Ok, there's a lesson for me, don't type 2500 words into a web browser without saving them elsewhere first. Sigh.
Ok, I’m going for a redo!
A lot of people, here and elsewhere, get confused over the meaning of inflation and deflation. The government uses a “market basket” approach to measure inflation, a rubber ruler at best.
The true definition of deflation is a contraction in the money supply. Inflation is an expansion in the money supply. While either can affect prices in a broad way, neither is directly connected to the price of any single item.
For example, suppose some company develops nano assembler technology that allows for the building of anything, an atom at a time, in a matter of a few seconds. Dump scrap iron, a few trace elements and some old tires into the hopper, out comes a new car. Put in a batch of silicon, aluminum, old plastic and some odds and ends of glass and a tiny bit of gold and some copper, out comes a new computer. Or a new nano assembler device comes out the far end, and production doubles.
Of course, the production cost of all consumer goods falls to the cost of raw material (plus electric cost of running a nano assembler) at once. Food prices would go crazy, as bakers closed shop due to hot loaves of perfect bread being produced by the nanos. Cattle would roam wild, as nobody could pay for the slaughtering and transportation costs and compete with the cost of simply building a steak or a gallon of milk.
Prices would fall to as close to zero as can be imagined, there would be immense economic chaos, but there would be not one bit of deflation in the real sense of a change in the money supply. (One would expect the money supply to undergo enormous INFLATION, as soon as people caught on to the idea of mass producing perfect 100 dollar bills – in fact, money would be replaced by something else, but this would be the final end of every existing economic system based on production and consumption – IOW, all of them.)
Production improvements and discovery of new resources have a much larger impact on prices than rises and falls in the money supply, certainly over the short term and very often over the long term as well.
For a real world example, silver to gold price ratios were reasonably stable for centuries at about 12 to 1 (yes, some say 15, some say 10, some only point to peaks at 5, but 12 to 1 is about average) and it held in that range for a very long time indeed. With the discovery of the Comstock Lode, that ratio changed, and now it holds at an average of about 45 to 1 – at this moment I do believe it’s about 62 to 1, though that might change at any time (and does point to either silver being undervalued, which I doubt, or gold being in a bubble, which seems very likely, IMHO). This had to do with a growth (or inflation, if you will) in the physical supply of silver itself, nothing else. And it is bloody well worth noting here that I’ve read a great many rah rah buy silver lectures on the Internet, and I honestly cannot recall a single one that mentioned the Comstock Lode. Certainly there were very few that mentioned it.
Gold coin as money does not prevent inflation, as the history of the Roman Empire (and a great many others) plainly show, the Romans inflated their money by debasing the gold content of the coinage, and the later coins from the Empire assay out very poorly. One would do well to remember the jeweler’s secret, mixing gold with any metal with a lower density will give a much larger volume of gold of the given carat number than would be expected from the relative weights. A 50% (12 carat) by weight mixture of gold with another metal may very well result in a much lower ratio by volume.
There isn’t much reason to demand a constant money supply either, unless you have both constant production and constant population, though that’s another subject.
The reason for the above is simply this, I dislike arguing definitions and historical facts and the above are the definitions and starting points I use in economic discussions. Talking to people who aren’t using the same definitions is unprofitable, and at least if they disagree, we know where we disagree.
With all that as a starting point, given that we live in a credit based economy, credit is money. This would have no effect, save for the fact that bankers can issue more credit than they have in capital. Therefore, banks can create money in the form of credit. Many point to the fact that debits and credits have to balance to naysay this, but in fact I can spend credits and buy anything I wish. Until both checks and credit cards are refused at the stores, it’s just a fact, credit is money.
When bankers created a great deal of unsound credit over the last few years, they created a lot of money on a very bad basis. In effect, they watered down the currency, inflating it hugely. This inflation, of course, was reflected in the increase in prices in the rest of the economy, though it was very interesting to see that the Fed moved to force most of this inflation into the stock market. As long as the debt bubble held up, this inflation could continue, and it put trillions into the pockets of the people who were driving it.
Now it’s over. As these debts are written off, that money disappears from the money supply and the money supply shrinks, thus, we are in a deflationary period. The Fed is drastically intervening to limit (not stop) deflation by pouring money into the banks to slow or prevent the write offs/mark downs. (Nobody seems to be pointing out that the Fed is supposed to REQUIRE the mark to market, by law, and to punish those who don’t, but again, another subject. Well, nobody besides John.
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Since neither the Fed nor the US government has the money to prevent the write offs, we are in for a very protracted period of slow deflation, which will accelerate in two years when the government is forced to stop propping up the banks for a half dozen very good reasons, though number one will be the upcoming elections.
So I agree with John about being in a deflationary period, though I do temper this with the statement that we may or may not see certain consumer prices decline during the period. Deflation doesn’t mean every price falls or falls equally.
As for gold, gold appears to me to be in a bubble. I was in Kuwait City recently, and the Kuwaii papers were up in arms about the price of gold going to 7.5KD per gram. Silver was getting premium space at the Marina Mall, and the Kuwaii seem to be sitting on their hands as far as buying gold at that price. Many are reporting the same all across the Mid – Far East, the traditional buyers of physical gold have just stopped. If what I saw in KC in February is typical, that’s exactly what is going on.