Irrational fears of deflation have wrought irrational monetary and economic policies. And that has us headed toward something truly scary.
To state the obvious, the Federal Reserve's announcement that it intended to keep the federal funds rate rates at zero longer than folks had expected was perhaps the biggest news of the past couple of weeks. (The Lord of the Dark Matter, my anonymous friend whom I also quoted last week. described the situation as follows: "The FOMC is attempting to wrap a giant gamble in a thin tissue of probity and monetary science. They have no clue how this will pan out. None.")
The bond market, notably, managed to pull out of its recent funk, as rates out to three years are now approaching zero. But, that knee-jerk response aside, I believe it is starting to dawn on people that the central banks of the world are going to win the battle over the scary "deflationary accident" that is being threatened by the debt mess in Europe.
The Fed, the Bank of Japan, the Bank of England and the Swiss National Bank are all understood to have printed plenty of money and will continue on that path. The European Central Bank has also printed a great deal of money, but its long-term refinancing operation was initially sort of scoffed at, though it is now being taken more seriously. Round 2 will be at the end of February, and it is possible that in its wake we will finally get past the period of people worrying about deflation.
Longtime readers know that my motto has always been that, "in a social democracy with a fiat currency, all roads lead to inflation." The past few years have shown why. It is the fear of potential deflation that precipitates the policies that have seen gold trade from $250 to almost $2,000 an ounce over the past 10 years and have boosted the price of most items that aren't related to the burst real-estate bubble (which decidedly does not equal deflation).
It remains to be seen if Europe can avoid a banking-system collapse precipitated by the inability of governments there to roll their debt. But, if enough money is printed by the European Central Bank (even if that printing is just called an LTRO), then I think Europe will skinny on by.
And, if we are finally at that inflection point, the world will then slowly begin to concern itself with stagflation and inflation, and eventually the world's bond market participants will start to demand more in interest-rate compensation due to real rates being negative, which will shut down the central bankers' printing presses. No one will accept negative real rates and just getting their money back if they are no longer worried about a deflationary collapse.
In sum, I believe we are approaching (if not at) that inflection point and that deflation is about to become very old news until sometime down the road, potentially when the printing press is taken away from the central banks.
Obviously, in a world without money printing, we could eventually see deflation. But that would be a good thing. After all, deflation occurs when prices of goods and services decline, and who is against that? Unfortunately, deflation has come to mean the economic environment of the 1930s, and thus people are terribly confused about what the word actually means. (They are also confused about what constitutes inflation.)
In that environment, gold will do well, but if the bond markets of the world take rates higher, despite the protestations of the central banks, people will have to adjust the way they think about the stock market and the economy.
My latest interview with Eric King on King World News was a wide-ranging discussion touching on the current situation in Europe; the latest Fed maneuvers; deflation, inflation, and stagflation; the perversity of markets; the economic outlook; and, of course, metals and miners. Interested readers can listen to it here.
At the time of publication, Bill Fleckenstein owned gold.
This column is a synopsis of Bill Fleckenstein's daily column on his website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.
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