary, “Calling All Inflationists.” We asked readers to explain how inflation could occur with asset values, credit and business collapsing around the world. Hundred of you wrote back, and we are still sorting the replies. Lodewijks’ e-mail was among the first to arrive, and it contains some interesting ideas that seem quite plausible to us.
If there is a weakness in his thesis, it is the notion that the banks, whose TARP-fattened reserves are currently sitting in Treasurys, will crank up loans in two or three years as the business climate starts to thaw. We would ask, simply, loans on what collateral? Housing has been spent for that purpose, and we can’t imagine any asset class that could takes its place.
Lodewijks writes as follows:
Inflation is not just about the amount of money in circulation, but the velocity. Therefore, if we double the money and halve the velocity, there will be no impact on inflation. All the money created in the last months has not improved liquidity since the banks have hoarded it for the following reasons:
** They lodged their suspect securities with the fed for funds at 0.5% and reinvested in Treasurys at 3.0%. Therefore, they would be fools to lend the money out at risk if they can get 2.5% guaranteed.
** They are hoarding cash to shore up their balance sheets against losses, future credit defaults and hedge/investment losses.
**They are reluctant to lend, as they do not know who is creditworthy since seemingly secure companies are folding without warning.
Money Unavailable
Therefore, by analogy, all the money created in the last years and the staggering amounts created in the last few months may as well have been dumped in an offshore tanker as it is not available to the economy. However, it has been created and still exists, although it is not in circulation and moving around as evidenced by lower velocity. Accordingly, the question is, “What will happen when the floodgates are opened and that money is finally released” - and that is where you and I are looking for the first sign that will signal that inflation, and maybe hyperinflation, is about to begin. The factors that have a bearing on this and some consequences are as follows:
** Since the banks represent the supertanker in my analogy, the first sign will be when the banks stop hoarding and start lending again, thereby causing the velocity of money to start picking up again. That will only be when the trend of unexpected insolvencies slows and they start feeling that. Then the banks will lend, tentatively at first and then faster and faster;
Two More Years of Dominoes
** Before this happens, the dominos have to stop falling and I feel this will take a year or two as the ripple effects of the lack of credit have not yet stopped. A company that had containers at the harbour and could not get LCs to ship has probably not folded yet and the people they supply have not folded yet for lack of product, and the suppliers they owe have not folded yet for lack of payment (cash), etc. However, without credit it is only a matter of time, as the company cannot resume business as usual. Equally, the ripple effects of the drop in motor sales has not run its course through the giants and their suppliers, especially those who were not financially strong - not many businesses can survive a 35% drop in sales, so many will fold in time. The same thing is happening in almost every sector of the economy as the effects of people suddenly without jobs, who cut back on spending, cause a spiral of lower future sales, higher future losses and further job losses;
** So let us say that the global markets and the global economy will continue to tank for a few years and then slowly rise from the ashes. That would mean no inflation for three years at least and possibly longer. But the market anticipates and discounts, so it may pick up the inflation risk a year earlier. So normally, Gold - the ultimate inflation-watcher, will resume its run in two years. In the absence of inflation in the next few years, I accept that Gold could tank. However, if the markets continue to collapse and the derivatives pyramid unravels, the destruction of wealth will, in all likelihood, cause a flight to value that will cause Gold to become the focus of attention in the near future;
** In the interim years, while the banks sit on their cash, governments will embark on direct job creation by way of infrastructure projects and such to inject liquidity into the system at unprecedented levels. This job creation will progressively give the banks more confidence. Imagine the tsunami that results when their direct liquidity meets the liquidity arising when the banks return to the playing field;
Gold Has a Role
** The only thing holding things together at the moment is that the public still believes in the dollar, euro, Treasuries, etc. However a fiat currency can only prevail for as long as the masses believe in it. I know for certain that there is no countervalue in a bank note as there was in the days when you could exchange paper currency (read promissory note) for Gold or Silver. That means that if I hold cash, I actually hold nothing. You can fool all of the people some of the time, some of the people all of the time, but not all of the people all of the time. The latter prophesy is at hand as evidenced by the interest the public is showing in Gold and Silver coins. But if the amount of fiat money created is sufficient, and I think it is, the Zimbabwe spiral commences where you have to inflate or die (as Richard Russell preaches). I believe the USA, Europe et al. have reached the point of no return: Deflation is not an option, and they have to adopt inflation. I do not think we will get a Zimbabwe situation as the powers that be will resort to some fiscal discipline before it gets to that point - at least I hope so, failing which we are in for a Mad Max scenario.
I for one still believe that Gold has a role to play. Where else do you put your money in these times of uncertainty? Regards, Eelco Lodewijks.
***
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-- Posted Tuesday, 13 January 2009 | Digg This Article | Source: GoldSeek.com
