Inflation & Deflation in a Storm

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Jim Willie CB is the editor of the "HAT TRICK LETTER"

Use the above link to subscribe to the paid research reports, which include coverage of critically important factors at work during the ongoing panicky attempt to sustain an unsustainable system burdened by numerous imbalances aggravated by global village forces. An historically unprecedented mess has been created by compromised central bankers and inept economic advisors, whose interference has irreversibly altered and damaged the world financial system, urgently pushed after the removed anchor of money to gold. Analysis features Gold, Crude Oil, USDollar, Treasury bonds, and inter-market dynamics with the US Economy and US Federal Reserve monetary policy.

The events of the last ten days are surely for the history books. The story must be told through a prism of the epic battle between inflation and deflation. The Jackass hates the parlance, since each term is abused. Inflation is the expansion of the monetary supply, while deflation is the decline in that supply. The Powerz would prefer that the public misconstrue what inflation is, so that they can continue to exploit it for their private gain and control of entire banking systems. The US Federal Reserve would prefer that the public remain clueless on the inflation threat, by citing the deflation threat in a manner to justify their Weimar-like hyper inflation. They have expanded the US$ money supply through USTreasury debt monetization severely, to the tune of $2 trillion in two years. That is bigtime inflation!! The downstream consequence is a fast notable rise in the cost structure across the entire global economy, complete with loud outcry. The reaction has been to protect against the price inflation (higher costs) and bond deflation (lost value) by the widespread purchase of both Gold & Silver (bonafide safe haven).

GOLD/OIL RATIO SPIKES UP
Three price directions have been vividly clear in the past few weeks.

• The Gold price has hit record high levels in several major currencies
• The Crude Oil price on West Texas has plunged to multi-month lows
• The Silver price has stayed stable at a still elevated level.

Notice the Gold/Oil ratio over the past three years in the above chart. The ratio has returned to a post-Lehman high level. The extremes are back. The financial sector damage, dislocation, and abuse are evident in the crumbling sovereign bond market, the wrecked big US bank stocks, and the discovery of Gold as the true safe haven. Do not be fooled by the knee-jerk pied piper response to flee the frying pan and find the fire, as investors moved from stocks to USTBonds. They are sheeple in boats led by a powerful application of leverage by siren calls to the rocks ashore. Last week, it was mentioned the gigantic $9.1 trillion additional Morgan Stanley application of Interest Rate Swaps. They exploit the artificially low short-term USTBill yields and create phony demand in long-term USTreasurys like the 10-year and 30-year maturities. The demand is artificial but felt with impact in a TNX approaching the magic 2.0%. When it reaches the milestone, shrill calls will come of an asset bubble. The investor community incorrectly believes that actual money is flowing into USTBonds as safe haven. They are fooled by the powerful Interest Rate Swaps applied by the big US banks, the agents of the Syndicate. The only massive asset bubble in existence is the USTreasury Bond. It loudly proclaims USEconomic recession also, just like Chairman Bernanke's admission following the FOMC meeting this week. More still, the chart contradicts the myopic focused Deflation concentration that ignores the monetary inflation consistently and errantly. They earn their Knucklehead label every passing day, from being half blind. My contention is that none of them is very intelligent.

Aside from the grand deception, the markets, the pundits, the investors, and the analysts, all blessed by eyes and ears and clipboards are realizing the record price level for Gold. The Deflationist crowd and the Wall Street hive cite instability, uncertainty, and shaky confidence, all true, but off the mark. The actual motive and thrust behind the record Gold price are:

• Endless chronic 0% official interest rates in the United States, England, and Europe. The nil rate is the traditional trigger and sustaining force for the Gold market.
• The crumbling fortress of sovereign bonds, broken on the peripheral nations, the deep damage working its way to the core of USTreasurys and UKGilts through Italy and Spain, despite the sheep-like retreat into USGovt bonds. Watch out for France!!
• The utter wreckage of the big US banks, kept afloat by the generous FASB accounting rules since April 2009, insolvent to their core, under siege from both toxic mortgage assets and bond investor lawsuits, under Basel II strain on reserve management, and suddenly finding themselves grossly under-capitalized after showing unwillingness to recapitalize when their stock shares were much higher last year.
• The witness of the Euro Central Bank putting up another EUR 850 billion to bail out Italian and Spanish Govt debt, after several bailouts of Greek debt fixed nothing and only served to apply patches amidst continual bank redemptions.
• The general sense that fiat money is losing its value, its meaning, and public confidence, as central banks are observed in the HariKari Keynesian Monetary exercise ritual, having lost their prestige and credibility, but seen still as the last hope. Every action they take debases the currencies further and lifts the Gold price.

