 Casey Interview:
Inflation or Deflation?
An interview with Bud Conrad,
Casey Research chief economist
Louis James
International
Speculator
Apr 9, 2008
The following interview,
conducted by Louis James, a senior analyst and editor with Casey
Research, appeared in the March '08 edition of Casey's International
Speculator.
Louis James (LJ): The first question we think most
readers will want to know about is this: if the U.S. is headed
for recession - if not already sliding into one - do you really
think we're facing more inflation in the near future, or could
falling spending power cause deflation?
Bud Conrad (BC): There are strong deflationary pressures
in a credit collapse because as housing prices drop and defaults
rise, some of the ability to buy new items is lost. Traditional
analysis suggests that we could have deflation such as that which
occurred in the Great Depression in the U.S. in the late 1920s,
early 1930s. I would point out, however, that in the Great Depression
the dollar was linked to gold, limiting the amount of money printing
that could be done, a limitation that does not exist today. In
addition, with $100 oil it is hard to argue for deflation. My
base prediction is that we are heading into an inflationary period.
LJ: If there was any doubt about inflation vs. deflation,
has it been settled by the central banks of the world as they
responded to last summer's credit crunch with greater liquidity?
BC: Yes. That is the point. The governments and
their central banks have no limit on how much money they can
create since there is no tie to gold or anything else. It is
only logical to expect them to take the easy road and print money.
The result is predictable. New government bailouts for whatever
problems arise are going to continue.
LJ: With war spending, ballooning entitlements,
a crisis of confidence in the U.S. financial system stewing,
along with many other woes, do you think there's any chance that
the U.S. will not try to inflate its way out of its current economic
predicaments?
BC: In a word, no. Inflating its way out of problems
has become the default solution for the U.S. government, and
governments around the world. Consider, the price tag for the
wars in Iraq and Afghanistan is now credibly estimated at $3
trillion. The economic stimulus package passed by the U.S. Congress
will cost $150 billion, which will come on top of slowing tax
receipts due to the recession, confirming that the U.S. budget
deficit will jump to $400 to $500 billion this year.
That kind of deficit will put
yet more pressure on the dollar due to the expectation that the
government will inflate the dollars to pay for the deficits,
as well as further bailouts that may be required as the credit
crisis continues to unfold. And just over the horizon, it gets
worse because of the unsustainable costs of the entitlements
due to the 76 million baby boomers now beginning to look to retirement,
and for their government medical payments.
As governments don't actually
produce anything, paying for all of this will have to come either
in the form of direct taxation, which has well-established limitations
past which it becomes counter-productive, or from indirect taxation,
in the form of a steady erosion in the value of the dollars that
will be used to meet the government's many obligations. In other
words, inflation.
LJ: There's a view among many observers that U.S.
trading partners will have to devalue/inflate their own currencies,
or their own economies will be slammed by a loss of competitiveness
of their products in U.S. markets. This could spill over to those
countries that supply raw materials or labor to the first tier
of dominos. Do you think such a "race to the bottom"
is likely? Our survey finds almost universal inflation around
the world, and it seems to be accelerating in most places. Is
the race happening already?
BC: Again, yes. The Asian exporters want to expand
trade to keep their workers employed, and are trying to accomplish
that goal by supporting the dollar with unwise, outsized investments
in dollar-denominated investments like Treasuries. As a result,
our foreign trading partners have accumulated $6 trillion of
such assets, an unprecedented level of holdings.
This circular investment strategy
- in which we buy from foreigners and they reinvest in our government
paper - has provided the capital for the U.S. economy that our
domestic saving has not been able to provide. In the process,
it has kept a lid on consumer prices here in the U.S. for over
a decade, essentially exporting inflation offshore, along with
our manufacturing. But the net result is that the U.S. has done
the equivalent of selling off about 23% of its tangible net worth
to foreigners, leaving the system at risk of collapsing.
If there is a positive, it
is that we have an environment that evokes memories of the long-standing
military strategy of Mutually Assured Destruction, where no one
wants to be the cause of collapse. The Chinese have pegged their
renminbi to the dollar rather than let it rise, and that has
fostered inflation that is over 6%. The Persian Gulf oil states
that peg their currencies to the dollar suffer the weakness of
the dollar, causing higher internal inflation.
The world money supply is growing
faster than the production of "stuff," resulting inevitably
in less purchasing power for all currencies. How much longer
this is sustainable is hard to say, but the odds increase every
day that foreign holders of dollars will come to believe that
the U.S. government is willing to sacrifice the dollar, and then
they will begin to unload dollars in earnest. There are signs
of this happening already, with the Chinese and others using
their considerable dollar reserves to buy up large natural resource
deposits, even shares in U.S. corporations. In other words, tangible
items.
