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Formulating a Strategy when Inflation and Deflation Stare You in the Face

by James Rickards

Today’s investment climate is the most challenging one you have ever faced.

At least since the late 1970s, perhaps since the 1930s.

This is because inflation and deflation and deflation are both possibilities in the near term.

Most investors can prepare for one of the other, but preparing for both at the same time is far more difficult.

The reason for this challenging environment is not difficult to discern.

Analysts and talking heads have been wondering for five years why the recovery is not stronger. They keep predicting that stronger growth is right around the corner. Their forecasts have failed year after year and their confusion grows. Perhaps even you, who have seen scores of normal business and credit cycles come and go for decades, are confused.

If this “cycle” seems strange to you there’s a good reason. The current economic slump is not cyclical; it’s structural. This is a new depression that will last indefinitely until structural changes are made to the economy.

Examples of structural changes are reduction or elimination of capital gain taxes, corporate income taxes and the most onerous forms of regulation. Building the Keystone Pipeline, reforming entitlement spending and repealing Obamacare are other examples.

These are other structural policies that have nothing to do with money printing by the Fed. This is why money printing has not fixed the economy. Since structural changes are not on the horizon, expect the depression to continue.

altHow can there be a depression?

Well, let’s take each one by one.

The soup lines are here. They’re in your local supermarket. Government issues food stamps in debit card form to those in need, who just pay at the checkout line.

Despite popular beliefs, unemployment is at 1930s levels too. If the Bureau of Labor Statistics measured the rate using the Depression-era method, it would be much higher than 6.2%. Also, millions today are claiming disability benefits when unemployment benefits run out — that’s just another form of unemployment when the disabilities are not real or not serious, as is often the case.

What about prices? Here the story is different from the 1930s. Prices declined sharply from 1929–1933, about 25%, but they have been relatively stable from 2009–2014, rising only about 10% over the five-year period.

The Federal Reserve’s money printing is responsible. The Fed had an overly tight monetary policy in the early 1930s but has employed unprecedented monetary ease since 2009. Ben Bernanke, who was in charge at the time, was reacting to what he viewed as the erroneous Fed policy of the 1930s. In a 2002 speech on the occasion of Milton Friedman’s 90th birthday, Bernanke said to Friedman, “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

But this did not mean that Bernanke had single-handedly discovered the cure for depression. Fighting deflation by itself does not solve the structural problems of the economy that lead to depressed growth. Instead, Bernanke, and now Yellen, have created an unstable dynamic tension.

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