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Mish Shedlock on Gold, Inflation, and Deflation

Gary North
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June 24, 2009

Mike "Mish" Shedlock has one of the most successful financial blog sites.

He responds to articles from a unique point of view. This site is a convenient clearing house for information on articles from many sources.

He is known as a deflationist. He has positioned his site as the premier site that forecasts inevitable deflation. He has overshadowed Martin Weiss, the son of J. Irving Weiss, who was predicting price deflation back in 1967. I was predicting price inflation in 1967. Martin Weiss continued the family tradition all through the 1980's and 1990's. He had a near monopoly on the position, sharing it with A. Gary Shilling and a few others. Then Mish showed up. He has a far larger audience than they do. His site is far more informative than any other deflationist site.

This is Mish.

Before he started his site, he was a highly successful photographer. This barely describes his achievement. He got his photos published in 85 publications, including covers. It takes years to build this sort of portfolio. You must eat, drink, and sleep photography. You must master the tools of the trade. You also need creativity. This is not a part-time occupation. It is not a hobby. It is a career.

I know what it takes. I used to be an amateur photographer. I gave it up in 1960. I knew I did not have the time to become really good and also pursue my work in economics, history, and markets. I had to choose. (Economist Thomas Sowell made the same decision.)

Mish launched his site in 2005, as far as I can determine. His photography must have suffered, because he spends a lot of time updating the site and commenting of the state of the markets.

He is known as a deflationist: a man who predicts price deflation. Yet he is also an inflationist. Let me provide examples.

Thursday, June 30, 2005
The deflation debate heats up

As debt everywhere is repudiated in a deflationary crash, the grand experiment in Fiat money backed by nothing will lead to reinstatement of the gold standard or a gold/silver standard and once that debt is all wiped clean and we start over from a complete K-Cycle deflationary debt purge, then we can see inflation take off.

Sunday, October 28, 2007
Basket of Insanity at OPEC

Eventually, all currencies (except gold) go to zero. The only difference is the speed at which they get there. Warranted or not on relative merits, the U.S. dollar is winning the race among major currency pairs.

Tuesday, June 02, 2009
Speculative Bets Against The Dollar Highest Since July 15 2008

Of course fiat currencies do not really float anyway. They simply sink at varying rates, slowly going worthless over time.

Eventually, every fiat currency in existence is headed for zero. Gold is not headed to zero.

So, he sees some nations returning to a gold standard. Others will not. This is a political prediction. We have not seen any country return to a domestic gold standard since 1933, when the USA, the last gold standard nation, abandoned it by Presidential fiat. We have not seen an international central bank gold standard since 1971, when the USA abandoned it by Presidential fiat.

You must understand his scenario before you judge the plausibility of his criticism of those of us who predict mass inflation. He says that every currency that is not gold-backed will fall to zero. The world will be a two-standard economy for a while: gold standard currencies and fiat currencies. Then the fiat standard currencies will all die: fall to zero. That will leave only the worldwide gold standard currencies. We will see what the 19th century did not: a universal gold coin standard, with full redeemability of paper money and credit money on demand.

As you might imagine, I regard this as utterly Utopian, but wonderful. The thought of the whole world on a gold coin standard, with no more central banking, no more fractional reserve banking, and free floating private currencies. That's either heaven on earth or else the final stage of Jesus' postmillennial kingdom.

But, in his scenario, for those nations that refuse to adopt a gold standard, there will be hyperinflation. To avoid predicting this for America, he necessarily must predict mass deflation -- years of a secular decline in prices -- followed by a return to full gold convertibility for the dollar.

You can evaluate the likelihood of such a scenario. Then you should place your bets.

But how? Do you buy gold coins now? Why? Why won't gold fall in price before today and the collapse of prices in mass deflation? Why not hold dollars (cash currency -- greenbacks), and then buy gold when the dollar appreciates (prices fall) to the maximum? Isn't buying gold today jumping the gun? He recommends gold. But why?

He says that gold does well in times of deflation. This is an astounding argument. Copper falls. Lead falls. Zinc falls. Every other commodity falls. That is the meaning of price deflation: currency appreciates. Yet gold supposedly does not fall. Here is what he wrote in 2007 on gold as an investment.

