First world economies face an unavoidable dilemma, regardless whether globalization is switched on or off, either sacrifice now with decades of retirement demographic deflation (globalization off), or sacrifice later by inflating the deflation of globalization for temporary illusionary "wealth", which will end in a hyper-catastrophic global collapse Greater depression.

World politics have chosen "sacrific later", and on the order of 30 - 50% of the capital in developing markets derived from globalization, as well as the matching consumption debt in first world, is "unproductive" and due to be wiped out.

Contrarian investors can drastically increase their wealth betting on hyper-inflation of commodoties and precious metals.

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Inflating Deflation

by Shelby H. Moore III

Created: February 12, 2006
Updated: March 23, 2006

March 23, 2006 Update: An interview with John Williams who publishes ShadowStats.com, explains with expert detailed accounting using hidden government data, that the USA is excessively bankrupt beyond any levels in history of mankind, and near the cliff of an unavoidable severe global depression. In the interview, John documents the concepts I made below, that we are actually in a broken financial system which is deflating in real terms, yet is being nominally inflated to keep afloat, while government hides the true statistics. This info was brought to my attention by the free "What We Now Know" highly acclaimed newsletter from CaseyResearch.com. End Update

There are 6 billion humans on earth, and predicted to increase to 9 billion at least through middle of this century.

In the following, by "labor supply", I mean the number of people employed in something other than subsistence agriculture, i.e. other than basic survival mode, third world lifestyle.

I suspect there are two (2) main competing macro trends in the globalization trend global economy-- labor supply inflation and labor price deflation. As labor supply inflation exceeds labor demand inflation, then labor price deflation results.

In a capitalistic homogeneously priced labor market, generational labor supply inflation typically results in innovation and productivity increases, thus stimulating general economic production inflation at rate higher than debt (monetary inflation) cost of financing the increased activity. In other words, real GDP growth (inflation) is the trend of homogenous generational booms. However, when the labor supply inflation results from disjoint high and low priced labor markets, innovation and productivity in the low priced labor market may be relatively high internally to the low price labor market, but is a small proportion of existing high priced labor markets innovation and productivity, and thus overall economic production (real GDP) inflation rate is proportionally lower than a homogenous generational boom scenario. If the low priced labor demand is disproportionately created in the manufacturing and construction sector, disproportionate (proportional to overall economic production inflation) manufacturing and construction resource demand inflation results.

It is key to understand that real GDP inflation (growth), by which I mean real return on investment, i.e. real productivity gains, is (initiated by) the (cost of financing the) increasing productivity and entry into workforce of generational demographics. Today the global economy does not have booming homogeneous generational demographics. Instead, we have declining generation demographics in the main (high productivity, high price labor) economy, and an appendage of extreme (billions of) oversupply of low price labor (low productivity economy) which is not efficiently (low real return on capital) integrateable into the main economy-- i.e. real global GDP deflation that began decades ago (see -0.9% DJIA/M3 chart since 1960, and also calculations below), but which is currently obscured by accelerating low real return investment (i.e. debt/monetary inflation) in a futile attempt to inflate away the natural deflation cycle, which will return to the major deflation trend with a catastrophic implosion. This trend, which I call "inflating deflation", is in an economist's model of money supply, is evident in a decades trend of decreasing velocity (V) of money circulation.

New age informational technologies and science, e.g. in manufacturing (just-in-time & ISO quality templates, etc), telecommunications, networking (internet), finance, investing, human migration, and trans-shipment, have facilitated much more rapid displacement of labor demand from high price to low price markets. The feedback loop to create inflation of labor demand has significantly taken the shortest path via equivalently rapid debt creation. This debt has created an illusionary "wealth effect" in high priced labor markets, exchanging consumption debt for income, savings, and investment. This feedback loop mostly avoided either limiting labor supply inflation (as it had in past century) or deflation equivalent to the amount economic expansion due to "unproductive" debt creation, where "unproductive" is defined in previous two paragraphs as disproportionately low innovation and productivity returns on investment.

