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SPDR Gold Shares Message Board

  • michael_j_dsouza michael_j_dsouza Oct 13, 2008 10:55 AM Flag

    Inflation or Deflation

    I see a lot of people on this board suggesting that we are in for inflation (the Gold longs). Others say we are in for deflation (the Gold shorts). Who is correct, I don't know but here's some thoughts.


    Personally I think short term this is inevitable. Investors have lost a lot of paper wealth worldwide in stocks and housing prices (housing is concentrated in the US and UK). Easy credit for the consumer and businesses are likely a thing of the past. A recession is imminent, rising unemployment. These all make short term deflation likely in my opinion. Hence sell gold.


    The argument I have seen here is that worldwide governments have been providing vast amounts of liquidity and there has to be inflation (some say maybe not short term, but in the long term). In principle I agree, back in the Greenspan days the interest rate was at 1% and money was pumped into the system to kick start it and housing, oil and the markets inflated. So it would seem that in the very least there will be inflation (or even hyper inflation) in the future. Hence, buy gold as a hedge.

    Except there is one flaw I see in this inflationary argument that no one has noticed. Yes, the governments of the world are increasing liquidity... but why?

    Simple, because all the financial firms and banks are rapidly de-leveraging at a rapid rate. So the question is, is the money being pumped into the system more than the rate that the banks are de-leveraging and shrinking the money supply caused by over-leveraging? I'll leave you to answer that one on your own.

    Comments? Thoughts? Perhaps there is a problem with my argument?

    Disclosure: I don't own gold, nor am I short.

    Good Luck all.

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    • Completely agree with your post. Your post illustrates it better on a microeconomics level as the spiral downward effect occurs.

      The key here is highlighting that the effects of deflation are "wealth destruction" and an offsetting strengthening of the currency.

      Anyways its clear that Ben and Paul are inflating like mad to prevent this from happening. The TED spread has fallen for two days straight, so that seems to suggest that its starting to work.


    • Mr. Dzousa,

      I see what you are saying. As you say, it is probably too simplistic.

      In reality the value of the home to the homeowner isn't in it's price as you discussed. It's in the equity, the value over what is owed on it.

      So if the first owner put down $20,000 to buy a $100,000 home, then the price drops 20% when he goes to sell, upon sale the first owner loses $20,000 of wealth, his total value invested. The second buyer doesn't actually gain anything. In a deflationary spiral each owner keeps losing wealth on each succesive sale.

      Deflation destroys wealth in hard assets.

      Since on each sale the price is lower, then you can buy later with fewer dollars. This is the strengthening of the currency.

      The currency gets stronger during a period of deflation.

      Best of luck,


    • I put this in a separate post in this thread, but I'll copy and paste it here:

      Consider this illustration:

      You live on an island completely isolated from the rest of the world and your nation uses a currency called dollars (for simplicity sake).

      The cost for a house on the island on average is $100,000 dollars. This is a function of normal supply and demand, buyers are willing to pay $100,000 and sellers are willing to sell at $100,000.

      But lets say a confidence crisis occurs and people are worried, they think housing prices are overpriced.

      The prices fall to $80,000. Nothing really changed here, except that suddenly the sellers are worse off and the buyers are better off (assuming they had $100,000 to buy with). A wealth transfer has occurred.

      The only problem is if everyone owns a home. Then everyone lost $20,000. So in fact a deflationary equilibrium shift rather than a wealth transfer has occurred. In this case the $20,000 that each person lost is gone, no one else got it. It just means that all the houses are worth $80,000 and each dollar is worth more relatively.

      On a mass scale no one is worse off in this scenario if everyone owns a home, since everyone has less dollars but those dollars buy more.

      Of course this example is overly simplistic but serves to show how deflation works in a simple society with a single good. Let's go back to the real world. When deflation occurs it means the value of all the goods has fallen (everyone is holding goods represented by stocks/bonds/houses/etc). But here its almost like scenario where everyone loses $20,000 BUT its not exactly that way, it's only like 90% of the people that are worse off, enough to still have the deflationary equilibrium shift but the 10% are better off (the people holding cash instead of goods), these people are gaining relatively through the residual wealth transfer. So in the real world some of the money disappears into the void and the rest changes hands. Some people get richer, most get poorer and some of the money ceases to exist due to de-leveraging (deflation) and the rest changes hands (like when the buyers got the upper hand in the simple example)

      In this credit crunch we are seeing the global repricing of all assets to a lower level. The problem is this loss is that it is not equally distributed to everyone, there is a wealth transfer occurring as well. Thus average loss is not compensated by a proportionally increased buying power.

