Despite the undue attention that has been paid to the chimera of inflation this year, it should be clear by now that deflation is the far greater structural problem. One clue that deflation, not inflation, is the main issue can be seen in the biggest form of savings and investment among the U.S. middle class, namely real estate.
Real estate is an excellent asset to own during the inflationary phase of the long-term cycle of inflation/deflation but it’s one of the worst assets to own during hyper deflation. As an illiquid asset, housing prices tend to depreciate in the final years of the deflationary winter season, as many have discovered. This is one of the biggest proofs that the economic long wave, or Kondratieff Wave, is still in its deflationary phase and hasn’t bottomed yet.
Consider the following real estate prognosis from Doug Ramsey, an analyst with the Minneapolis investment firm Leuthold Group. Ramsey has calculated that single-family housing starts would have to increase from 60 to 70 percent from their current 50-year low of 419,000 annual rate just to reach the average low of the past six housing busts since 1960. Needless to say this would be asking a lot for even an energetic housing market.
Ramsey, who is an avid student of financial history and has studied numerous financial bubbles, has said that every housing statistic he follows has so far matched the price pattern following the bursting of other asset bubbles. According to Ramsey, asset bubble collapses tend to follow a similar pattern, including most famously the 1929 stock market crash and Japan’s 1989 Nikkei crash. He says it starts with a steep decline lasting three to four years followed by a brief rally that is followed by years of stagnation. He points out that the Dow Jones Industrial Average took 35 years to return to pre-crash levels. Japan’s Nikkei stock market index, meanwhile, trades at less than a third of its 1989 peak.
Ramsey concludes, “The housing decline will be a long, multiyear process, and the multiplier effect across the economy will be enormous.” Until housing prices bottom investors are safe in assuming that deflation is the dominant trend underscoring the economy, notwithstanding occasional periods of Fed-induced (QE) pockets of inflation.
Many investors have asked, “If deflation is the main problem facing the economy, why should I own gold?” Gold, they reason, is an inflationary hedge and if that be so, how can it possibly benefit from deflation?
Gold is more than an inflationary hedge, however. As Samuel Kress has shown in his cycle work, gold benefits from both extremes of the 60-year cycle, namely hyper inflation and hyper deflation. During the inflationary period of the current 60-year cycle in the 1970s, gold benefited from the extreme inflation as the cycle was peaking. In more recent times gold has benefited from deflation while the cycle is declining. Consequently, investors look to the precious metal for financial safety in times of uncertainty.
Gold has in fact become the new long-term investment vehicle of choice for retail investors. Traditional forms of savings such as real estate have become depreciating assets and no longer offer protection against the ravages of the long-term cycle. Meanwhile savers are punished with extremely low interest rates while the value of the currency diminishes through central bank money printing schemes. It’s no wonder then that investors are turning to the yellow metal as the safe haven du jour during the “winter” season of the 60-year/120-year cycle.
Gold is in the unique position of benefiting from Fed-driven inflation, as the recent quantitative easing program proved. Yet it also derives strength from uncertainty in the global financial and economic outlook. Certainly there have been more than a few instances of this in recent years. A survey of the year-to-date alone would suffice to provide enough examples of how gold has benefited by the recurrence of worry. The current worry among investors is how a potential Greek debt default would impact global markets. In the last few days since this worry has made headlines, the gold price has managed to climb from its June correction low of $1,483 to its latest high of $1,563.
The current leadership of the Federal Reserve are committed to fighting against the forces of long wave deflation and have shown a steely determination in carrying out an anti-deflationary policy. This can be clearly seen in the Fed’s first and second “quantitative easing” programs, a dignified term for fighting deflationary pressure by increasing debt. The latest round of quantitative easing (QE) ended on June 30, yet on Tuesday, July 12, the Fed released the minutes of its June meeting and hinted that a third round of QE may be in the offing. The minutes suggested that most members of the Fed’s board of governors would favor another round of QE if the economy continues to show signs of weakening. This may have been one reason behind gold’s spike to new highs on Tuesday.
Gold should ultimately benefit from either course of action, whether it be the uncertainty that accompanies long wave deflation or the artificial boost in asset prices brought about by quantitative easing. This is one reason why gold remains the investment safe haven du jour in the final years of the deflationary cycle.