8) A Hedge against Deflation

Deflation is the other end of the spectrum. For reasons outlined above I think that's where we are headed. Gold has done very well historically in deflation. Think of the great depression. Who didn't want gold coins? The purchasing power of gold soared in the depression. But isn't this contradictory? Can gold rise in all situations? The answer is that it's not contradictory because gold does not do well in all situations. Gold does poorly in "normal times". In normal times stocks and bonds are the place to be, not gold. Gold does well at the extremes, very well in fact. Hyperinflation and deflation are the extremes. Once again consider it an insurance policy, and one likely to be needed one way or another as well. Bankruptcies and rising unemployment with a consumer led recession is all that it may take to set thing off. I believe a severe consumer led recession is coming. With that recession, rising unemployment is a given. Once again consider gold as an insurance policy. I think it will be needed.

He wrote: "Gold has done very well historically in deflation. Think of the great depression. Who didn't want gold coins? The purchasing power of gold soared in the depression." This is true. Why was this true? Because gold had a fixed price in dollars guaranteed by the U.S. government. Gold soared along with the dollar. Put differently, most other prices fell. Why did gold match the dollar's appreciation? Because it was the legal equivalent of dollars. If you brought gold to the Treasury, you were given $20 an ounce.

Then gold coins were made illegal by Roosevelt's unilateral fiat command in 1933. Americans had to turn in their gold coins to the government at $20. In 1934, the government raised the price of gold to $35. It was a bonanza for the government. That increase made gold mining shares go through the roof. But this was a rigged market.

That dollars-for-gold market ended on August 15, 1971, when Nixon unilaterally abolished the gold standard for international transactions. He "closed the gold window."

On January 1, 1975, it became legal for Americans to own gold. There was no government-guaranteed price. Its price fell from just under $200 an ounce to $105 in mid-1976.

So, there is no historical evidence -- none -- that gold does well in times of price deflation, unless there is a government-run gold standard, which means a fixed dollar price for gold guaranteed by the government. We have not seen price deflation since 1955 (one year, 1% down). The world has not had a fixed price for gold ever since the Treasury ceased paying $35 an ounce for gold sold to it by mining companies and foreign central banks in 1971.

In times of deflation, gold's price will fall. I covered this in a 2006 article. I covered it again in a 2009 article.

The only argument against a falling gold price in a time of general price deflation is John Exter's: "pushing on a string." He says there will be a rush for gold as the most liquid asset. Here is his pyramid of solvency.

It was an untested theory in 1973. It remains untested.

Notice that Exter put currency just above gold. This theory is logical. Cash money in hand rises in value in times of price deflation. This is the definition of price deflation. That is what happened in the Great Depression. Banks went under because of bank runs: withdrawal of currency. He who had currency when the banks closed was a winner.

I have shown why Exter's argument was wrong with respect to central banks' supposed loss of control over the money-creation process.

Pushing on a String? (2001)
Pushing on a String (2009)

To summarize Mish's scenario:

1. The debt pyramid will implode.
2. The Federal Reserve will not be able to stop this.
3. There will be serious, bankrupting, depression-creating monetary deflation.
4. There will be long-term price deflation.
5. When prices finally reach bottom, or close to it, thereby reversing 100+ years of FED inflating, the government will restore the gold standard.
6. All nations that do not copy the USA will experience hyperinflation: money with zero value.
7. Then there will be only the gold standard.

This is what I gather from what I have read. If my summary is incomplete, then he needs to write a book detailing his scenario: the economic evidence, his theory of political action, and the chain of events that are likely to bring scenario to pass. I have done this for gold in my book, The Gold Wars. He should do the same.

If this scenario is inaccurate, and if we don't go back to the gold standard, then the USA will experience hyperinflation: money of zero value. Then we will have to go back to the gold standard, or start all over again: mass inflation.

Your assessment of Mish's arguments against me and all other predictors of price inflation depends on your assessment of the accuracy of his forecast.

What would systematic price deflation do? We would see a collapse of overleveraged large banks and overleveraged insurance firms all over the world, a huge increase in unemployment, an increase in bankruptcies, and double or triple the number of home foreclosures. We would see the Great Depression.

What then? He is saying that the voters all over the world will respond by adopting Ron Paul's view of the gold standard and central banking. They will force the politicians to restore the gold standard and shut down the central banks, so that the banking system cannot undermine gold again.

This is a theory of political action, not a theory of inevitable economic processes. He is implicitly arguing that in a time of incomparable economic crisis, Congress will abandon Keynesianism, monetarism, supply-side theory, and rational expectations economics in favor of Austrianism. Congress will do this, despite the opposition of 99.9% of all economists and business school professors. Meanwhile, the voters will not cry out for more government money. The voters will demand budget cuts, a balanced Federal budget, and the abolition of the Federal Reserve System.

My assessment: somewhere, over the rainbow, way up high.

Mish needs to answer the ten questions I have proposed for all deflationists to answer. Let's see if they agree with each other. Let's see if they try to duck these ten questions.

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