The USTBonds and UKGilts will most assuredly continue their rallies toward 2.0%, proof positive of a broken manipulated controlled market having no bearing on reality. That reality extends from an historically unprecedented flood of debt securities supply, rampant price inflation, strained auctions, and heavy reliance upon the USFed for the last resort bid. The entire world has been watching the US central bank print money, buy debt, and avert the disaster of failed auctions that has plagued other major industrialized nations lacking the luxury of counterfeit money operations. A strong ugly rub has hit the UKEconomy and European Economy. Their central banks print money to cover their deficit, to redeem toxic sovereign debt as last resort, and to stimulate their swooning economies. The end result in stronger price inflation in the United Kingdom and European Union. They cannot pawn off their newly hatched debt to China and other export nations that accumulate toxic paper. Check the Big Mac hamburger combo index to monitor price inflation. It is $8 to $9 in the US, but $15 to $18 in the UK and EU. It is only $5 to $6 in sunny/rainy Costa Rica.

The conclusion, evident in the Gold/Oil chart, is that Inflation and Deflation are both running hard & fast, each strong & durable, both evident & ugly. My harping disrespectful criticism of the deflation camp with all their half-blind observations and blockheaded conclusions and mindnumbing errant forecasts has been steady and well deserved. The best description of the current situation is the collision of high pressure zones against low pressure zones. The high pressure is the result of thrust by central banks of monetary expansion that has actually wrecked the USFed balance sheet, and the EuroCB balance sheet. Each is the shameful owner of worthless mortgage bonds and sovereign bonds respectively, that nobody wants, that will never recover in price. The low pressure is the result of a powerful push by falling housing prices and big bank balance sheet insolvency. The banks are making a transition from insolvent Zombies to undercapitalized Dead Made Men. They are soon to be recognized as dead. They are agents of the Syndicate, and thus guaranteed for slush fund income from multiple sources.

An aside, notice the $24 spread between the West Texas and the Brent crude oil price. This too is evidence of the massive interference in energy markets by the Wall Street and hedge fund players. Nobody mentions it, but it is glaring. Blame is put on Libyan oil supply shortages. But the US gamers are pushing down crude oil in support of the USDollar. They also hope that the lower energy costs can aid the flagging USEconomy. The energy costs are important to be sure, but they are dwarfed as a factor by the powerful housing market decline and bank insolvency problems that plague the nation. They will not go away. US industry is largely gone. Dependence upon home equity backfired and killed the USEconomy.

S&P500/GOLD RATIO SPIKES DOWN
Since the end of July an epiphany has taken place. The entire Western world has awakened to reality. The gold analysts have been yelling in the crowded theaters that recession is worsening badly and noticeably, even that the last recession never ended. Their warnings were largely ignored. As a group, we pay little heed to the falsified Consumer Price Inflation and its equally corrupted cousin the Consumption Deflator Index or whatever the heck they call it. How about queer CPI twin? In the last few weeks, ever since the USFed had firmly put a stake in the ground about No New Quantitative Easing, the USEconomy has shown broad signals of resumed decline. A realization has finally come that the USEconomy is as crippled as the USGovt political apparatus. The dysfunctional officials, the corrupt bankers, and the compromised sell-side analysts have been calling the USEconomy in slow growth erroneously for two years. It has been in at least a Minus 5% recession for the last two years, a horrible outcome from the supposed stimulus and debt relief programs. The data is bad across the board, from ISM manufacturing to ISM service, from Jobs growth to Jobless claims, from durable goods orders to business investment, from Big Business demand to Small Business credit.

