Chris Mayer

I was in St. Kitts last month for the Liberty Forum conference, where I was a speaker. I also moderated a debate pitting Peter Schiff against Harry Dent on the inflation-deflation question.

Things got really hot. There was some yelling, and at one point, Harry stood up and tossed his mic in frustration. I thought they might go at it.

I want to tell you about this debate…

Peter Schiff is the chief strategist at the brokerage firm Euro Pacific. He has a radio show and has written some books. He’s probably most known as calling for a collapse in the dollar and being generally bearish on the U.S. economy.

Harry Dent is also a well-known financial commentator. He writes a newsletter and is author of several books. He’s probably most famous for his predictions based on demographics. He’s also a vocal deflationist.

Inflation here means generally rising prices. Deflation means prices are generally falling. There are other consequences associated with each. For example, Peter believes interest rates will rise. Harry thinks they will fall. Peter thinks the dollar will lose value, Harry thinks not.

Peter’s argument essentially was that the Fed is printing a lot of money and would continue to do so. Hence, inflation.

Harry’s argument was that the debt deflation dynamics were the more powerful force. The economy has to delever, and as debts are repaid or written off, that process destroys money, more than offsetting the printing press.

They touched on a lot of other things in the course of the debate — past hyperinflations, China’s role and more.

The debate started out calmly enough, but after about 20 minutes, they really starting going at it.

Harry won the debate, in my view. He had a good command of the facts and presented them well. I had also watched the presentations of both before the debate. Harry had marshaled an impressive array of evidence and made a good argument.

My respect for Harry went up. For whatever reason, I had thought of him as a bit of a quack, but he has done a lot of good work on this stuff.

Before 2008, I was solidly in the inflationist camp. But think about what’s happened since 2008. If I told you back then that the Fed’s balance sheet would balloon fivefold — creating lots of money — what would you have guessed the world would look like in 2013?

Wouldn’t you be surprised to see the 10-year Treasury note pay just 2.8%? Wouldn’t you be surprised to find gold languishing at $1,235 an ounce? The inflationist view had interest rates and gold higher — not lower.

So something is clearly not right with the “Fed’s printing money and we’re going to have inflation” argument. At some point, you have to re-evaluate the way you look at the world. Or you just sit content to be wrong. In financial markets, that can be costly.

In this light, I appreciated Harry’s efforts, as his framework was the more challenging one to believe, but it has unquestionably been a better predictor of what’s happened post-2008.

Even in the course of this debate, though, it struck me how many assumptions get passed off as givens.

For example: Commodities will protect you in times of high inflation.

Well, they don’t have a history of doing that.

As James Montier of GMO points out in his most recent research note:

“Commodities are often seen as an inflation hedge; however, this is almost entirely due to the experience of the 1970s and the creation of OPEC, and the domination of energy in the generally used commodity indexes. If you had held the ‘wrong’ commodities, their inflation hedging performance would have looked very different (witness copper and grain).”

Here is the chart:

Oil, Copper and Corn Prices 1970-1982

So during the highly inflationary 1970s, oil was a great investment, but copper and corn were terrible. Commodities generally have lost value over the last century at the rate of almost 2% annually, according to GMO. Yet I see it repeated again and again by various advisers telling their clients/readers to own commodities to protect against inflation.

The same is true of gold.

Here is Montier again:

“Gold is often held up as an inflation hedge. However, the data provide a challenge to this view. [The next chart] shows the decade-by-decade average inflation rate, and the real return to holding gold over the same decade. It doesn’t make pretty viewing for those who believe gold is an inflation hedge. That perception is down to one decade (the 1970s) when it held that inflation and gold were positively correlated. The rest of the time there isn’t a good relationship between gold and inflation.”

And here is the chart:

Gold's Record During Inflation

Yet people repeat — on faith, I guess — that gold will protect them during inflation. The record of gold on this front is spotty. It might. It might not.

Montier’s paper, by the way, concludes that there aren’t any good inflation hedges in the short term. But over the long term, stocks and real estate are good inflation hedges. (He says the best is TIPS — Treasury inflation-protected securities.) In fact, Montier shows that even in countries that have suffered high inflation (or even hyperinflation) in the 20th century — such as Germany and Italy — stocks still delivered positive real returns. And real estate value correlates with replacement costs, which rise during inflationary times.

