Inflation and Deflation: Two Sides of the Same Coin!

The most frequently asked question I seem to get is, “Larry, don’t you see hyperinflation for the U.S. in the years ahead?”

It’s understandable. After all, we have seen the U.S. Federal Reserve print trillions of dollars. We see, in real life, most costs rising.

And there is no shortage of pundits out there proclaiming the U.S. will soon experience hyperinflation.

So let me clarify my position, here and now: There was a time when I expected the U.S. economy would eventually experience hyperinflation.

But in September 2011, when the price of gold failed to react to the Fed’s QE III announcement of virtually unlimited money-printing and the yellow metal entered an interim bear market, I knew something had radically changed.

So I further researched the known periods of hyperinflation in the world. And I found something that completely changed my view: There has never been a major core economy that has died at the hands of hyperinflation.

There was the Weimar Republic, of course, but it was not a core economy for the world. And even more important, the Weimar Republic’s infrastructure had been wiped out, and it had no bond market to boot — a market that could contain inflation via bond vigilantes, who would inevitably send rates high enough to kill it off.

Then there are the hyperinflations of Zimbabwe, Brazil, Argentina and countless other small economies that were never at the core of the global economy, and importantly, also didn’t have bond markets deep or liquid enough to counteract the forces of inflation and hyperinflation.

And upon further study, I found that even the Roman Empire, certainly a core economy during its reign, didn’t even die of hyperinflation. 

It died largely because of abuse of power by politicians, which drove citizens away from the Empire. By rapidly rising taxation, which had the same effect; and by a corrupt Treasury and justice system that tracked down and confiscated citizens’ wealth, largely to fund increased military campaigns, which were hoped to revive the Roman economy. Sound familiar?

Was there high inflation in Rome before it fell? Yes, but nothing like the hyperinflation we saw in Weimar Germany or any of the countries I mention above.

So, then, what does the U.S. economy face? Further disinflation, outright deflation, eventual reflation or something else?

My view, and I am not hedging my answer or talking out of both sides of my mouth: We face a combination of further disinflation in the short term, followed by a rather large jump in inflation years from now.

But we don’t face hyperinflation, period. Our economy, even as it is eclipsed by China a few years from now, is a core economy.

Our bond markets are too deep and liquid, and our bond vigilantes, ever sensitive to inflation, will simply not allow hyperinflation to ever emerge in our country.

How high will inflation eventually go? It’s hard to say, but I wouldn’t be surprised if three years from now, we see 20 percent or even 25 percent inflation.

But I highly doubt we will ever see inflation in the thousands or even millions of percent. It’s just not possible in our economy, which is at the core of the global economy, and given our deep, liquid bond market.

Whether we have deflation or inflation is also the wrong way to think about the U.S. economy.

The reason? Ever since we abandoned the gold standard, inflation and deflation have become two sides of the same coin.

In other words, they are both present in the economy at the same time. You can have certain goods and services and even asset classes deflating, while others are inflating. It’s as simple as that.

Ever since we abandoned the gold standard, inflation and deflation have become two sides of the same coin.

For instance, the price of LED TVs has crashed, as have the prices of laptop computers, cell phones and many other goods. Not to mention real estate prices since their peak in 2007.

Meanwhile, other items have experienced inflation. Food prices, legal and health-care services, and more.

So it’s not a matter of one or the other, it’s a matter of what sector is inflating and why, versus which sectors are deflating and why.

Nevertheless, there’s another important underlying force that you need to understand, another one that resulted from the abolishment of the gold standard.

A certain level of general, system-wide inflation is always baked into the cake.

It’s due, again, to the fact that we no longer have a gold standard. But it’s also due to many other forces, such as population growth, limited availability of natural resources, the constant desire for people to improve their lives and more.

This is important to understand, because it’s the chief reason prices will be higher a year from now, five years from now and even 10 years from now … no matter what the U.S. or global economy does.

For instance, $5,000 in cash squirreled away in a bank in 1913, when the Federal Reserve was created, is now worth only 4.13 cents. That’s right: 4.13 cents. 

Put another way, it would take $121,000 of today’s money to buy what $5,000 would have bought in 1913. 

Want more recent examples? Consider the following …

It now takes $6,760 to buy what $5,000 bought just 14 years ago … $8,910 to buy what $5,000 bought in 1990 … and roughly $30,000 to buy what $5,000 bought in 1970.

Even a McDonald’s Big Mac, which cost a mere 57 cents in 1959, now costs about $3.99, an increase of 600 percent, for an average annual increase of just nearly 11 percent a year.

The bottom line: There are several.

First, we have, and pretty much always will have, a base level of inflation in our economy. It’s the natural state of things.

Second, that said, inflation and deflation are again, two sides of the same coin. While there will always be prices and sectors that inflate, there will also be prices and sectors that simultaneously deflate.

Just consider the stock market, which is inflating. Or the dollar, which is also inflating, its price rising, which in turn, causes deflation in certain other assets, namely commodities, because the inflating dollar automatically purchases more of those goods.

And third, and perhaps most importantly, never let anyone convince you the U.S. is headed into hyperinflation. It simply will never happen. Buy into their theories, and you will lose your shirt, failing to recognize the yin and yang of the markets, the deflation and inflation that are both ever present.

I repeat, I am not talking out of both sides of my mouth. Deflation and inflation are ever present, two sides of the same coin.

Once you recognize that, you will become part of the savvy investor crowd, and you will be able to follow the money flows as they shift from sector to sector, asset to asset, based on the ever present and ever changing faces of inflation and deflation.

Gold and other precious metals are still largely on the deflation side of the coin, and I sure hope you have taken advantage of my recent suggestions to purchase inverse ETFs on both. If you have, you should be sitting on some very nice gains indeed.

Best wishes,

Larry