Inflation and Deflation Perspectives

          Despite last week’s rally in stocks, the highs of mid-November remain the market’s high point.  As I have been noting, my long-term, trend-following indicators remain negative.

          This past week, I began to read the most recent book by James Turk, a past guest on my radio program.  Mr. Turk’s book is titled, “Money and Liberty; in the Pursuit of Happiness and the Natural Theory of Money”.

          In the book, Mr. Turk offers a perspective similar to the perspective I have offered in the past regarding money and currency and the difference between the two.  Currency is used in commerce and money is a good store of value over time.  Sometimes in history, currency and money have been the same thing, other times, including the present time, they are not the same thing.

          Mr. Turk offers the example of West Texas Intermediate crude oil.  When a barrel of oil is priced in US Dollars, Euros, or the British Pound, one concludes that the price of crude oil has risen significantly since 1950.

          However, when priced in gold grams, the price of a barrel of crude oil hasn’t changed since 1950.

           Fiat currencies, over time, are devalued by central banks or governments.  That makes fiat currencies poor measuring units.

          Economic output, or gross domestic product, is measured in fiat currencies.  Devalued currencies make the reported economic output number look better than it is in reality.

          The same is true when it comes to stock values.  Stock prices reported in fiat currencies move up as the currency is devalued.  The same devalued fiat currencies that make the price of consumer goods like groceries rise also make the price of stocks increase.

          Historically speaking, this devaluation of currency is controlled and gradual initially, but then the politicians and policymakers lose control of the devaluation process and inflation gets out of control.

          Economist John Meynard Keynes, the father of the loose money policies that are being pursued worldwide today, knew that control over the devaluation process would eventually be lost with dire consequences. 

          In 1923, Keynes wrote a tract on monetary reform.  The second chapter of the tract is titled, “Inflation as a method of taxation”.  Keynes, in his writing, discusses devaluation of a currency or inflation as a method of taxation that allows a government to survive when there is no other means of survival.  This from his tract (Source:  https://delong.typepad.com/keynes-1923-a-tract-on-monetary-reform.pdf):

A government can live for a long time, even the German Government of the Russian Government, by printing paper money.  That is to say by this means, secure the command over real resources – resources just as real as obtained through taxation.  The method is condemned, but its efficacy, up to a point, must be admitted.  A government can live by this means when it can live by no other.  It is the form of taxation which the public finds hardest to evade and even the weakest governments can enforce when it can enforce nothing else.” 

          Keynes indirectly states that the positive effects of currency printing diminish over time when he states that “its efficacy, up to a point, must be admitted.”

Keynes clearly understood that in the long run, the point is reached when currency devaluation doesn’t work and the adverse consequences of currency creation emerge.  One of Keynes’ most infamous quotes is “in the long run, we are all dead.”  Keynes clearly understood that eventually, this monetary policy would fail but it would be long after he and his cohorts exited the planet.

          Mr. Turk, in the aforementioned book, has this to say about Keynes’ statement.

“These words, which are frequently quoted, are among the most grossly irresponsible statements ever spoken by an economist.  Actions have consequences and planning for the next generation is an essential element of economic activity.  What is important to society and indeed our civilization is not just how we live, but what we leave for future generations.  That the planet’s environment has become so scarred is an indication of how much we have accepted the ills of progressivism, socialism, and authoritarian control by the State and moved away from capitalism, private property, and individual liberty.  The State today rarely leaves people alone.

Keynes’s comment is typical of socialists and progressives who focus on satisfying their innate yet perverse need to control others rather than where their attention should be directed, which is the consequence of their actions.  For example, they proclaim their vision that forces the world to drive electric cars so that we do not inhale the emissions from exhaust pipes, yet they are blind to the number of plants needed to generate the electricity to power all those new cars.  Decisions cannot be made on emotion.  In our world of limited resources, they must be made based on sound economics and that requires trustworthy money spent and invested at a true cost of capital.  These are requirements that only gold can provide.  Further, to achieve the best possible outcome decisions need to be unfettered by government involvement and their market interventions.

For Keynes, the long-run has arrived, and he wrote his own fitting epitaph:

‘Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.  Madmen in authority, who hear voices in the air are distilling their frenzy from some academic scribbler of a few years back.’

It’s time to bury Keynes, Keynesianism, and socialism.”

          I agree with Mr. Turk.

          But abandoning currency creation will come at a cost.  A deflationary period of time will materialize.  Continuing with the Keynesian policies of currency creation will not avoid the deflationary period, it will only make the eventual deflationary period worse.

          The choices are grim; an ugly deflationary period, or an uglier deflationary period.  The longer currency creation continues, the more severe the resulting deflationary period will be.  Keynes touched on this in his 1923 tract:

“In the first place, deflation is not desirable because it effects, what is always harmful, a change in the existing Standard of Value, and redistributes wealth in a manner injurious, at the same time to business and social stability.  Deflation, as we have already seen, involves a transference of wealth from the rest of the community to the rentier class and to all holders of titles to money; just as inflation involves the opposite.”