After the debate, I sat on a panel with several other speakers. Asked if we’d have inflation or deflation, my first answer was an honest one: “I don’t know.” Forced to guess, I think we have deflation first, inflation later.

In general, the long-term way to bet is that the U.S. dollar in your pocket will buy less tomorrow than today.

Even Harry’s own presentation had a chart that makes it hard to argue any other way:

The Value of the U.S. Dollar, 1900-2010

It is true the dollar can do something different for years at a time. (I mean, look at the 1930s.) But as a long-term investor, I’d rather own businesses or real estate than cash. Then again, I’d rather own cash-spinning businesses and real estate than commodities or gold.

Whatever you do, though, don’t let an old assumption pass uncontested. If you think there’s going to be inflation, you could at least be in the right things. And keep an open mind as to what may happen in 2014. The only certain thing about investing is that there are no certainties. That was my main takeaway from the fiery debate in St. Kitts.

Sincerely,

Chris Mayer
for The Daily Reckoning

P.S. “I buy on the assumption,” Warren Buffett once said, “that they could close the market the next day and not reopen it for five years.” These days, you never know what’s down the road. That’s exactly why I’ve come up with an incredible strategy that can help you make a ton of money by doing practically nothing. Many successful investors are already using this strategy to build their fortunes, and in today’s Daily Reckoning, I gave readers a chance to check it out for themselves. Just one little perk of being a member of the FREE Daily Reckoning email edition. Don’t miss another issue. Sign up for FREE, right here.

Chris Mayer

Chris Mayer is managing editor of the Capital and Crisis and Mayer's Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas. In April 2012, Chris released his newest book World Right Side Up: Investing Across Six Continents. 

  • Chuck (Smithfix) Smith

    Where is the audio of the debate? did the fact that Jp Morgan is selling paper silver/gold into the market to manipulate the price come up? And the fact that this is only legal if the US Gov. is the ‘client’? What market? All the figures are lies. There is no free market or price discovery possible.
    Put the audio out and lets decide for ourselves.

  • GTR003121

    So I guess we’re just supposed to pretend the Gold and Silver markets aren’t hugely manipulated?? Its not a conspiracy theory. But it IS a conspiracy – and one which could be easily proven in a court of law – if not for the rampant corruption within the US Govt and Justice Dept. Conspiracies are all around us. Nowhere is this more obvious than in our system of(allegedly) “free-market capitalism”. The “market” we have today is driven primarily by the Fed, but also by US Government lies and manipulated numbers. Not exactly a recipe for long-term stability.

    The actual market died in 2008. Whatever the fcuk it is that we have today is certainly not based on sound principles, so I’ll stick to my ongoing program of acquiring physical PM’s(and other necessities) thank you very much. And the audio of this debate should really have been included in the article.

  • therevolutionwas

    So China, Russia, India and etc…, are all making a bad investment by sucking up all that gold and silver? Which reminds me; why is the metals price so stable/low when there is such incredible demand?
    I think we have deflation and inflation going on at the same time.

  • Dale Holmgren

    Who says there is no inflation? Ask China at 3%, Brazil 5.77%, Russia 6.5% India 7.52%, Indonesia 8.37%, Pakistan 10.9%, Turkey 7.3%, Iran 32.3%. They don’t buy gold in these countries? Mr. Mayer’s argument is that we can continue to shovel dollars around the world and that these countries will be happy to gobble them up rather than investing in something that cannot be printed with abandon.

    I do agree with Harry Dent’s implied point that inflation is the expansion of money AND/OR credit. In fact, since money is put into existence with the issuance of government bonds, I would argue that today inflation is EXCLUSIVELY the expansion of credit. But why would other countries continue to buy US bonds when the interest rate paid doesn’t cover inflation in their own country? Well, as we are seeing, they are starting to wake up to this, which is why the Fed is now buying 2/3rds of it. If this has no consequence, why not eliminate taxes altogether and have the Fed buy all the debt issued by the Treasury, no matter how much?

    Actions have consequences. In fact, Peter Schiff has said something that is in partial agreement with Dent: We will get deflation – when priced in GOLD.

  • j christensen

    why not just have the treasury issue all the currency and leave the Fed out of the picture?

  • Pl0ns

    Dear Chris Mayer,

    I’m not sure where to start but here we go…

    You put two famous names to support your stance witch is badly misleading and wrong and I’m 100% sure non of the names you have provided would sing under your “article”.. as it violets economics basics and spreads confusion.

