Federal Reserve officials have pared their outlook for economic growth through 2009 to minimal levels and are prepared to cut interest rates further, while concern has risen that a deflationary spiral may take hold. The central bank expects growth in the United States to contract in the second half of 2008 and the first half of 2009, while some even were more pessimistic, according to minutes released on Wednesday of the Fed's October 28-29 meeting, when it cut its benchmark interest rate by a half percentage point to a percent. … David Coard, head of fixed-income sales and trading with The Williams Capital Group in New York, said the Fed's comments painted a particularly glum picture. "They left no question that they see the economy contracting and that means we are in a recession," he said. – Reuters
Dominant Social Theme: What to do? What to do? Great minds are stumped, though hopefully not for long.
Free-Market Analysis: The way the economic conversation is understood and reported leaves one little choice ordinarily, if one is in the mainstream media, as to how to explain economic events. Deflation, we are told, is a terrible phenomenon that takes place during a contraction such as the one that is going on now.
Central banks struggle against deflation much as a tiny band of Spartans struggled against overwhelming Persian forces so long ago. Under this scenario, one is to visualize Ben Bernanke, Hank Paulson, et. al. as overwhelmed but battling courageously on our behalf. We are meant to root for them because they are valiant. We are to back them because their cause is just. We are to pray for them because they need all the help they can get.
But what exactly is deflation? Sure, it is the devaluation of assets – and it is not a good thing within a fiat-money environment because it presages further industrial downturns. But perhaps there is more to deflation than this run-of-the-mill definition.
Bear in mind, first of all, that deflation is actually the result of inflation. What goes up must come down, it's kind of a basic law of nature. Therefore deflation in a fiat money environment occurs as a direct result of massive money over-printing by central banks that have left economies so weak and malformed that they cannot properly make use of new money. Think of a farmer who has spent all his time perfecting a kind of plant that is a substitute for gas. He has been encouraged to do so by government, which has provided him money and credit. But eventually, it turns out that the new kind of fuel is wildly expensive, gas prices have come down and there is no market for his crop. So he burns what he has got and waits for next year. But as he does, he discovers that his food-stocks are low and that, since it is winter, he cannot plant new crops. It will be a miserable time. The government sends him more money, but it does not make a difference as there is nothing he can do with it.
The above scenario, while highly simplified, is an attempt to show what is going on right now in the larger economy, not only in the United States but in Europe, too. Governments have wildly overprinted money and in doing so have encouraged mal-investments by otherwise sensible people. Billions and trillions of dollars have been wasted on industrial efforts that have proven ephemeral. In the early 2000s, Western economies produced a tidal wave of Internet related technology that proved illusory and unnecessary. In the later 2000s, the overabundance of money went into unnecessary housing but also helped inflate even further the kinds of white-collar professions that thrive during a money-boom – accounting, law and of course various kinds of financial services including most prominently banking and brokerage.
So now it is winter. Central banks make money available, but so much time and energy has been put into making things that are unnecessary that it will take time for people to figure out what is necessary and begin to produce that which is needed. Until this unwinding takes place, until people reorient themselves towards productive work, no one can use the money that is available to them via fiat-money banking.
For central banks create money out of nothing, money which then competes in the market for goods and services against money generated by means of actual production. How can a system such as this possibly work? How can you have a favored few with the means to print money that is delinked from any productive means competing for goods and services and not expect maladjustments?
Money, honest money, is supposed to be based on value. Today's fiat money is based on an illusion and as such, the deflationary effects witnessed now in the market are simply the unwinding of a long and often misunderstood game of paper money. Unfortunately it's a game rooted in corruption and propaganda that insidiously drains nations of their productivity and ultimately leaving unsuspecting citizens in financial and civil ruination.
Bigness pervades a fiat-money economy during a boom phase. Central bank over-printing of money makes it possible for certain individuals and businesses, those near the money spigot, to amass wealth that would otherwise be impossible. But during a real downturn such as the one that is occurring now, the bigness of enterprise is not necessarily to be seen as an advantage.
This is the reason that big companies can collapse so quickly. It is why the American auto industry can contract into bankruptcy in a matter of months. During a time of money inflation "big business" grows simply on impetus. When people have money, they may wish to buy new cars every year, the more expensive the better, regardless of whether they need them. But in a downturn, need becomes a more relative value. And as an economy deflates back to reality, many large enterprises are seen for what they are – environments in which nothing special or necessary is produced with little skill and less craftsmanship. These are the businesses that are most vulnerable to an economic downturn because they likely owe their existence, or at least their scale, to central banking easy-money in the first place.
Ok, so … within this context, we would argue, deflation is not the enemy. Deflation is reality. Deflation happens because it takes time for people to realize that they need to plant crops for food, not worry about cultivating plants that will provide a substitute for oil. Or to put it in another context, people have to find jobs in the current economy that do not further fuel a housing market that is intent on providing 5,000 square foot McMansions for people who cannot afford them.
There is not much central banks can do to combat deflation, which is why those in leadership positions within fiat money economies are so afraid of deflation. But, again, deflation is a natural phenomenon that occurs as economies begin to find their real shapes once more. Those real shapes would include less bigness and more individual human action on the local level. People rediscover the normalcy of individual economics, banding together in groups of dozens or low hundreds – human-sized historical tribes – to trade among themselves, and create value within their own communities. The artificial bigness of the boom phase is temporarily reduced.
Of course it won't last. It is not in the interest of the powers that be that economies take on natural shapes, or that people gain more control of their own destinies within these more normalized environments. No, the money spigots will be turned on full blast and renewed inflation will be the result, fueling a further illusory boom. Once more gigantic, incompetent corporations will reflate and the white collar froth that accompanies such reflations will swell and swallow up more good minds and hearts. All this will be welcomed, by the way, as a triumph by Western leaders, over the forces of de-industrialization and economic backwardness. Is it really so?
Because the distortion of Western economies obviously got so big after decades of continuous monetary stimulation, it will take a while for central banks to blow up the balloon once again. In the meantime, we will be constantly subjected to yet another barrage of financial propaganda – this time about a bogeyman called deflation. As we have tried to show, above, deflation is a perfectly understandable consequence of central-bank style economic development. And were deflation not to be combated, but allowed to run its course, people would end up with far more rational ways of living and working, locally oriented and community focused.
Deflation is also feared by central banking types because it strips away assets that would otherwise appear attractive, the stocks and bonds of large centralized enterprises. In fact, what thrives in a deflation, curiously enough, is gold and silver, both physical and securitized. Common wisdom has it that gold and silver only rise during times of high inflation, but in fact gold and silver are safe havens and become ever-more valuable, relative to the central banking economy during downturns such as the one we are in.
During such downturns, violence spikes and economic disruptions, or fears of same, cause people to store gold and silver – real money. The impetus is not so much inflation as pure worry about what the future holds for the fiat economy. If the economy becomes bad enough, and deflation severe enough, it is quite possible that nations find themselves embroiled in some sort of military encounter. Alternatively, leaders turn reluctantly toward an international gold standard of some kind to sort out an otherwise unsalvageable economic situation. All of this provides a boost for gold and silver – and an especially big boon for shareholders of gold and silver mining companies.
In the 1930s and 1970s gold and silver thrived in all forms from bullion to junior mining stocks. Gold and silver have risen considerably in the 2000s as well, though price inflation has been held in check. In fact, gold and silver – money metals – are in a long term bull market and have further to travel. They will likely travel up on a wall of worry, just as stocks do during a fiat-money bull market. Yes, money metals are in the ascendance – another reason why deflation is so worrisome to the powers-that-be. They have temporarily lost control of the economy. Reality rules, for now.