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Safe Havens, Whatever the Crisis

October 25, 2002

Last week’s commentary noted the expectations of favorable performances by gold and silver should deflation overtake the world’s economies. Those expectations were based on historical precedents, primarily the Great Depression when gold’s proxies, free trading silver and gold shares, rose in price as investors sought safe havens. (The price of gold was fixed during the Great Depression.) CMI is of the opinion, however, that the likelihood of outright deflation is small.

During the Great Depression, deflation (a general decline in prices) set in for several reasons. First, the Federal Reserve shrank the money supply in an effort to wring out the excesses of the 1920s when it employed a loose monetary policy, which brought on the Roaring 20s. With the shrinking money supply came a slowdown in the economy that went beyond what the Fed had hoped for. Banks collapsed, which further shrank the money supply and ushered in the Great Depression. CMI believes that significant changes in our monetary system since then eliminate the prospects of widespread deflation.

Nowadays, the FDIC “guarantees” bank depositors up to $100,000. However, although the FDIC plays a role in the arranging mergers of failing small banks, it would be helpless against massive bank failures or a collapsing banking system. The FDIC’s reserves cover something like 1%-2% of bank deposits. So, the really important guard against deflation (and a collapsing monetary system) is the Federal Reserve.

Today, there are no limits on how many dollars that the Fed can print. It used to be that the Fed was constrained by the amount of US gold reserves, but that restriction was lifted long ago. So, with the Fed able to print all the money it needs, to cover any crisis, including threats to the banking system, we do not have to worry about a shrinking of the money supply from collapsing banks. Further, we do not have to worry about the Fed shrinking the money supply. The Fed is doing just the opposite, printing more money to combat any crisis. And, the 1990s were replete with crises, against which the Fed acted.

First, there was the early 90s recession. Remember Clinton’s slogan, “It’s the economy, stupid!” Later came a plethora of crises that caused the Fed to put the pedal to the metal: the Russian debt default, the Asian crisis, the Long-Term Credit Management failure, Y2K, and in 2001 a sharp decline in stock prices. In 2001, the Fed lowered interest rates a record 11 times. And, with gold not restricting the number of dollars in circulation, the Fed is free to print at will.

So, when signs of deflation rise, the Fed knows what to do. And, if the Fed does not move fast enough, it is prompted by “noted” economists. This gives the Fed governors “comfort.” When things later go bad, such as hyperinflation kicking in, Fed governors have many defenders.

Additionally, the media, with their lackeys and ill-educated “economic writers,” will find other causes for rising prices. In the 1970s, OPEC received the blame. Ask anyone over the age of 40 what caused the 1970s inflation, and the answer will be OPEC. In reality, OPEC only caused the Fed--and other central banks--to increase the money supply, which resulted in inflation (higher prices.)

OPEC’s hiking the price of oil was a “tax” on the world’s economy. It was an increase in the cost of doing business. If the money supply had not been increased, the higher cost of oil would have resulted in there being less money for other purchases, which would have resulted in lower prices for other goods and services. Further, if the money supply had not been pumped, OPEC’s full price hike would not have held because there would have been a reduction in the demand for oil. Some of the increase would have stuck, but not all.

Economists everywhere, however, feared that the oil price hike would bring on a recession--and it most assuredly would have--one that would have caused “people to suffer.” Frankly, that’s what happens in a recession. Economic activity slows, incomes cease to rise or even fall, and standards of living decline. So, to avoid a severe recession, the world’s central banks increased the money supply, resulting in inflation, which caused people’s standards of living to decline. It was a “no-win” situation. The world was addicted to oil, and OPEC knew it. It was a massive transfer of wealth from the industrialized nations to oil-producing countries.

So, the Fed, wanting to avoid a severe recession that would cause the people to suffer, opted for inflation that caused the people to suffer. And, so it is today. Economists are calling for massive increases in the money supply. For months, The Economist’s lead editorials have called for the world’s big three economies, the US, Japan, and Europe, to inflate their money supplies to combat deflation.

From The Economist’s September 28 issue and its editorial titled How to rescue it (It being the world’s economy):

”One way out of this dilemma would be a sharp fall in the dollar, which would allow America to unwind its imbalances without a recession. A cheaper dollar would boost exports to offset weaker domestic spending and also prevent deflation by lifting import prices.”

“There is a risk that by the end of next year the big three economies, America, Germany and Japan, will all have falling prices. History suggests that central banks should do everything they can to avoid deflation, which is far more harmful than inflation, especially when economies are awash with debt.”

If monetary policy--the printing of more money and the loosening of credit--does not get the job done, The Economist calls for fiscal stimuli. That means government spending, which forces money into the economy. It wrote:

“If monetary policy becomes impotent, a budgetary stimulus is the only weapon left.”

This editorial concluded with:

”If the world economy is to get moving again, it is time not only for the Fed to cut interest rates but also for Europe and Japan to turn on their engines. Doldrums are dangerous.”

An earlier editorial (9/12/02) was titled Dial D for deflation, with a subtitle The biggest risk facing the world economy may be deflation, not a double-dip. From that warning:

“Deflation is much more harmful than inflation. Falling prices encourage consumers to postpone spending in the expectation of cheaper goods tomorrow; they also make it impossible to deliver negative real interest rates if these are needed to drag an economy out of recession. Most dangerous of all is a cocktail of deflation and debt. Deflation pushes up the real burden of debt, while the value of assets linked to that debt, such as house prices, may have to fall even more sharply in nominal terms to return to a fair level. This has already caused severe balance-sheet problems in Japan, and now America and Germany may be at risk: in both countries debts have surged to record levels.

“Central bankers in America and Europe—but not in Japan—still have room to cut interest rates. However, the ECB held interest rates unchanged at 3.25% on September 12th. So long as inflation remains above the ECB's target of “less than 2%,” the bank will be in no rush to ease policy. The Fed is also widely expected to keep rates steady at its policy meeting on September 24th. Why wait, when the risks are so lop-sided? Once deflation sets in, monetary policy can do little to revive an economy. If economies perk up and a rate cut turns out to have been unnecessary, it can be reversed: with ample excess capacity, the risk of inflation taking off is low.”

Finally, the October 10 lead editorial was titled Of debt, deflation and denial, with the subtitle The risk of falling prices is greater than at any time since the 1930s. It warned:

“For decades inflation was the bogeyman in rich countries. But now some economists reckon that deflation, or falling prices, may be a more serious threat—in America and Europe as well as Japan.”

Other notables are calling for increases in money supplies and government spending to ward off the evils of deflation. But, The Economist is read worldwide, is held in great esteem, and influences the economic thinking of persons in positions to implement the policies it advocates. Right now, The Economist is advocating inflation.

And, as all readers know, gold and silver do quite well during periods of inflation, as during the 1970s. So, if the demon of deflation causes policy makers to opt for inflation--which it most likely will--then gold and silver investors will be protected. If--on the outside chance--deflation becomes a reality, gold and silver will protect then also. It boils down to the fact that gold and silver are safe havens, whatever the crisis.

Call CMI at 1-800-528-1380 for answers to any questions or clarifications.  Our hours are 7:00 a.m. to 5:00 p.m. Mountain Standard Time, Mondays through Fridays.  Our offices are in the middle of the Phoenix, Arizona financial district.  CMI has had the same bank account since its inception in 1973.  References available on request.  http://www.certifiedmint.com

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