    You claim : “Inflation here means generally rising prices. Deflation means prices are generally falling”

    Inflation is NOT price rise ! and deflation is NOT price drop !

    Inflation is increasing money supply beyond means witch leads to dropping purchasing power of the money. – general level of prices quoted in units of money.

    So it is a function of money supply or its loosing purchasing power not a price rise ONLY as such! You can have price rise when high demand and short supply with no inflation at all ! Inflation depends of money velocity as well. Check the formula.
    My point is you are MBA and definition and understanding of the issue you discus is wrong and misguiding !

    FED provides money supply as they monetize debt. They create money from tin air. No production, economy efficiency increases – just money supply. Then money goes to banking system and to the stock market, bonds, derivatives… Hence we have investment inflation ! Stock bubble ! There is harder and harder to invest for ordinary people ! as it causes stock price rise – Here you have it !
    As money doesn’t go to ordinary people it doesn’t meant there is no inflation ! It is just low common goods inflation as there is LOW money speed transfer at this direction as wages stays the same or going down and common goods prices rises slightly – and deflation of this market is a killer ! So don’t tell there is no inflation.

    Then you mentioned gold. COMEX gold or raw metal ? COMEX GLD-ETFs are papers – 55-69 times more of them then amount of raw metal. So what happens when paper ETFs are sold ? Does it mean raw physical metal is losing value ? Quite oppsite and as gold price indicator is base on paper the real value of gold is hidden for the public. India China experience split gold price from COMEX or goverment indicators.

    Of course commodities doesn’t show the inflation as they are manipulated as the futures market.. no more comments here.

    Then you have Real Gold to Inflation graph witch is close to non sense.
    When you have f(x)=y it is a function x related to y with function and you can graph them as a line. Inflation to gold value is much more complex with complex economy in between. Economy is not a strait line function ! It is complex model based on chaos ! line any natural process. Trying to relate Inflation with gold price is like expecting the temperature rise in a split of second when pumping Co2 in to the Earth atmosphere. Then you have politics delay, wars, money velocity whole economy and you try to relate one parameter with the other with perfect match ? or expecting to discover new law there ?

    There is far more then this – I hope it will make the readers much clearer view.

    Thank You.

  • Pl0ns

    Dear Chris Mayer,

    I’m not sure where to start but here we go…

    You put two famous names to support your stance witch is badly misleading and wrong and I’m 100% sure non of the names you have provided would sing under your “article”.. as it violets economics basics and spreads confusion.

    You claim : “Inflation here means generally rising prices. Deflation means prices are generally falling”

    Inflation is NOT price rise ! and deflation is NOT price drop !

    Inflation is increasing money supply beyond means witch leads to dropping purchasing power of the money. – general level of prices quoted in units of money.
    So it is a function of money supply or its loosing purchasing power not a price rise ONLY as such! You can have price rise when high demand and short supply with no inflation at all ! Inflation depends of money velocity as well. Check the formula.
    My point is you are MBA and definition and understanding of the issue you discus is wrong and misguiding !

    FED provides money supply as they monetize debt. They create money from tin air. No production, economy efficiency increases – just money supply. Then money goes to banking system and to the stock market, bonds, derivatives… Hence we have investment inflation ! Stock bubble ! There is harder and harder to invest for ordinary people ! as it causes stock price rise – Here you have it !
    As money doesn’t go to ordinary people it doesn’t meant there is no inflation ! It is just low common goods inflation as there is LOW money speed transfer at this direction as wages stays the same or going down and common goods prices rises slightly – and deflation of this market is a killer ! So don’t tell there is no inflation.

    Then you mentioned gold. COMEX gold or raw metal ? COMEX GLD-ETFs are papers – 55-69 times more of them then amount of raw metal. So what happens when paper ETFs are sold ? Does it mean raw physical metal is losing value ? Quite oppsite and as gold price indicator is base on paper the real value of gold is hidden for the public. India China experience split gold price from COMEX or government indicators.

    Of course commodities doesn’t show the inflation as they are manipulated as the futures market.. no more comments here.

    Then you have Real Gold to Inflation graph witch is close to non sense.
    When you have f(x)=y it is a function x related to y with function and you can graph them as a line. Inflation to gold value is much more complex with complex economy in between. Economy is not a strait line function ! It is complex model based on chaos ! line any natural process. Trying to relate Inflation with gold price is like expecting the temperature rise in a split of second when pumping Co2 in to the Earth atmosphere. Then you have politics delay, wars, money velocity whole economy and you try to relate one parameter with the other with perfect match ? or expecting to discover new law there ?

