Gold News

Debt Deflation vs. the Fed

Deflation, Gold, emerging economics & more from the Vancouver Symposium...

of the current lull in the markets to pass on a few observations from last week's Agora Financial Investment Symposium in Vancouver, Canada, writes Dan Denning of The Daily Reckoning – now in Australia.

   Three points need passing on, mulling over, and sorting out. First, the debt deflationists reared their collective head.

   The argument, in a nutshell, runs that falling values on financial assets (real estate, shares, mortgages) lead to a reduction in aggregate consumer wealth and thus demand and a general slowdown. People spend less, slowing down the economy, production, and wages.

   The result, the deflationist argument goes, is a fall in the general level of prices. It begins with the bust in financial asset values, but works its way, eventually, into the real economy through slower consumer spending and final demand. It is one reason the debt deflationists given for falling commodity prices, including Gold.

   It's worth thinking about. But the trouble is, so far as we can see, that debt deflation is nearly impossible when you have a modern central bank willing to expand the money supply by any means necessary. Not that Ben Bernanke is the Malcolm X of Central Banking. But you take the point, we hope.

   The point is, as our old friend Gary North pointed out, the Fed may let regional banks fail. But it will never let big banks fail (they own the Fed). And it will be the buyer of last resort for things like US Treasury bonds, should it ever come to that. That's an important point, being the buyer of last resort.

   What it practically means is that the Fed can create new money out of thin air and trade it for debt-backed assets owned by the banks or issued by the government. It can even buy shares in public companies (or Fannie and Freddie). In the world of modern central banking, the Fed can always exchange cash for debt or impaired assets. And if that doesn't work, the government can always use fiscal policy to just mail people checks which they'll have to spend.

   It's not falling prices we reckon you should worry about. If the world's fiat money system utterly collapses, then yes, we'll see a general decline in the price level. But until then, inflation is the bug-bear to worry about. Anything can be monetized by the central bank, and before this whole perverse period in financial history is over, many things will be.

   Another point from Vancouver? The rise in per-capita incomes in the developing world is what's driving commodity demand at the margin (thinks of the Bowen Basin in Queensland, the Pilbara in West Australia). The question everyone wants to know the answer to is how vulnerable the emerging markets are to a slowdown in US consumer demand.

   That is, can emerging market savers and consumers survive the period between the decline of the US as the global growth engine and what comes next? What comes next is emerging markets driving global growth through their own domestic demand. But they aren't ready to do that, at least not at the same level the debt-fuelled US consumer manages.

   Per capita incomes in the developed West range from US$25,000 to $44,000. In the developing world (China and India) – where they have so much larger populations – it will be awhile before per capita incomes even hit $5,000 per year. But when they do, it kicks off a new phase of demand for resources as discretionary incomes rise.

   Our take? Commodity demand in emerging markets is just now entering its most resource intensive phase. But the credit crisis and high energy prices will take some steam out of the emerging markets. They will still emerge. But it might take longer...and the transition to a post-American consumer driven world will be bumpy.

   Finally, the best quote of the conference came from Doug Casey. "America is turning into the kind of place where everything that isn't banned is compulsory." It probably goes for Australia too, and pretty much everywhere else in the "free" West.

   There is a long list of things you can't do or say anymore. But no one really learns anything by being told what they can or can't do. You don't make people healthier, smarter, or more moral by making them less free to make and learn from their own mistakes.

   Take trans fat. Will California really make people healthier by banning it? Or will they just make people even more stupid and childish and dependent on the government? You can't make people healthy. They have to want to be healthy and have healthy habits. What's surprising about the world we live in is how many people are willing to be told what to do by someone, anyone.

   And just how afraid some people are of being accountable for their own actions, or just being truly free.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

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