      That help?

    • you are absolutely correct about the trade deficit. that will have to be part of the rebuilding process for the rest of the world to continue the $ reserve status.
      I think ending the wars-which is possible if the Taliban agree not to harbor terrorism and the Iraq war can be wound down. then if we get our energy program going that will go a long way towards correcting our trade and budget deficit.
      unfortunately right now deficits don't matter only bank liquidity.

    • Actually I exactly agree with you. The reality is that not everyone is sharing equally in the short term deflation, thus there is wealth transfers happening (those caught holding multiple houses will be the worst off).

      My simple theoretical example was simply trying to illustrate what deflation is. (I didn't intend it to be a reflection of reality), but in the real world while the majority is worse off (through lower housing prices, lost equity value and job loss) there is a minority that is profiting from this.

      I'm want to be a part of that minority =)


    • mike,

      grab a few coins man. some real nice ones out there.

      get 3-4 and see what happens?

    • Well, I certainly agree that historical precedent suggests that all fiat currencies eventually fail (or are at least replaced). Will the current countries in the world exist forever. I think it would be naive to believe so. I think we can safely agree that the US dollar will not exist forever (heck it might be replaced by the Amero). But I feel confident enough in it to say it (or its replacement) will be around for my lifetime.

      And I also agree that the dollar's rise is temporary, although I think its a flight to safety short term rather than gold selling but that's probably nit picking.

      I also agree that long term we are going inflationary again based on the arguments of other posts. So a precious metal position is a good idea. To that end I am currently investigating what particular way I will invest right now.

      "excuse my off the cuff writing. not as well rounded as yours."

      It gets the job done, don't sweat the details.


    • mike.

      you hang in there!! and keep composure!

      good to converse.

      1. I do own a remington700 and other Pieces. its our consitutional right. and i enjoy the feeling of sleeping safe. intruders? while we still have that privledge!

      2. the united states is not iceland, far larger and powerful and huge resourses. for this reason, its taken soo long to devalue it-or bleed it dry. can you imagine, only one time we have been hit on our own land? mildly..imagine a full force war? and the consequences thereof? lucky so far.

      3. short term dollar strength. well, my strongest answer? central banks-imf-and maybe those "privledged heirs of the finacial elite" selling mass amounts of gold and buying dollars. FT knox has not been physically audited since 1955?

      im glad the dollar popped up a bit, but im not convinced. its popped up relative to the euro..and pound..and some other currencies, but not all. accordingly, gold is at new all time highs in euro-pound.

      4 fiat -failure. look up all the massive civilizations who have failed with fiat. (fix it again tony)..........EGYPT-GREECE-ROME-----KEEEEEP GOINGG.............

      accuracy of the length of the average fiat run...some say around 100 years? im not sure.

      for me..i cant afford another ream job by stocks. ill hold that yellow crapp and kiss it while ceo's fly in jets at shareholder expense. ken lay? lying on balance sheets. missed earnings. stiff competition. hell, we got real problems with asia eating our lunch with this globalization game. we CANT COMPETE!!!!!

      asset deflation possible...but surely inflation--

      wages are not close to what they used to be a few years ago.

      enough, and excuse my off the cuff writing. not as well rounded as yours.

    • one problem with your scenerio.
      you assume people own 1 house.

      in fact. they owned more in our situation.

      again...somebody makes money when selling at profit..and somebody looses when selling at a loss.

      the money supply is the same in the illustration.

      the money supply is not the same in real.

      assets are worth less, due to market conditions. no new debt available to fund the ponzi scheme. so create more debt-money.


      invitation to as debt. google it. video. masters.

      great thread!

    • I agree with everything. I think this is exactly what is happening. Way down the thread in other posts we've established the same facts. I refer you to them.

      The government came close to going into a deflationary black hole but they are printing their way out of crisis and as you mention the taxpayer gets fubar'd but the end result will be inflation.

      The government made a huge mistake not bailing out Lehman Bros. Moral Hazard, God, what a bunch of idiots. What good are morals when the world collapses.

      Anyways good summary. As I've mentioned in other posts, I'm going to get a precious metals position to hedge the coming inflation that will follow the credit crunch.
      And who said I would invest here, I'm just having the discussion here. =)

      By the way, in addition to your comments, hopefully the new guy will resolve the balance of trade inequity. That's the underlying root cause of all these problems.

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