A fundamental problem with globalization has always been that to create capital in low priced labor markets, means either expanding the entire "pie" (the global GDP, e.g. global productivity) or cannabalizing the high priced labor markets' GDP. When expanding the global GDP via debt creation, the net expansion of the "pie" (real GDP growth) is nominal GDP minus monetary inflation (debt creation). Given very high monetary inflation in most all fiat currencies of the world, I suspect that real global GDP growth has been negative or very low, since 1970s, especially since 1996 when monetary inflation accelerated. This means that a significant portion of at least a decade of compounded economic global expansion has not increased productivity (is redundant or inefficient), and will eventually have to be deflated (shutdown).

I suspect it is obvious which sectors of the economy are most "unproductively" debt inflated and thus most prone to catastrophic deflation. Those are the sectors which are obviously not so unique, i.e. have high duplicity, low unique value added, and can be done by someone of average skills who can get financing. The housing market is an obvious sector, and interestingly contrary to many pundits, the housing sales chart shows that housing sales are increasingly volatile but the bubble trend continues as long as the overall inflating deflation trend does.

To quantify the "unproductive" debt (monetary inflation) portion of the economy, i.e. the decades trend of real GDP deflation, I did some rough calculations using official USA government statistics on monetary inflation (M3) and nomimal GDP:

http://research.stlouisfed.org/fred2/data/M3SL.txt
http://research.stlouisfed.org/fred2/data/GDP.txt

Since Jan 1959 to Sept 2005, the M3 has increased, 9976 / 289 = 34.5 (3450%), and nominal GDP increased, 12590 / 495 = 25.4 (2540%). Thus even though nominal GDP has averaged roughly 7.2% annualized since 1959, monetary inflation (debt creation) has averaged roughly 8% annualized, and thus real GDP growth since 1959 has been roughly averaged annualized -0.8% compounded to -43%. The productive activity of the USA economy has been negative since 1959, shrinking by roughly 43% (almost half). The "almost half" correlates well with the need to double the number of workers (both parents now work) per household to support a middle class household. The goverment will report higher positive real GDP growth, because it calculates by subtracting consumer price inflation (CPI), instead of monetary inflation (M3), but CPI is only a sample of economic activity with aliasing error and does not capture all the debt (monetary inflation) created. Besides CPI is manipulated for political reasons. Similar calculations show that in USA, real GDP growth deceleration has roughly doubled since 2000. Note, the USA Federal Reserve announced it will stop publishing M3 data in 2006, so we will no longer be able to calculate how much "unproductive" debt is being created!

The growth of the "unproductive" debt (monetary inflation) portion of the economy, is evident in rough calculations using official USA government statistics on savings and size of government:

http://research.stlouisfed.org/fred2/data/PSAVERT.txt
http://hussmanfunds.com/html/datapage.htm

Since 1970 (before the gold debasement and massive monetary inflation), the USA had a personal savings rate of roughly 10%. In the 1990s, it declined precipitiously towards 4%, since 2000 it has headed towards 1%, and now in 2005 it is consistently negative. Since 1930s, the size of USA federal government has increased from 3% to over 20% of nominal GDP, such that now more than 1/5 of economy is mostly "unproductive" government, and that doesn't include state and local governments. Estimates of total USA national debt run into the 300 - 400% of nominal GDP and accelerating, which is considerably higher than the 260% right before the catastrophic implosion of Great Depression in 1930s.

Without globalization, high priced labor markets would still be faced with catastrophic economic deflation, due to declining demographics (retirement), and low relative headroom for productivity growth given the already relatively high productivity level. There is a natural force driving labor supply inflation.

Thus, central banks have to choose between deflation or inflating deflation via debt. Given that deflation (economic contraction) is a not a politically viable choice, central banks (and governments) have no choice but to pursue inflating deflation as long as they can. As we approach the catastrophic implosion of the "unproductive" debt inflated sectors, central banks will have no choice but to accelerate debt creation in order to delay the implosion. The more debt that is created, the more catastrophic the implosion must be.