“But, whilst the oppression of the taxpayer for the enrichment of the rentier is the chief, lasting result, there is another more violent disturbance during the period of transition.  The policy of gradually raising the value of a country’s money to (say) 100% above its present value in terms of goods, amounts to giving notice to every merchant and every manufacturer, that for some time to come his stock and his raw materials will steadily depreciate on his hands and to everyone who finances his business with borrowed money that he will, sooner or later, lose 100% on his liabilities.  Modern business, being carried on largely with borrowed money, must necessarily be brought to a standstill by such a process.”

          If you’re not familiar with the term ‘rentier’ class, it refers to someone who relies on a pension, rents, or other fixed-income sources.

          These people benefit from a currency that buys more over time.

          On the other hand, borrowers benefit from a currency that buys less over time.  Mortgage holders, business owners with debt, and the government all benefit from a currency that is being devalued.  In this scenario, dollars borrowed, buy more than dollars that are used to pay back the debt.

          When Keynes fails to acknowledge in his 1923 tract is constant money.

          Gold is constant money.

          When we go back and revisit the example of West Texas Intermediate crude oil that Mr. Turk used in his book, we find that the barrel of crude oil that sold for $2.57 in 1950 now costs more than $70 to purchase when using US Dollars in the transaction.

          That barrel of oil purchased with gold grams in 1950 and today would cost the same amount.  Gold has historically been constant money.

          At different times in history, the paper currency has been only partially backed by gold which allows for more currency creation and is inflationary.

          Today, there are zero currencies in the world with any level of gold backing.  Currency creation worldwide has been expanding and consumer price inflation is now manifesting itself in earnest.

          In response, many world central banks are raising interest rates to attempt to suppress inflation.  Wolf Richter (Source:  https://wolfstreet.com/2021/12/22/end-of-easy-money-global-tightening-in-full-swing-fed-promises-to-wake-up-in-time/)  reported last week that the central banks of Czechoslovakia, Russia, England, Norway, the European Central Bank, Mexico, Chile, Hungary, Pakistan, Armenia, Peru, Poland, Brazil, Korea, New Zealand, South Africa, Iceland, and Japan have all increased interest rates.

          The Fed has kept interest rates at zero; look for more inflation before we see deflation. 

          As for Keynes, he was right about being dead in the long run.  Keynes passed away in 1946.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

About Stocks and Bonds

          The stock market highs of November have not yet been taken out and my long-term trend-following indicators continue to become more bearish.  At this point, a “Santa” rally looks less likely especially given the Fed’s recent statements about accelerating the taper or slowing the rate of currency creation.

          As the longer-term readers of “Portfolio Watch” are aware, I believe the Fed’s taper talk is just that.  The math doesn’t lie; the federal government cannot fund its deficit spending without currency creation.  While the Fed may taper officially, liquidity will have to be made available in order to close the budget gap.

          Of course, common sense dictates that this process of currency creation will have to cease at some future point.  When it does, it is my belief that a reset will have to occur that will affect many assets including stocks and real estate.

          Both stocks and real estate are in a bubble in my view.

          David Stockman, former budget director, penned an article last week that examines just how extended stocks likely are.  Here is a bit from Mr. Stockman’s piece (Source:  https://internationalman.com/articles/david-stockman-reveals-the-truth-about-the-stock-market-and-what-it-means-for-you/)

The fundamental consequence of 30 years of Fed-fueled financial asset inflation is that the prices of stocks and bonds have way overshot the mark.

That’s why what lies ahead is a long stretch of losses and investor disappointment as the fat years give way to the lean.

These will hit hard the bullish investor herd and aggressive buyers of calls who can’t imagine any other state of play. They will be shocked to learn — but only after it is way too late — that the only money to be made during the decades ahead is on the short side of the market by buying puts on any of the big averages: the FANGMAN, S&P 500, NASDAQ 100, the DOW and any number of broad-based ETFs.

The reason is straightforward. The sluggish, debt-ridden Main Street economy has been over-capitalized, and it will take years for company profits and incomes being generated to catch up to currently bloated asset values. Accordingly, even as operating profits struggle to grow, valuation multiples will contract for years to come, owing to steadily rising and normalizing interest rates.

We can benchmark this impending grand reversal on Wall Street by reaching back to a cycle that began in mid-1987. That’s when Alan Greenspan took the helm at the Fed and promptly inaugurated the present era of financial repression and stock market coddling that he was pleased to call the “wealth effects” policy.

At the time, the trailing P/E multiple on the S&P 500 was about 12X earnings — a valuation level that reflected a Main Street economy and Wall Street financial markets that were each reasonably healthy.

