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Why We're Facing Deflation

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How velocity, money supply, and currency-printing affect the economic environment.

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There Are No Good Choices

What we're looking at in our near future isn't inflation. We're in a period where the Fed is in the process of reflating, or at least attempting to do so. They'll eventually be successful (though at what cost to the value of the dollar, one can only guess). One can have a theoretical argument about whether that's the right thing to do, or whether the Fed should just leave things alone, let the banks fail, etc. I find that a boring and almost pointless argument.

The people in control don't buy Austrian economics. It makes for nice polemics but it's never going to be policy. My friend Ron Paul is not going to be allowed to make monetary policy, although he might get a bill through that actually audits the Fed. I'm much more interested in learning what the Fed and Congress will actually do and then shaping my portfolio accordingly.

A mentor of mine once told me that the market would do whatever it could to cause the most pain to the most people. One way to do that would be to allow deflation to develop over the next few quarters, thereby likely hurting gold and other investments, before inflation and then stagflation become (hopefully) the end of our perilous journey. Which of course, would be good for gold -- if you can hold on in the meantime.

Is it possible that we can find some Goldilocks end to this crisis? That the Fed can find the right mix, and Congress wakes up and puts some fiscal adults in control? All things are possible, but that's not the way I'd bet.

While there are some who are very sure of our near future, I for one am not. There are just too damn many variables. Let me give you one scenario that worries me. Congress shows no discipline and lets the budget run through a few more trillion in the next two years. The Fed has been successful in reflating the economy. The bond markets get very nervous, and longer-term rates start to rise. What little recovery we're seeing (this is after the double-dip recession I believe we face) is threatened by higher rates in a period of high unemployment.

Does the Fed monetize the debt and bring on real inflation and further destruction of the dollar, or allow interest rates to rise and once again push us into recession -- a triple dip? The Fed is faced with a dual mandate unlike other central banks. They're supposed to maintain price equilibrium and also set policy that will encourage full employment. At that point, they'll have to choose one over the other. I can construct a number of scenarios, but they all end with the same line: There are no good choices.
No positions in stocks mentioned.

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