According to media reports, the new US Fedhead Ben Bernake bases his academic career on studying how to defeat deflation. Bernake has stated that the optimum solution is a low targetted price inflation. I suspect central banks hope that as long as aggregate real growth is positive (even though very small as percentage), then they are making gains that will be beneficial to minimizing the net deflation over the entire period of bringing low priced labor markets in balance with high priced labor markets. However, when real growth as percentage of debt creation is very low (my previous definition of "unproductive" debt), then debt creation must accelerate because real returns are not funding the additional debt at current velocity. The best the central banks can hope to do with the inflating deflation scenario, is maximize real growth for as long as possible and hope it is enough to provide political stability during the ultimate implosion. However, it appears they are accomplishing cannabalization of real growth in high priced labor markets, in exchange for highly "unproductive" leveraged (proportionally) real growth in low priced labor. The paradigm of the global financial system seems inefficient at integrating and balancing low and high priced labor markets. Perhaps the definition of "return on investment" needs to change to include intangible returns, such as feelings of reward from sharing, spiritual, etc.., or some intrinsic highly productive capabilities of low priced labor markets such as possibly natural medicines and lifestyles, else it will be a slow grind after the collapse of the current selfish material consumption based paradigm. This is one reason why I see the future in general and especially of the internet in terms of "sharing".

Thus, central banks have no choice but to destroy all their fiat currencies (e.g. US dollar, Euros, Japanese Yen, etc), with accelerating monetary inflation in "competing currency devaluations". Also during this period of rapid acceleration (hyper-inflation) of debt and subsequent implosion, great political unrest and probably wars must occur (see also how historical gold-to-DJIA ratio correlates to war escalation), and individual freedom will decrease (e.g. War on Terrorism, Patriot Act, last year's bankruptcy law all designed to trap and enslave the citizens when the depression starts). Trust in fiat currencies, governments, investments, and banks will decrease. Out of the ashes, the only money that will have any credibility will be money that has an intrinsic value that does not depend on government and debt creation. Historically that has always been gold. Silver to lesser extent because it has greater industrial demand, which makes it's instrinsic value more volatile (dependent on debt creation in general economy). However, since silver has a dual personality as a monetary metal and as an industrial precious metal, historically silver will swing up more than gold before the peak in hyper-inflation, yet it will quickly loose it's advantage against gold after the peak. My best guess based on gold-to-oil, gold-to-DJIA and gold-to-silver historical ratio charts, model of gold price, gold bull market historical stages, demand greater than supply of silver, the insight of experts who have predicted correctly in past, and my previous gold analysis, is that at the peak, an ounce of gold will cost $3000 to $5000 (and DJIA at same level), and an ounce of silver will cost $200 - $350. Thus gold roughly up 600% - 1000% and silver up 2400% - 4000%. Imagine that buying $25,000 of silver today, could make you a "millionaire" within a few years. I guess that is why Warren Buffet bought 130 million ounces (roughly $1.2 billion at current price) several years ago-- Buffet may become the first "trillionaire" if he lives another decade. After the peak, I expect silver will fall more than gold. Note also, that a complete failure of fiat as implied by Alan Greenspan, could mean the peak price of gold and silver can not be expressed in current fiat-- it may be infinite, or nearly so. Thus we may only be able to say that a ounce of gold at peak will buy perhaps 6 - 10 times more than it does now, but this will eventually revert to historical average and for example an ounce of gold will continue to roughly buy a fine quality man's suit. In short, gold will become the only true money, probably traded as ETF-like certificates or electronically in allocated accounts (e.g. GoldMoney.com). After the peak, Silver may become "pocket" money again for physical trading.

Note the Japanese Yen is a possible exception, because Japan is the only significant first world country (perhaps other than Canada and Australia) that has (short-term) inflating domestic demographics after emerging from a long (domestic demographically driven) deflation period. Japan is also well positioned in Asia where most of the (viable, other than currently unviable Africa) low priced labor over-supply is, although this could be a negative if wars break out. However, Japan's Central Bank has been supplying liquidity to the world over the past decade with negative interest rates and the Yen carry trade (speculators borrow Yen, then buy US dollar investments), thus politically Japan may be forced to continue this policy, and accept hyper-inflation, as the price to pay for being part of the global economy. Canadian and Australian fiats could possibly remain viable due to real returns on their raw materials driven economies, mitigated to extent of their declining demographic propensity to create consumption ("unproductive") debt.

Physical resource supply can not be as rapidly inflated via debt creation, because it takes time (up to decades) to develop physical resources, especially mining of raw materials and energy. Thus during rapid acceleration of resource demand, resource supply lags, and inflation of resource prices accelerate. Some infrastructure and resources have supply dynamics that can catch up more quickly (e.g. roads, food supply), others that run increasing supply deficits all the way to the demand peak (e.g. many raw materials), yet other resources (e.g. light crude oil) have supply dynamics that have peaked and can not increase.