The banking leaders prefer to put a Confidence spin on everything, from inflation expectations to the business confidence toward capital investment. The USFed even purchases the TIPS bonds, which are supposed to provide an accurate reflection on the bond market after consideration of inflation. So the CPI is corrupted, then the TIPS are doubly corrupted!! The keys are business incentives, removal of regulatory burdens, and an initiative to bring back industry from Asia. The US leaders from all sectors are incredibly dimwitted with respect to capitalism and job creation. They have no clue. Our cast of leaders still believes the key is a strong stock market, which the USEconomy has grown dependent upon rather than industry. They also believe the key is to put sufficient cash in consumer pockets, unaware than investment is required. They are so misguided as not to be too concerned about the source of cash dispensed. So if consumers are handed money from the USGovt, by means of debt extensions, that is ok. It offers a fleeting effect, nothing more.

The S&P/Gold ratio has plunged again, to levels similar to early 2009 in the months following the Lehman Brothers failure, and what can best described as the death of the US banking industry. That industry has not recovered in capital or lending capability. They are mere twisted casinos struggling to recapitalize under the relentless strain of a housing bear market and lawsuit siege, working the USTreasury carry trade to its conclusion, riding the Interest Rate Swap wave on surfboards bearing a South Manhattan brand. The USEconomy is stuck in recession, now accelerating downward in what could better be described as an inflationary extreme recession. Bear in mind that what the USGovt identifies as an official recession is a Minus 6% recession or worse, since they lie on the price inflation by at least 6% in real adjustments. Recall the Jackass forecast made last December and January that most of the perceived growth to be seen by summer 2011 will actually be mislabeled price inflation. It is much worse than my forecast, since what they call flat growth is actually a powerful recession. Much more stimulus, much more USGovt deficits, much more bond floods, much more currency debasement are coming.

The most important featured message from the FOMC meeting and Bernanke's speech was that he painted a powerful recession picture. He admitted the recession in clear terms. He promised 0% rates for two more years, an admission of failed policy and wrecked system. No central bank in history has ever admitted such failure indirectly. It was not enough, as stocks will resume a powerful downward trajectory, seen in stark fashion on Wednesday. The stock market will decline until the USFed announced a broad new QE3 with features directly to support the failing US Stock market. That decision will also be unprecedented. Gold senses it and rallies into breakout territory.

My firm forecast is that QE3 will be announced. The so-called QE2.5 powered by the positive effect on mortgage bonds that releases $25 to $40 billion per month will prove woefully inadequate. Mortgage rates are falling, rendering bonds more valuable. The USFed exposes its own vested interest in lower bond yields, the likely master hand behind the Interest Rate Swap lever. The QE3 needs another $1.0 to $1.5 trillion, as the mortgage benefit will be shown as inadequate. My firm belief is that the next QE3 will be admitted to provide strong S&P stock support. The USFed might declare the stock market to be a vital element that supports the USEconomy and confidence levels. The other more hidden motive for QE3 is to prevent USTreasury auction failures. Low bid action at 3.0% yields will be worse at 2.0% offered. The QE3 will be seen as a necessary evil, an urgently needed alternative, a perilous road that must be taken. Worse still, QE3 will be taken with full knowledge that QE3 will not stimulate the USEconomy at all. The discredited and defensive USFed will look for moral support at Jackson Hole at the end of August. From the banker bunker will come QE3, just like QE2 which was also fully denied until urgently required. In fact, that QE3 will be intended to boost stocks will be obvious to all, the main priority being to stabilize the financial markets on a global level. Foreign central banks will pressure the USFed, despite the risks. In doing so, the USFed will admit that they have routinely being intervening in the US Stock market.

GOLD RECOGNIZED AS BEST SAFE HAVEN
So the debt crisis is flourishing, as contagion has spread to Italy, Spain, and the United States. The broken nature of the Southern Europe sovereign debt is manifested in higher bond yields. The broken nature of the USGovt debt is manifested in ultra-low bond yields, evident of a massive liquidity trap, and excessive reliance upon Interest Rate Swaps. So the sovereign bonds are being ruined, both by grand losses in Europe and forced participation in an asset bubble in the Untied States. So the price inflation is rising worldwide, the unfortunate but unavoidable consequence of the USFed monetary expansion in hyper inflation style. Observe the next 3-step breakout process in the Gold price in staircase action. It should be followed by consolidation, but that consolidation phase will most likely feature a Silver price breakout. Gold fights the political wars, but Silver rides through the broken phalanx on a white horse to capture outsized gains. This time will be no different. Some mistakenly expect Silver to be regarded as an industrial metal. It is that, but it is much more. It is not replaceable in industry. It is expanding its role as both a reserve asset and a household saving vehicle. Silver will follow Gold in this round, as they are inextricably linked through history. As colleague Andy Hoffman said, "Gold & Silver will go no offer soon!" The Jackass could not agree more. Eventually the Silver metal will not be available at any price from profound shortage, and Gold will be scarce since central banks scramble to recapitalize their wrecked currencies. At that time, even the Sprott Fund will not both to source the silver in an expanded fund offering. Well, maybe they will try, just to expose the extreme silver shortage!!