The US GDP in Q2 1987 stood at $4.8 trillion and the total stock market was valued at $3.0 trillion, as measured by the Wilshire 5000. Back then, Wall Street stocks were stably capitalized at 62% of Main Street GDP.

Over the next 34 years, a vast unsustainable gulf opened up between the Main Street economy and the Wall Street capitalization of publicly traded stocks.

During that three-decade period, the Wilshire 5000 market cap rose by 1,440% to $46.3 trillion. That’s nearly four times the 375% gain in nominal GDP to $22.7 trillion.

Accordingly, the stock market, which was barely three-fifths of GDP on Greenspan’s arrival at the Fed, now stands at an off-the-charts 204% of GDP.

If we assume for the moment that the 1987 stock market capitalization rate against national income (GDP) was roughly correct, that would mean that the Wilshire 5000 should be worth $14 trillion today, not $46 trillion. Hence, the $32 trillion of excess stock market valuation hangs over the financial system like a Sword of Damocles.

In fact, we believe that the gulf between GDP and market cap has been growing wider and more dangerous since the Fed sped up money printing after the Lehman meltdown. To wit, since the pre-crisis peak in October 2007, the market cap of the Wilshire 5000 is up by nearly $32 trillion, while the national income to support it (GDP) is higher by only $8 trillion.

The stock market’s capitalization should be falling, not soaring into the nose-bleed section of history. After all, since the financial crisis and Great Recession, the capacity of the US economy to generate growth and rising profits has been sharply diminished. The real GDP growth rate since the pre-crisis peak in Q4 2007, for instance, is just 1.5% per annum, which is less than half its historical trend rate of growth.

Back in October 2007, the stock market’s capitalization was 106% of GDP and in just 14 years it has soared to the aforementioned 204%. So even as the growth rate of the US economy has been cut in half, stock market capitalization has doubled.

Given that the stock market has gotten way, way ahead of the economy, the longer-range implication is a long spell during which financial asset prices will stagnate or even fall until they eventually recover the healthy relationship to national income.

Looking at this from a different angle, the current $46 trillion market cap of the Wilshire 5000 would not return to 62% of GDP until US GDP reaches $75 trillion. At an average of 3.3% per annum increase in nominal GDP since Q4 2007, it would take 38 years to get there!

That’s right. The massively over-valued stock market is currently capitalizing on an economy that might exist by the year 2060… if all goes well.

            Mr. Stockman offers a terrific perspective on where stock valuations have moved since the Fed began the ‘temporary’ policy of currency creation.

          Real estate has followed a course similar to the course tracked by stocks.

          The Case-Shiller Housing Index is the commonly used metric of housing values.  The chart illustrates housing values for the past 25 years.

          Looking at the chart, one can see the decline in housing values at the time of the financial crisis.  The index fell from 200 to about 150. 

          Notice that housing values began to increase in earnest after the Fed began quantitative easing.  Since that time, housing prices have nearly doubled.

          And, as inflated as housing prices were at the time of the financial crisis, they are far more inflated presently – they are about 50% higher than they were prior to the collapse that began in 2007.

          Of course, as we have demonstrated many times in the past if real estate and stocks were priced in gold rather than depreciating US Dollars, one gets a completely different perspective.  In 2007, gold was about $650 per ounce.  Today, the spot price of gold is about $1800.  That’s an increase of about 275%.  Priced in gold, both stocks and real estate have declined in value which one would expect given the massive levels of debt that exist.

          The reality is that the US Dollar and every other fiat currency around the world is no longer an accurate metric when examining economic data and asset pricing.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Gold Price Analysis

          Stocks continued their rally last week, with many indexes making new all-time highs by the slimmest of margins.

          I noted last week that the ‘gaps up’ on the daily price chart are most often closed by falling prices.  This is still a possibility but last week’s price action muddies up the waters from a technical analysis perspective.

          We will need to see how this week’s price action plays out and assess where we are.

          By now, clients and subscribers have received the October issue of the “You May Not Know Report”.  In it, I offer an analysis of gold, silver, and oil relative to the expansion of the money supply.

          I offer that explanation here again for context before discussing a recent article published by Mr. Egon von Greyerz that validates this analysis using a completely different method of analysis.  I hope you find it interesting.

          This is from the October “You May Not Know Report”:

I’ve had conversations with many readers, radio show listeners, and clients about the recent decline in the price of precious metals.  Those conversations always lead to two topics of discussion.  One, where should the price of precious metals be from a fundamental viewpoint?  And, two, why is the current reality not reconciling with the fundamentals?

          In this update, I’d like to address both topics.  Let’s begin with the fundamentals.  I’d like to have this conversation from the perspective of the expansion of the fiat money supply and then compare the expansion of the money supply to the price of gold, silver, and another commodity – oil.  This comparison is easy to do when visitingusdebtclock.org.  The screenshot on this page is taken from that website.

