Here's the post Heinz was replying to (probably from someone who posts here):
Inflation/deflation consternation -- mmontagne, 13:40:27 08/02/06 Wed
I have been a Kitco lurker for years.
I have been trying to wrap my head around the great inflation/deflation debate because it has important implications for my portfolio.
In considering this, I believe the following can be assumed with a very high degree of likelihood: the “housing bubble” has “burst”. Depending on the location, housing prices will disinflate, hold steady or deflate, but, in aggregate, we will see housing price deflation in the US and many other industrialized countries. A consumer-led recession in the US has begun or is beginning in the US, will become well-established in the next six months, and may be protracted and severe. In response to the above, the fed will pause and/or lower fed funds rate. The yield curve will steepen as rates drop at the short end and middle of the curve. The above trends, if not already well-established, will become well-established in the next six months.
The “inflation scenario” as articulated by in part Peter Schiff is: decreasing short-term interest rates will result in an increase in the US money supply (i.e. inflation). The US dollar will drop against other currencies and gold due to this inflation, as well as negative sentiment by the rest of the world (ROW) towards the US. The dropping US dollar will cause the price of imported goods to rise for US consumers, resulting in consumer price inflation. [When I say consumer price inflation, I mean the actual prices US consumers have to pay for things, not the phony CPI published by the government, although CPI will probably rise as well.] The dropping US dollar will cause the price of commodities to rise in US dollars. The US will see increasing prices for imported oil, gasoline, food imports and other commodity imports. Increasing energy prices will also add to consumer price inflation. Gold prices will rise, perhaps dramatically. The US stock market will drop, perhaps dramatically. US gold stocks may do well or may be dragged down for a while by the US stock market decline. Foreign gold stocks will do well. The decreasing US dollar will prompt foreigners will sell US treasury securities and commercial paper. This will decrease the beneficial effect of decreased fed funds rates on borrowing costs. The above trends, if not already well-established, will become well-established between now and the end of the year 2006. Mr. Schiff favors investing now in high-quality, dividend-paying foreign stocks with a bias towards commodities, energy, energy-service and precious metals equities. [I apologize to Mr. Schiff if he reads this and I have misrepresented his position.]
The “deflation scenario” for me is harder to articulate, because I admit that I do not understand it as well. It is taken in part from Mr. trotsky and also from Mish Shedlock: despite lower interest rates, borrowing will slow, because the US consumer cannot afford to borrow any more, and US businesses will have no need to borrow, owing to slowing business activity. Since US money supply growth is directly dependent on increasing borrowing, the increase in the US money supply growth will slow, plateau or perhaps will turn negative (i.e. US money supply deflation). The US dollar will hold up against other currencies, due to the disinflation/deflation of the US money supply relative to ongoing monetary inflation in the ROW, whose economies may slow or do poorly, but not as poorly as the US economy. The US dollar may also benefit from a “flight to quality” during a “global liquidity crunch”, as it continues to be perceived by the ROW as the world’s “reserve currency”. The prices that US consumers pay for imported goods may inflate, but not dramatically, or may even deflate, because the US dollar will hold its value against other currencies, and US businesses will be unable to raise prices, due to decreased consumer demand. Prices for imported oil, gasoline, food and commodities to the US, absent a geopolitical event price shock, will plateau or even drop due to the strength of the US dollar, and weakening demand in the US and worldwide. The US stock market will drop, perhaps dramatically. US treasury securities will show decreasing yields and increasing prices. US treasury securities will be a good investment going forward, but US commercial paper will not, owing to default risk. Gold and gold stocks may muddle through or drop short term to intermediate term, but will rise long-term as gold represents the ultimate “flight to quality”, and the relative cost of holding gold drops, owing to low interest rates. [I again apologize if I have misrepresented anyone’s opinions.]
In the inflation scenario, the US will “do an Argentina”. In the deflation scenario, the US will “do a Japan”.
I would welcome comments on the above. Specifically, have I accurately summarized these positions? Are there important implications of the two scenarios that I have omitted? Which way do you think that we are headed? Is it possible that the counteracting forces of the two scenarios result in a massive “muddle-through” in most or all markets for a long time to come? Are my assumptions correct? Does anyone think that the fed will continue raising rates through the end of the year and beyond?
Thanks in advance for your thoughtful comments.
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