Hack analysts, compromised fund managers, and otherwise clueless mavens trot out their favorite arguments against Gold. The are propaganda shills. Their claims are vacuous, vapid, and empty. They claim that no significant price inflation exists to undermine the asset valuations. They must believe the 3.0% CPI nonsense, or must not notice all the fast rising prices, led by food & gasoline & insurance. All components of the CPI are higher than 3% in the real world. Also, the substitution of falling home prices (inclusion) for rising rent prices (exclusion) was timely. Their other goofy point claimed is that Gold offers no yield. Neither do short-term USTreasurys, UKGilts, or EuroBonds!! Besides, selling gold option calls does provide an interest yield, as Warren Buffet can verify. He owned 129 million ounces once upon a time early in the 2000 decade. He bought the white metal on advice from Hank Greenberg at AIG, earning a nice hefty yield of several percent per month. He frequently mentions Gold offers no yield, but he knows better. He lies.

Better than any advantage, Gold offers preservation of value in an era when all major currencies are being horribly debased. The Euro Central Bank is printing money to cover the Greek Govt bonds, and lately the Italian and Spanish Govt bonds, their newest debasement project. The Bank of England is printing money to cover wrecked banks, and soon to cover riot damage. Not only is Gold on fire, but London is on fire also. Its streets look worse than Athens ever did. The USGovt and USFed are printing money to pay for a runaway $1.5 trillion chronic deficit, the Fannie Mae cesspool, the AIG black hole, the endless sacred wars, and misdirected economic stimulus. Soon the USGovt can be expected to relieve a million homeowners of their mortgage burdens, a desperate maneuver. Toss more broken planks on the bonfire. Witness systemic failure in the United States, which is Greece times 100. To be sure, Gold & Silver win on all counts versus fiat paper money, whose bonds have been exposed as toxic. The entire modern currency system rests upon the broken sovereign debt foundation. It is being exposed.

REALITY CHECK
In conclusion, consider some cold water on the face. The USDollar is not the safe haven currency any longer. The Swiss Franc has risen by an astonishing 42% in the last 12 months. Money and paper-based assets are fleeing for safety in Europe. They find Switzerland, where paper is king and gold is missing. The Asians are finding safety closer to home. The Japanese Yen currency has returned to the stratosphere over 130 in recent weeks. In just the last week, despite an incredible $50 billion in FOREX intervention by the Bank of Japan, the Yen currency has returned to 76.43 in the popularly reported US$/Yen after touching 79, which translates to 130.8 in US$ terms after going below 127. Therefore, the limp-wristed BOJ intervention over a week ago failed in a single day. The huge BOJ intervention late last week failed in less than a week, a loud victory for Gold in a critical skirmish. Central banks the world over are angry at having to react to a broken discredited desperate USFed. The Swiss Franc and Japanese Yen upward moves serve as ample evidence, contrary to the beliefs by naive observers and investors who maintain that the USDollar is ultra-dominant.

A parting note for those who believe the Chinese are backward militarily. They are not. They are well funded by export surplus wealth. They have demonstrated an ability to hack into Sandia Labs and make off with weapons schematics. They have demonstrated an ability to knock out telecomm satellites. They have a strong blue water naval fleet, from the infusion of Japanese technology. Furthermore, by 2015 they should have some modern aircraft carriers, of catamaran design for greater stability and speed. A brief glimpse for the benefit of those who believe naively that the USMilitary exerts full spectrum dominance. To be sure, the USMilitary might is awesome, but it will be challenged. Look for a New Policeman in the Persian Gulf. The Saudis have already cut the deal.

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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 25 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com . For personal questions about subscriptions, contact him at [email protected]