    There is far more then this – I hope it will provide to the readers much clearer view.

    Thank You.

  • Kirk Matranga

    We did that during the War of Southern Secession in the 1860’s, didn’t turn out too well then either. You are assuming that gov’t officials would act responsibly with financial instruments, ARE YOU KIDDING!!!

  • dan

    gold IS money….not fiat….fiat IS debt…..say what you will…….I believe in PM’s as money

  • John

    It’s dangerous to talk about 2 different things as if they are interchangeable. Rising prices and inflation are not the same. Inflating the money supply only puts upward pressure on prices but that upward pressure could be offset by anything that causes a sudden economic surplus, such as a panic that leads to forced sales.

  • Gordon Barlow

    PI0ns. Oh dear! Unfortunately, I am of an age and disposition that require commentators to write proper (standard) English if I am to take their ideas seriously. When you write “witch” instead of “which”, I doubt your ability to comprehend what you have read throughout your life. When you write “loose” when your context requires “lose”, I wonder how many other words you have accidentally mis-used. Sorry! Must try harder.

  • Pl0ns

    Thank You Gordon :) I appreciate Your reminder. Let’s call it short lunch time brake rush negligence.

    As our financial system management looks like a witchcraft indeed, I hope my negligence has not disturbed the core of my logic against Chris article regarding. It was better to send it as it was then miss it – I reckon.

    So I appreciate for your forbearance ;)

  • Gordon Barlow

    Your points were all good ones, PI, and it bothered me to see the possibility that they might be regarded with less than the admiration they deserve!

  • Pl0ns

    My base background is robotics engineering and physics science. I was doing research of the idea of entropy ( energy status ) in economical systems. So from technical point of view my interest was focused purely on logic – where private or commercial interests disturbs the system. So it is much easier to look at economy by physics or mechanical concepts then by political – as politics obscures and disturbs the view completely. So by looking with natures eye logic we can discover lack of coherence easy ;)

    Favourite author – James Turk recently ;)

  • agentinsure

    While the fed printing presses are running over time, stagnate wage and employment growth have forced Americans to draw back on their spending. Therefore Velocity has declined more than that rate of growth in currency, which is exactly why we are not seeing inflation as we would normally expect. However I suspect, at some point we will be so awash in cash all around us that spending will have to pick up and that is when all those green backs will hit, and hit hard they will.

    Its quite similar to what we saw in the housing market over 2 decades. In the early 90′;s you had to have 20% down and/or great credit, and as that market became awash in cash/credit, eventually everyone had to start buying a house and of course we know the rest of the story by now.

    But this is too narrow of a view, the market is much more dynamic than to allow one to simply look at one specific fact, ie: printing fiat in excess of gdp growth. For example, the threat against the dollar as the reserve currency may very likely occur sooner, but replaced by what? And if replaced by who or whatever, will their military might be greater than ours to support their cause instead of our own. There will be simply too many parts moving to make simplistic assumptions such as Peter S does.

    I prefer Warren B. advice and I noticed the author eluded to the same advice above as well, Id rather own cash producing assets, not financial but real things. Maybe rental, but then you have to worry about prop taxes and rent controls, Buffett owns railroads, well I cant do that. Businesses? Like what? Restaurants, grocery stores, no way. IF anyone has ideas here I m all ears, I just think of any that a person of modest means can buy. I did see Buffet on an interview once give some sage advice for younger people; learn a skill/trade that will be in demand regardless. Electricians, plumbers, nurses, pharmacists, xray techs, auto mechanics. No matter what happens to the dollar, at the least you will be able to barter for goods and services with a skill. Thoughts?

  • agentinsure

    I believe you may have just given me an answer…if the $ collapses, we as a nation out of neccesisity will be forced to do 2 things at least; 1) export more and 2:) consume less. Of course those who have grown dependent on the govt dole will experience a painful realignment and their special interests might very well cause our leaders to get into the way making such a realignment of our economy all the more painful if not impossible.
    No matter what happens to the dollar, if you can feed a 1000 people, fix a car or an heat pump, drill for water and so forth a person should be able to survive and maybe even thrive in a new economy.

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