Inflation/Deflation and the Dollar

[OrAnarch]

Please excuse this post if it is nothing more than ignorant rambling from a non-economist. Ive never taken an economics course, as I was too busy seeking a lucrative CompSci career, which I will soon fufill as I depart to India.... :) j/k



It becomes quite apparant to me that as the dollar inflates in our micro economy, from a global macro standpoint, it usually coincides with the decline of the dollar. Simply put, from every standpoint, the dollar is worth less and loses buying power. Because of this movement, I have taken to investing in Gold and other precious metals to secure my wealth. As the fed reserves prints more dollars and our trade deficit increases, the dollar will probably continue to drop in both contexts, and gold will cost more of such US dollars.


On the other hand, I am curious how deflation will play into macro economics and the price of PMs. When the feds state that inflation is at a all time low, it is almost code for "we are facing deflation". There are numerous indicators still lurking, such as the housing market and the distribution of disposable income amongst the consumer class, which suggest that certain sectors, if not all, can most certainly deflate under the proper conditions. In a sense, we know that domestically the US Dollar will then have more purchasing power. But, how will this effect the price of gold domestically, and also, will the US dollar rise on the global markets if such deflation happens?


Can the dollar deflate domestically, but still plummet on the global markets (what happened in Japan)? What I am trying to do is decipher the connection between our micro and macro economies in regards to the value of a currency. It seems to me that Gold would be an unwise investment if a country were on the verge on deflation, unless it was possible that despite the domestic deflation, the currency still globally lost value.


Sometimes it seems our own economy is teetering on the brink of either such disaster (and more likely being forced to inflate, as it has less of an effect on the election). But should the proper variables ever play out and deflation runs rampant, would PM speculating then be a bad idea?

[jeter]

1. Deflation seems likely

Only because after all the stimulous:

- record low interest rates

- record high govt. spending

- trade protectionism

- record tax cuts

- record deficits.

And not a budge in the inflation rate. That is hard to believe. If that is the case, it must be because deflation is a serious threat. And when those numbers finally work through the economy (ie when there are no more tax cuts to give. When there is no more money to spend. When people realise the seriousness of the deficit situation) then the economy will be in for trouble.

I fear for the second half of this decade. More now than ever. Baby boomers will begin retiring in 2011. Costs for Medicare and Social Security will begin skyrocketing in 2007/2008. Then the real trouble will begin. At that time, our economy will be in rough shape because of the decisions made by this Bush Administration.

[Frodo]

2. Don't worry about that.

Deflation should not be a concern any more.

First: Massive deficit spending means far more dollars "floating around". Without a concurrent increase in production (far more than the numbers we've been seeing) you have more dollars per unit of production... so prices go up.

Second: As the dollar falls, the price of anything being imported goes up.

Third: Record low interest rates encourage borrowing from financial institutions. The banking system actually "creates" money as the "same dollar" is both "in deposit" AND in the account of the company that took out the loan (or the account of the company they paid with the loan). Again, larger money supply without a completely offsetting increase in production.

All of these factors are inflationary.

We're far more likely to face unreasonable INflation than DEflation over the next several years.

[rapier]

3. note

Quite a jumble. I don't mean to be dismissive. I can make no sense of "as the dollar inflates". Then again these terms, inflation and deflation, are sometimes tricky because they are relative. The trick being relative to what?

I must warn you off this sort of thing, "....fed reserve prints more dollars". The Fed does not print dollars. I cannot possibly go into the mechanisms of money creation but please belive me the fed does not print dollars nor create them directly in any way.


Now back to inflation. It is unconventional to refer to currencies as inflating or deflating against each other. The dollar is inflating against other currencies only to the extent that it takes more of them to buy other currencies, but this is an unconventional way to look at it. The common usage is rising or falling against others and in this case the dollar is falling in value against other currencies. In other words it takes more dollars to buy a eurodollar now than it did before.

