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HOW WILL THE FED RESPOND
TO DEFLATION?
INFLATION, INFLATION, toujours INFLATION
You don’t need the
imagination of Hans Christian Andersen to understand that as surely
as “tire” follows “flat”, a debt deflation follows every credit
inflation. No divine insight is required to understand that this
debt deflation (“bankruptcy”) will continue writing off the bad
debts which the credit inflation created until they are all gone.
Economic activity will drop until all the bad debt is written off
around the world. No prophetic revelation is necessary to discern
that the engine of this boom and bust is the central bank, the
Federal Reserve system.
THE DEADLY DEFLATION
A deflation is a deadly
disease that does not respond to inflation. It must progress until
it weeds out all the old bad debt. However, the Establishment – the
people in Washington and New York who run your financial and
monetary system – have only one weapon against deflation: money
creation, i.e., inflation.
Apply logic. When the
debt deflation bites, what will the establishment do? Well, what is
the only weapon they have? Inflation. What weapon will they
use? Inflation.
INFLATIONARY DEFLATION
Therefore we have the
paradox of depression-like economic conditions usually associated
with monetary conditions of deflation (a falling money
supply) taking place against a monetary background of inflation
– an inflationary depression.
AGAINST A GOLD AND
SILVER SYSTEM . . .
Against a gold and
silver monetary system backdrop, a deflation usually means that the
money supply actually shrinks as money substitutes such as banknotes
are repudiated. This shrinkage affects banks’ willingness to lend
and borrowers’ willingness to borrow. Pessimism takes hold,
bankruptcies increase, prices fall, and economic activity
declines, the recipe for “hard times.” Increasing bank reserves
(which the central bank can do by selling bonds or various other
tools) does not slow the deflation, because lenders and borrowers
are unwilling to enter into new debt to increase economic activity.
The Fed finds itself “pushing on a string.” This is what
happened in the 1930s Great Depression.
AGAINST A FIAT
MONEY SYSTEM . . .
How did the government
and the central bank respond to the Great Depression? With
inflation. The inflationary scheme had as many heads and bodies
as Hydra, but all had the same essential thrust: increase the money
supply. Inflate. That was the only weapon they had. That is still
the only weapon they have.
Against a fiat
money backdrop, a deflation might mean that the money supply
actually shrinks as debt shrinks. Why? Because all the money
created today must be borrowed into existence. When debt is
destroyed, the basis for fiat money is destroyed, and that
implies deflation.
However –
And upon this hangs all
my strategy for financial survival during this depression –
we no longer live under
a gold and silver monetary system We live under a fiat money
system and money creation monopoly, and that changes everything.
All circumstances of the financial and monetary foundation differ
from the 1930s, so the outcome of this debt deflation will differ
from the 1930s’.
MONEY MEANS POWER
Why? Because the
Establishment that rules us draws all its power from a monopoly on
money creation. They will do everything to perpetuate that power.
They will use every weapon at their disposal. How do they keep the
public content to be ruled? By manipulating “prosperity,” under the
old proverb that “revolutions are not made on full stomachs.” How
do they manipulate prosperity? By controlling the money supply.
Then along comes
deflation, not a deflation they have engineered themselves, but an
insatiable, unstoppable collapse of debt with a life of its own, a
Frankenstein they caused by their own credit inflation. Deflation
threatens to take power out of their hands and leave them utterly
impotent.
They only have one
weapon against deflation (a falling money supply): create more
money. Inflation.
Will they use it to
attempt to maintain their control on power? Does a hog eat acorns?
You know he does.
The federal government
and Federal Reserve will respond to deflation by inflating, up to
and including hyperinflating the US dollar to worthlessness.
PROOF? WITNESSES?
How can I prove my claim
that the Establishment will try to combat deflation with massive
inflation? I draw that conclusion from a broad reading in history,
and in the Establishment’s own documents and reports. Perhaps the
Council on Foreign Relations’ Financial Vulnerability Project stated
it most clearly, but then, none of these Establishment –
policy wonk documents read clearly. Part of what you pay me for is
reading their stuff -- boring enough to knock off an insomniac in 30
nanoseconds. Carefully studying the documents around the Financial
Vulnerabilities Project[i]
leads inevitably to the conclusion that (1) financial crisis belong
to the system by its nature, and (2) their only weapons
against it are blarney and liquidity. Liquidity by any other
name remains inflation.
BERNANKE
Lately another and even
more reliable witness has stepped forward, Governor Ben S. Bernanke
of the Federal Reserve Board of Governors He spoke to the National
Economists Club in Washington on November 21, 2002, under the title
“Deflation: Making Sure `It’ Doesn’t Happen Here.”[ii]
We ought to bear in mind
a few things as we read his words. First, Federal Reserve
governors do not make idle speeches. As anyone who has ever
suffered through Greenspan’s mumblings can testify, every word
spoken in public is spoken for effect. So we must believe that
Bernanke made this provocative and savagely honest speech for a
purpose.
Second,
nothing is confirmed until officially denied. Bernanke
repeats too often that the Fed will find deflation no problem at
all. Rather, such protestations force us to infer that the Fed is
scared --- well, scared to death of deflation, as well they ought to
be. Bernanke is here using Samson’s preferred weapon against the
Philistines to whack the bogeyman of deflation, for benefit of the
panicky public alone. Sure, there are (as he argues) a lot more
measures the Fed can undertake, but all of them are essentially the
same – inflation – and all of them failed in the 1930s in the US,
failed in the 1990s in Japan, and will fail today in the US.