LJ: What other factors do you think might mitigate
or exacerbate inflation worldwide? Do you think the overall trend
will be for increasing inflation that will continue for some
time, or are there mitigating factors that might slow it?
BC: The slowing of world economies we expect in
the mid-term may somewhat mitigate inflationary pressures. However,
as we also expect governments to react as they always do when
faced with an economic downturn - namely attempting to stimulate
growth through further monetary creation - this will only plant
the seeds of much higher inflation over the next decade.
LJ: Do you think robust economies like China's can
handle whatever inflation is likely ahead without too much trouble
- or is this a serious worldwide storm that's brewing?
BC: The storm is worldwide. China depends on Western
countries to buy its exports and there will be convulsion from
overcapacity in an economic slowing. They are not immune to U.S.
slowing. The Shanghai stock market that went from 1,000 to 6,000
has already pulled back to 5,000 with some anticipation of further
slowing. The world is not decoupled; it is even more coupled
than ever. But on an inflationary view, China has strengths,
most importantly goods that the world wants to buy, and that
results in a trade surplus.
LJ: Can you think of any countries insulated enough
from the spreading loss of value that it makes their currencies
safer places to put cash? Switzerland?
BC: I look to the countries that are rich in natural
resources to maintain an edge because of the commodity boom.
Russia is not a safe country from an investment perspective,
but their oil has given them a completely new life. Canada has
benefited greatly from the natural resource boom and should continue
to do so.
LJ: It's clear from the research you've done that
the advent of a pure fiat monetary system in the early 1970's
has triggered a significant increase in monetary inflation, but
why hasn't that caused a greater level of price inflation than
we have seen in recent decades?
BC: Well, we have seen it, but most people don't
seem to realize it. The U.S. dollar has lost 81% of its value
since 1971. Bad as that is, it would have been much worse, if
not for the Chinese and others buying our treasuries. That, in
effect, funded our deficit spending and exported our inflation
to their shores. Look at the inflation in China: it's headed
higher. Their purchasing our government and corporate debt was
like a vendor financing program for the sale of their exports
to us. In effect, they loaned us the money to buy their goods.
We haven't faced the ominous
task of paying off what is equivalent to a maxed-out credit card;
and when we do, it could spell disaster for the dollar. We have
imported Asia's computers, TVs and clothes, produced with their
cheap labor, keeping our price indexes lower. The bubbles of
foreign investment capital went into the pool of financial assets
supporting our stock markets and housing markets, which certainly
had big price inflation, but which are not included in the common
price measures of our inflation like our Consumer Price Index.
Just applying the methods used in 1980 for the CPI, before the
government adjusted the statistics, would suggest that the dollar
of 1971 is worth about 7 cents today.
The Chinese and Japanese have
actively supported the dollar to maintain their exports, but
should world dollar holders reverse course, a floodgate of even
worse inflation could come from too many foreign holders all
wanting to exit the dollar at the same time. That almost happened
in August 2007. They stepped back from the potential melt-down,
but it's still not safely removed from our future.
The process is on the track
for even more price inflation in the future, because more people
will be waking up to the sham of tissue paper money.
LJ: General loss of value among fiat currencies
is obviously good for the price of gold and the kind of investments
we have been recommending here at Casey Research. Do you have
any other suggestions for investors who believe that inflation
of major world currencies is "baked in the cake"?
BC: Watch out for agriculture price rises. A situation
you might call Peak Food is developing. We have the lowest supplies
of grains ever, compared to usage. The prices of wheat,
corn, soybeans and rice are all double from what they were a
year ago. Dangers of energy shortages leading to food shortage
are growing daily and are not widely enough understood. Rising
food prices will be important additional drivers of inflation
across the planet this year.
LJ: May we ask what you're doing with the cash in
your own portfolio?
BC: I am, not surprisingly, overweight in precious
metals.
LJ: Any final comments?
BC: I usually confine my analysis to economic measures,
but the world political situation is extremely important and
intertwined with the economic consequences. As we look at Asian
ascendance, and their expanding importance on the world scene,
we should be aware of the dependencies of their claims on our
assets.
Similarly, the competition
for resources is likely to continue, and the worries over peak
oil probably have much to do with our presence in the Middle
East. How these unravel is a bigger discussion than we have time
for here, but I urge watching the international landscape almost
as much as our own internal actions, as the outside forces will
direct our future as much as the decisions at home.
***
Bud Conrad, chief economist
at Casey Research, is a regular contributor to the International
Speculator, Casey's monthly flagship publication. The International
Speculator focuses on undervalued junior exploration companies
in the gold and precious metals sector that provide the very
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within 12 to 24 months.
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###
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