Puplava Excerpt:
Inflation, Deflation, or Both?
The real question now is will inflation or deflation be the eventual outcome? I believe we will have both. For the majority of the economy, deflation will be the case. The confluence of factors, from contracting credit patterns to falling asset prices, point to the dominance of deflation for the majority of the U.S. economy. The collapse of credit produces the opposite of credit inflation. When credit is added to the economic system, it produces above-normal demand for goods and services driving up their price. A credit contraction causes the reverse action. The Long Wave Analyst editor, Ian Gordon, writes "This collapse of credit causes the deflation of values, a contraction of demand and the dumping of surplus properties and inventories at sacrifice prices; together with a sharp and prolonged rise in unemployment; all of which are typical of a depression.” 4
Gordon continues, “Once the credit bubble starts to deflate there is little recourse for the Federal Reserve because, to expand credit, you must have willing lenders and willing borrowers. However, when the scramble to get out of debt and to salvage a portion of the outstanding debt starts, there are simply no more willing or credit worthy borrowers left. A credit crunch begins when a large number of borrowers, each desperate for cash, try to tap a rapidly diminishing pool of credit. Long-term interest rates rise when investors flee from long-term bonds to the shortest terms and most liquid cash equivalent, such as Treasury Bills. Thus, the only place to be invested at the approach of a credit crunch is in short-term highly-liquid depository accounts”. 5
In The Long Wave Analyst, Gordon describes the pattern and bust that renews itself in each credit inflation cycle. We‘ve gone through the boom period. Now comes the bust. However, history never repeats itself in the same way. Patterns and outcomes may be similar, but never the same. There are unique circumstances in this last credit boom, which are going to make the next bust cycle different. They are the product of the parallel financial system that mutated out of the 1970’s inflationary experience. The transference of the credit creation mechanisms outside the banking system and through the securities market has created a uniquely different set of circumstances. One of which has been the explosion of risk transfer vehicles known as derivatives. These financial instruments have allowed the expansion of leverage to an unprecedented degree never thought possible before. This has led to a process referred to as "gearing.” Gearing is a process in which derivatives are used to gain control of a more expensive financial or tangible assets through the use of leverage at a very low cost. It allows for dominance of an asset class at a fraction of the cost of direct ownership.
financialsense.com
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