No matter the logcial jumble precious metals have been a great speculation for 2 years. Partly gold has gone up, inflated, against all currencies, but especially against the dollar. One way to look at gold is as an alternative to currencies. I can buy this concept but am not married to it. Becomming a gold bug is bad if carried to far in my opinion and 'hard money' is a profoundly reactionary idea.

Gold should go up in value, in dollars, if the dollar continues to fall. I say should, not will. Nothing is certain and while the relatiohship is highly probable in the long term a period of months or years could go against that.

One important concept I like to stress is that while inflation as measured by the CPI is tame there are other types of inflation. Most importantly is that stocks inflated in the bull market. All financial assets inflated over the last 25 years. This idea is PERFECTLY logical and normally totally ignored.

It is possible that financial assets could deflate while the price of things we need, as measured by the CPI inflate. This would be the worst of all possible worlds. This scenario is also quite probable when looking at things from the basis of so called 'classical economics'. However we are in a new age now and I say that half in jest and half in total seriousness. Can the New Age persist and grow? I'll get back to you.

[Petrodollar Warfare]

4. I recommend 2 books that address your questions...

...& both discuss that "easy credit" has created global overcapacity, which will ultimately lead to deflation.

"The Dollar Crisis" by Richard Duncan (whose solutions are not very good - but there really is no good solution). From Amazon.com:

http://www.amazon.com/exec/obidos/tg/detail/-/0470821027/qid=1071626625//ref=sr_8_xs_ap_i2_xgl14/002-0158479-4979249?v=glance&s=books&n=507846

...and the 2nd book recommendation is "Conquer the Crash" by Robert Prechter. This book was just released with a "2004 update"/81 extra page supplamental in the back (I bought it last night and have not yet read the new material).

http://www.amazon.com/exec/obidos/ASIN/0470870907/qid=1071626729/sr=2-2/ref=sr_2_2/002-0158479-4979249


<<<But, how will this effect the price of gold domestically, and also, will the US dollar rise on the global markets if such deflation happens?>>>

Gold will go up in times of uncertainty. Will the dollar rise? Doubtful, I think you are wise to invest in PM at this time...(and this is discussed by by both Duncan and Pretcher)

Just an fyi: The industrial output of the US is in the mid 70%, and this amount of idle capacity this can be found elsewhere too (except China and a few other places). The problem of course was the "mis-investment" of the 1990s boom. We have not worked that off, and the only way to fix this is to increase *global* aggregate demand. In otherwords, the Chinese et al need to start buying some of the products they export, in the most basic sense. Below is what a friend had to say about deflation and global capacity:

"The problem with the current global economy is that excess levels of supply capacity are well beyond those necessary to meet the requirements of aggregate demand. As a general rule, a period of deflationary contraction will simply permit a decline of supply capacity until such time that growth in demand initiates a new expansionary cycle."

As for the Fed, IMO they are trying to "re-inflate" the bubble, and it is working at the moment, but it will not last. I think we are about to hit the liquidity trap (mid-2004 is my guess...) Hope this info is uselful, if nothing else the book reviews on Amazon.com are interesting...

[54anickel]

5. Here's an article I came across, bit long, and a bit too gold-buggy

but it does have some very interesting ideas. This is part 2 of 2. There is a link to part 1 within the article which might be worth a glance.

In part 1 the author speculates that we would see deflation in large ticket items, homes, cars, etc. bought with credit (debt) and inflation in those daily needed items such as food, clothing, medical services, etc. In a way this makes sense as we have never seen consumer debt that the levels we have now.

In part 2, the author goes over much more data (lots of charts) and decides that deflation is not a real threat at all.

Too much info to summarize here. I think you are wise to divest some of your wealth into PMs.

http://www.zealllc.com/2003/infdef2.htm

[OrAnarch]

6. Thanks...

Ill give it a read through...

I also previously was thinking that pehaps this may be only isolated to certain sectors. Just so many mixed messages and I wanted to make sure possible deflation, however isolated and remote, would not effect the price of gold (in a negative way).