Why? Because the
deflationary forces strangling debt and economic activity are too
volcanic to conquer. I shall never forget as long as I live a
phone conversation many years ago with the ever gracious John Exter,
former VP for Gold Operations of the New York Fed, former banker,
and child of the Depression. He had attended Harvard right at the
tail end of the Depression, and knew what it could do. “Oh,” he
said, dropping his voice reverently, “when that deflation takes
hold, there’s nothing the government or the central bank can
do.”
Third,
the Fed does not, and probably will never, contemplate any
structural reforms that might deliver us from this deflationary
bust, or boom/bust cycles. Rather, all the potential
“non-traditional” tools Bernanke mentions are only variations on the
same theme: inflation. Thus my operating assumption remains
unchallenged, the only weapon the Establishment possesses is
inflation.
Fourth,
they will use that weapon, regardless how utterly it guts the
dollar.
Everywhere boldface or
italic type appears, I have added that.
WILL THE WITNESS PLEASE
TAKE THE STAND
“I am confident that the
Fed would take whatever means necessary to prevent
significant deflation in the United States. . .[emphasis added.
Then all the means he enumerates are inflation.]
THE FED IS NOT
“ZERO-BOUND”
Bernanke argues against
the conclusion that once the Fed has lowered interest rates to zero
it has run out of ammunition because it is “zero bound.” “[A]
principal message of my talk today is that a central bank whose
accustomed policy rate has been forced down to zero has most
definitely not run out of ammunition.” … “At a broad conceptual
level, and in my view in practice as well, this [zero bound]
conclusion is clearly mistaken. Indeed, under a fiat (that
is, paper) money system, a government (in practice, the central bank
in co-operation with other agencies) should always be able to
generate increased nominal spending and inflation …”
AS LONG AS WE HAVE A
PRINTING PRESS
“[T][he US government
has a technology called a printing press (or, today, its electronic
equivalent), that allows it to produce as many US dollars it wishes
at essentially no cost. By increasing the number of US dollars in
circulation, or even by credibly threatening to do so, the US
government can also reduce the value of a dollar in terms of goods
and services, which is equivalent to raising prices in dollars of
those goods and services.” [Is there anybody who does not
understand this? As long as they have a printing press, they have
an option – of inflating the currency.]
“We conclude that, under
a paper-money system, a determined government can always generate
higher spending and hence positive inflation. …” [emphasis
added]
“If we do fall into
deflation, however, we can take comfort that the logic of the
printing press example must assert itself, and sufficient
injections of money will ultimately always reverse a deflation.
[Like they did in the 1930s??]
OTHER MEASURES
“A more direct method,
which I personally prefer, would be for the Fed to begin announcing
explicit ceilings for yields on longer-maturity Treasury debt. …
The Fed could enforce these interest-rate ceilings by committing to
make unlimited purchases of securities up to two years from
maturity at prices consistent with the targeted yields. [Sure, if
the bond vigilantes would co-operate, which they won’t.]
“Yet another option
would be for the Fed to use its existing authority to operate in
the markets for agency debt (for example, mortgage-backed
securities issued by Ginnie Mae, the Government National Mortgage
Association).” [He means monetising land and real estate, the
scheme that got John Law kicked out of Scotland in the 1690s, before
he inflicted a similar scheme on France 1715-1720, nearly ruining
the entire nation.]
DEVALUATION’S THE TICKET
“Although a policy of
intervening to affect the exchange value of the dollar is nowhere
on the horizon today [sic], it’s worth noting that there
have been times when exchange rate policy [that is, depreciating
the dollar] has been an effective weapon against deflation. A
striking example from U.S. history is Franklin Roosevelt’s 40
percent devaluation of the dollar against gold in 1933-34,
enforced by a program of gold purchases and domestic money
creation. The devaluation and the rapid increase in money
supply it permitted ended the U.S. deflation remarkably quickly. [This
is not so, unless you count 10 years and a World War as “quickly”.]
Indeed, consumer price inflation in the United States, year on
year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to
3.4 percent in 1934. The economy grew strongly, and by the way, 1934
was one of the best years of the century for the stock market. If
nothing else, the episode illustrates that monetary actions can
have powerful effects on the economy, even when the nominal
interest rate is at or near zero, as was the case at the time of
Roosevelt’s devaluation.” [But at the price of a 40%
devaluation, and the fix didn’t last. The 1937-38 recession was as
bad as 1929-33. In the end, only getting into World War II
got the US out of the Depression.]
CONCLUSION
Now having offered you a
few quotations I will gracefully disappear, but before I go, please
apply what we’ve learned from Bernanke’s helpful speech to
your situation.
He is telling you that
to fight inflation, the Fed will inflate the dollar to
worthlessness.
Will that affect you?
Will that affect your
investments?
An inflation of the
reach and size that Bernanke implies will destroy the value of the
dollar, and dollar denominated assets with it. It will not,
repeat, not end the so-called “deflationary” effects on economic
activity. It will leave the US looking much like Argentina today:
depressed economic activity, rapidly depreciating currency, rising
prices on all imported goods, falling real asset (real estate,
stocks, bonds) prices, but a rising cost of living, widespread
unemployment, and deep gloominess of mind. It combines all the
worst nightmares of depression and hyperinflation.
Your only solution is
to be absent when the dollar turns to dust. You must avoid
dollar depreciation by getting out of stocks, real estate, and
dollars as much as you can. Your three chief havens of refuge are
(1) your own business,
(2) gold, and
(3) silver.
If you hold cash you
must be wary of accelerating downtrends in the US dollar.
Holding US dollars since February of this year has cost you about
15% of your value. And it goes without saying (although I will)
that you must get out of debt first. --- F. Sanders
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