Mass psychology of resources and precious metals is different, in that by definition the public will more readily accept the obvious scarcity of resources than the non-obvious accelerating non-scarcity of fiat currencies. The inflation of debt is largely obscured from public focus (psychology) by the balancing equation of labor supply inflation and matching labor demand inflation via debt creation. As mentioned earlier, the USA Federal Reserve will stop publishing M3 data in 2006, so there won't be an easy way to quantitatively calculate the obscured "unproductive" debt creation. It is not until the matching acceleration goes vertical (by definition that the public is abandoning the "unproductive" return on debt that are the fiat currencies) that the public is aware that fiat worth is decelerating. Thus resource price inflation is an early investment play (scarcity more quickly priced into investments), and precious metals (gold & silver) are the "end-game" investment play (scarcity not believed until the very crazy end). Mass psychology does not comprehend that fiat currencies (e.g. US dollar, Euros, etc.) are certificates of liability for debt they represent, and thus value of fiat being the real return (real growth of GDP) divided by the supply of fiat. Thus massive debt liability of fiat can be obscured by continually accelerating the rate of debt inflation, which creates illusionary temporary "wealth". It is a "Ponzi" scheme, which collapse when there are no more fools to be at bottom of the pyramid.

China for example can not stop inflating it's currency (pegging Yuan to inflated basket of currencies) and move to a stable gold standard, as it would deflate their economy. It is by definition, that labor price driven deflation is locked into the global economy, and the only option is inflating deflation. This is gift to those who are contrarian and realize the scarcity of gold & silver before the mass public does.

Because inflating deflation is naturally non-obvious to the mass public, and only a few very rich people take advantage of hording gold & silver, then many new "millionaires" will be created, and the middle class will be deflated to a lower class (balancing level between low priced and high priced labor markets). Investments which are not appreciating faster than the "unproductive" portion of debt creation (e.g. large cap stocks, general stock indices, bonds, etc), are losing real value, but the mass public is unable to realize it, until the very end when it is too late for them.

I suspect the USA counts on it's military and informational economy hegemony to maintain demand for US dollar fiat in face of increasing global destabilization. Congress Ron Paul of Texas in a speech that detailed the dollar hegemony policy of USA makes such dire implications. I suspect this insures a longer period of debt inflation, and ties the collapse to some precipitous event in USA economy. I suspect the baby boomer demographic peak age spending peak in USA around 2010 is the most likely catalyst.

A wild card risk is confiscation of gold & silver by governments to create new fiat currencies after the collapse, but this seems unlikely as by definition only the rich will hold significant quantities of precious metals, we know the rich control the government, so it seems unlikely to take wealth from yourself and give it to the lower class. But this may not be the case in third world (low priced labor) countries that become destabilized and vear back towards communism, after failure of their experiment with capitalism. And I expect controls on movement of assets by the lower class in stable countries (in order to maintain stability and wealth disparity). Having *LIQUID* assets in numerous stable countries will probably be the most successful strategy. Silver & gold mining and ETF stocks are a possible fit to this strategy. However, it is possible that only holding physical precious metals will be safe in the catastrophic crash, because every "Peter will be looking to rob Paul" in order to survive. Laws will likely be treated with inpunity, because humans are animals who act more unpredictably when backed into a corner.

If we expect silver bullion to increase up to 4000%, then we can expect selected silver mining stocks to increase several times that, due to the phenomenon that mining stock profits increase proportionally (as percentage) more than the increase of the price of the metal they produce, due to the fact their cost of mining does not rise proportionally. A wild card is the cost of energy (as an input to mining costs) rising proportionally, but as stated above, the price of energy is priced in earlier than for precious metals. Thus, we could expect select silver mining stocks to appreciate 100 - 400 times. Imagine only $2,500 - $10,000 invested today, could make you a "millionaire". LEVERAGE! Is it not worth investing at least 5% of your portfolio in silver mining stocks just to for the chance you may join the upper class in a few years, not to mention insurance against moving from middle to lower class status in a few years?

Disclaimer: I am not an investment advisor. Nothing herein should be construed as investment advice. Use the above at your own risk. I am not responsible for what you do with the above information. This page is my personal opinion and my employer takes no responsibility for the content of this page. Consult your own advisors.

Copyright (c) 2006, Shelby H. Moore III.
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