Inflation Or Deflation?

Ceri Shepherd
Trend Investor
May 10, 2004

I have read so many articles concerning this and my personal conclusion is that we can easily have both simultaneously. I understand that there is a very complex and often misunderstood reasoning behind the forces of inflation and deflation.

As the ordinary man in the street sees this issue inflation is rising prices and deflation is falling prices. Inflation is created because of two primary factors; first the simple and classic definition of too much money chasing too few goods. The best example of this was the German Weimar Republic, secondly more of a credit induced inflation such as we have with the Anglo/American housing bubble.

Owing to Greenspan's very lax monetary policies we now have a lot of physical, and debt-created electronic dollars floating around the system allied to interest rates that are simply too low to provide a support for the dollar. Which has led to a relative decline in the value of the dollar against many other world currencies. Notice that with fiat currencies it is always a relative issue, nothing is absolute, only Gold has an absolute tangible value. For example Americans have seen far more inflation with Oil and Gold prices than the Europeans, because of the relative dollar decline.

I believe that commodity inflation is primarily a function of a 20 year bear market leading to chronic supply side under investment at a time when demand is rapidly growing primarily because of growth in China and India this is an explosive mix as regards prices. We live in a global economy, commodity demand is global and growing and not limited to just North American or European demand, there are many new customers. However the supply of so many commodities is relatively limited, inelastic and finite. Commodities whether they are Oil or Gas, Food or Water are things we need to live and here I see continuing inflation.

However there are many things we don't need to survive; Big houses, expensive cars, Yachts, even stocks and bonds. The prices of many of these non-necessities have been inflated by easy, abundant and historically cheap credit. Their "price" is totally dependant on interest rates and therefore the affordability of credit, and not a function of true value much like the NASDAQ internet stocks in 1999.

Now imagine a situation whereby interest rates rise even slightly, the finance cost of carry of these heavily leveraged non-essentials now becomes far greater, which leads to large scale often forced asset disposal. The problem we now have is a situation where too many non-necessities are chasing too few potential customers, we have market oversupply and therefore corresponding deflation. The supply "price" of what is being offered reacts downwards in response to a limited demand so as to restore true value. The stockmarket is a great example of this, when prices thrust forward in a mania, market makers have plenty of customers willing to pay nearly any price for a piece of the action, price moves far ahead of true value, we have rampant stock inflation. However what goes up must come down, when the selling starts it can easily stampede very quickly as fear, the need to get out of the market, is a stronger emotion that greed. Now we have rampant stock deflation as the same market makers have very few customers so they must adjust price back towards value or probably under value to attract new customers

The banking system is terrified of deflation as it has the potential to make them insolvent very quickly as the value of their outstanding loans is more than the liquidation value of the secured asset. I feel that the inflation recently experienced by many of these non-essential assets is so extreme that infact the potential now for deflation is actually far greater today than it was. The solution has become the problem. Bubbles have been created everywhere, a bubble has to be not only inflated but more importantly kept inflated. Greenspan is like a man desperately trying to keep all the plates spinning so that they do not crash to the deflationary floor.

Ultimately the markets will have their way, they always do. I see continuing inflation in what we need because of increased demand against a backdrop of limited supply. Together with sharp deflation in what we do not need because of over supply against a backdrop of decreasing demand... Simultaneous inflation and deflation.

As regards Gold and Silver, we do not need them as a necessity of life but what we do need is a true store of value for the fruits of our labour. Gold is the truest form of capitalism, it has to be worked for, it cannot be simply created. It is tangible and it is fundamental, Its price is a direct function of demand against its scarce supply. It represents real wealth and therefore freedom itself. That is why the "barbarous relic" has stood the ultimate test of time, and will have true value long after Keynes, the US Dollar, Japanese Yen, Euro are just distant memories.

May 7, 2004
Ceri Shepherd
website: Trend Investor
email: ceri@trendinvestor.info

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