          Notice from the screenshot that the dollar-to-oil ratio, the dollar-to-silver ratio, and the dollar-to-gold ratio in 1913 are all noted.

          The ratio is calculated by taking the total increase in the money supply and dividing it by the yearly production of either oil, silver, or gold depending on the commodity one is examining.  For example, the dollar to oil ratio in 1913 was calculated by taking the total increase in the money supply and dividing it by the total world oil production.  A review of the history of oil prices concludes that the actual price of oil per barrel in 1913 closely tracked the price forecast using this simple formula.

          The same conclusion is reached when looking at the formula-derived prices in 1913 and the actual prices.  Gold was $20 per ounce in 1913 and silver was between $1 and $2 per ounce.

          Here’s the point, in calendar year 1913, using the formula of taking the increase in the money supply and dividing by annual world production of oil, silver, or gold; one arrives at a forecasted number that reasonably tracked reality.

          Fast forward to September 2021 and one discovers that this forecasting tool seems to have broken for gold and silver but still works for oil.  Observe from the screenshot that taking the total increase in the money supply presently and dividing by world oil production, one gets a forecasted estimate of about $72 per barrel.  Like in 1913, that tracks reality reasonably closely.  The current price of one barrel of oil as this issue goes to publication is about $75.

          However, when looking at the forecasted price of silver and gold, one reaches a much different conclusion.  The forecasted price of silver is more than $3,000 per ounce while physical silver is presently selling somewhere in the mid-$20 range.  The forecasted price of gold is more than $21,000 per ounce while reality has physical gold selling for around $1900 per ounce.

          The article in the “You May Not Know Report” goes on to discuss why gold and silver prices have not reacted to the expansion of the money supply like oil prices have, citing one of the reasons as price manipulation via the highly leveraged futures markets.

          This past week, as noted above, Mr. Egon von Greyerz looked at this topic from a fiat currency devaluation perspective.  Here is a bit from his excellent piece (Source:  https://goldswitzerland.com/shortages-hyperinflation-lead-to-total-misery/):

The US annual Federal Spending is $7 trillion and the revenues are $3.8 trillion.

So the US spends $3.2 trillion more every year than it earns in tax revenues. Thus, in order to “balance” the budget, the declining US empire must borrow or print 46% of its total spending.

Not even the Roman Empire, with its military might, would have got away with borrowing or printing half of its expenditure.

The most obvious course of events is continuous shortages combined with prices of goods and services going up rapidly. I remember it well in the 1970s how for example oil prices trebled between 1974 and 1975 from $3 to $10 and by 1980 had gone up 10x to $40.

The same is happening now all over the world.

That puts Central banks between a Rock and a Hard place as inflation is coming from all parts of the economy and is NOT TRANSITORY!

Real inflation is today 13.5% as the chart below shows, based on how inflation was calculated in the 1980s

The central bankers can either squash the chronic inflation by tapering and at the same time create a liquidity squeeze that will totally kill an economy in constant need of stimulus. Or they can continue to print unlimited amounts of worthless fiat money whether it is paper or digital dollars.

If central banks starve the economy of liquidity or flood it, the result will be disastrous. Whether the financial system dies from an implosion or an explosion is really irrelevant. Both will lead to total misery.

Their choice is obvious since they would never dare to starve an economy craving for poisonous potions of stimulus.

History tells us that central banks will do the only thing they know in these circumstances which is to push the inflation accelerator pedal to the bottom.

Based on the Austrian economics definition, we have had chronic inflation for years as increases in money supply is what creates inflation. Still, it has not been the normal consumer inflation but asset inflation which has benefitted a small elite greatly and starved the masses of an increase standard of living.

As the elite amassed incredible wealth, the masses just had more debts.

So what we are now seeing is the beginning of chronic consumer inflation that most of the world hasn’t experienced for decades.

This is the inevitable consequence of the destruction of money through unlimited printing until it reaches its intrinsic value of Zero. Since the dollar has already lost 98% of its purchasing power since 1971, there is a mere 2% fall before it reaches zero. But we must remember that the fall will be 100% from the current level.

As the value of money is likely to be destroyed in the next 5-10 years, wealth preservation is critical.  For individuals who want to protect themselves from total loss as fiat money dies, one or several gold coins are needed.

The 1980  gold price high of $850 would today be $21,900,  adjusted for real inflation

So gold at $1,800 today is grossly undervalued and unloved and likely to soon reflect the true value of the dollar.

          While it is difficult to pinpoint timing, from a fundamental perspective, it is my strong conviction that precious metals prices will have to reflect the real value of fiat currencies at some future point.

          Holding physical metals with part of your portfolio is critically important for many investors in my view.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.