Jim Rickards: We Have Both Inflation And Deflation Right Now

In a recent appearance on the Max Keiser report, Jim Rickards answers several questions which should be top of mind of our readers. The following is a transcript of Rickards’ most relevant thoughts.

We are in a depression since 2007. A lot of mainstream economists don’t like to use the word depression. The reason they don’t want to talk about a depression is because it’s not mathematically defined. A recession has a mathematical definition: it’s two consecutive quarters of declining GDP with rising unemployment. Depression is a little more amorphous, and it doesn’t mean that the economy is declining all the time. You can have growth in a depression. What makes a depression different is that you may get growth, but you don’t get trend growth. You get a sustained long period of below trend growth. For example, take the great depression 1929 till 1940, you had a good growth between 1933 and 1935. Then we went back down into a severe recession within the depression 1936/7.

Question: The media seem to be split nowadays: some people think that we are below trend line growth (which equals a depression), but the majority of mainstream media doesn’t even seem to recognize the depression at all. How to look at this split in the way it is reported?

Fairly simple, the majority of mainstream media are no economists. There are financial journalists to the standard of an economist. So they rely on what policy makers are telling. Policymakers are engaged in basically propaganda; they don’t like to say the word depression because it has a psychological effect. If Ben Bernanke would tell during a press conference that we are in a depression since 2007 it would make the liquidity trap worse, consumer sentiment would decline. But you have to call what you are seeing; with 0% interest rates for six years and below trend growth, I do not care what Bernanke says, that is a depression.

Question: The stock market is making new all-time highs while the price of gold is going down. Some economists are pointing to this dichotomy saying it is proof  the policies are correct while ignoring other data like real growth, unemployment, poverty, from day to day life.

The policiy makers are scared to death, but they won’t talk about it for the reason I just mentioned. Don’t underestimate the extent to which this is propaganda and happy talk. The Fed can make the money supply whatever they want, but the velocity is declining. Velocity is the turnover of money; it is a psychological and behavioral phenomenon. So the Fed has to make everyone else spend money; they have to make us feel good so they don’t want to talk about food stamps reaching 50 million Americans, 20 million Americans unemployed or underemployed, 10 million Americans with disabilities, household income and personal income flat, this all is the real America, a horrific situation. They understand all the indicators, we are looking at the same data, but the policy makers are not willing to talk about it because they are afraid of discouraging people.

Question: What about the decline in the price of gold? Is the bull market still on?

Gold actually never changes. Gold is the numéraire against which you measure everything else. When you say that the dollar price of gold is down lately, the way I think about it the dollar is up. The dollar getting stronger is very bad news for the Fed because the Fed wants a weaker dollar and inflation. A strong dollar equates to deflation. So the dollar price of gold coming down actually means the Fed policies are not working. Deflation is the central banks’ worst nightmare. The dollar gold price coming down from 1,900 to 1,350 means that deflation is prevailing over inflation and that the Fed needs to print more money. You have these two camps. First, the inflationists who say that the Fed balance sheet going from 800 billion dollars to 3, 4 or 5 trillion dollars, which is inflationary. But we have actually not seen inflation and here is how to think about it. People are looking at a snapshot, being the time series today, saying that inflation is approximately one percent. But that is like looking at a car that is rolling off a cliff. Looking at a snapshot shows there is nothing wrong with the car (there is not a scratch on it), but you know how will end (in a flaming wreck). We have to think about the dynamic and look forward a little bit.

We have two things going on at once right now. You have deflation which is perfectly natural and what you would expect in a depression. A depression means among other things that people are deleveraging; when you deleverage you sell assets; selling assets pushes prices down; that makes things worse and prices go down more. Against that, we have inflation from the Fed money printing. These two forces are pushing against each other: deflation and inflation at the same time. It has been possible to estimate precisely, but in rough numbers we might have 4% deflation and 5% inflation at the same time which net out to about 1% inflation in the CPI. That is not a stable series; that is actually two forces pushing against each other.

Think of it as a fault line; they do not move very much most of the time, but every now they snap and you have an earthquake which is massively destructive. That is what is building up. The question is: when will it snap and which way will it go (to inflation or deflation). We do not know that, but we know it will break eventually, and investors need to be prepared for both. If it flips to inflation, gold goes to 2,000 or 3,000 (my medium-term forecast is up to 7,000 dollars an ounce). But if it tips to deflation, that is a completely different dynamic. Gold could actually go down along with everything else, but at some point gold will skyrocket because the Fed will make it skyrocket.

Question: After the 2008 crisis, central banks printed a lot of money. They came in to save the day. After five years, the stock market is at new all-time highs and the bond market at 300 year highs. Why does the Fed not go back to normal?

Because the stock market would collapse if they did, and they know that. This is what is going on. The Fed is first trying to create a wealth effect. More than 50% of the assets of the American people are in two asset classes: housing and stocks. Here is where the wealth effect kicks in. If the net worth of people goes up, they feel better and spend more. The velocity is up, and nominal GDP keeps growing to create the sustainable growth path (which we haven’t seen in this depression). What the Fed hopes is that when people feel richer they will spend more. But higher stocks prices are not the result of a changed behavior (which is a higher consumption and investment). The Fed eventually hopes to change the psychology of people so to spend more money.

We have seen this movie four years in a row, since 2009. The recovery hasn’t come, it is not going to work now. It will start to fade again, and then the Fed will print more money. They have no way out of this; there is no way out of this policy.

Question: There is no exit strategy of the Fed, but at the same time the indebtedness is reaching all-time highs. The Fed is printing money just to pay the debt. Isn’t this a recipe for hyperinflation?

Velocity is the problem. The psychology is not there. We are in a liquidity trap. Younger Americans (in their twenties) are saving money. What Bernanke tries to do is to pay nothing on savings to drive people to the stock markets to make some money. But a lot of people believe that stocks are too risky (being in some bubble) and want to save more. In other words, if there is no return on savings people save more rather than. So the liquidity trap becomes worse. So this is the law of unintended consequences.

As far as the debts the story is concerned, it is a tale of two cities. We have fairly low interest on the treasury debt. But in the consumer sector, a lot of the consumer rates are 10, 15 or 20%. Savings by the way are near all-time lows. They went up a little bit on a precautionary basis after the panic in 2008, but they have come back down. The debt to GDP is still going up. The debt crisis is nowhere near over. The Fed printing just keeps it from collapsing, but it does not solve it.

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