How A Deflationary Credit Contraction Will Unfold Part 2

Continued from Part 1

Right Back Where We Started From

It seems to me we are heading right back to where we were, despite the media uproar over the latest $600 billion round of Bernanke nonsense. Nicole Foss explains we are simply extinguishing the excess claims to underlying real wealth. It is the collapse of debt that is occurring. Foss likens it to a game of musical chairs with 100 people and one chair. Good luck clamoring for that one chair. She says that credit is over 95% of the effective money supply. This is what the inflation hawks don’t address.

Foss goes on to say that markets invite speculation. She says that prices only reflect perception of things, not actual reality. So yes, it is possible for traders to jump on board a trend and push prices higher than would normally occur. The repercussions of this can be seen with the fall in the price of sugar, as an example, of over 12%, the biggest drop ever that occurred just last week.

Price Discovery Coming Soon

Foss believes there is a price discovery coming soon. While mark to market accounting has hidden true values, those in the know are calling it “mark to make believe.” Banks have been doing this for quite some time with the FASB easing of mark to market rules instituted in 2007.

What we have with many assets are what Nicole Foss calls “virtual wealth.” Until that wealth is cashed in and turned into real wealth, it can’t buy your groceries. This is what most people don’t understand about wealth, especially in a deflationary scenario.

Does Your Home Ownership Constitute Wealth?

What happens when you can’t sell your home? Is that home considered real wealth if you can’t spend that wealth? If you can qualify for a loan against what’s left of the value of the home, sure. But if you decide to move to a state with less taxes for example, or even want to rent instead of being a home owner to allow for flexibility should it be needed as the economy deteriorates, good luck selling that home in a market where there are no buyers.

That’s why keeping an eye on unemployment, which is not improving and has no prospect of improving in a nation of spenders, not producers, is an important piece of the puzzle. You need employed people to buy your home.

How will this person turn that illiquid wealth represented by their real estate  into spendable wealth?  These are decisions that should be made today, while there is still a possibility of getting out. I present a further analysis of how this deflationary credit contraction unwinds in Chapter 4 of my book, “Buy Gold and Silver Safely.”

Higher Interest Rates Will Trigger Future Debt Defaults

As this deflationary credit contraction unwinds, there will be a reluctance to spend and a fall in the velocity of money. The Fed and government can’t force people to spend and even dropping money from helicopters or handing people money would see them either pay off debt or use for necessities. Are higher interest rates good for the economy, or bad?

The above scenario with real estate and prices in general is what higher rates would precipitate. The economy comes to a halt. Consumers and businesses stop spending. Real estate prices would fall further. With people not spending, prices will fall. Foss says that like oil in the car that keeps the engine functioning. Money is the oil of the economy. Without people spending it, the economy contracts. In the 1929-1933 deflationary episode, prices fell 66%. Foss says it will be much worse today.

Inflation Eventually

This doesn’t mean that eventually we won’t have inflation rearing its ugly head. You can count on Bernanke and company to implement quantitative infinity. The inflation hawks will claim victory, albeit with some egg on their face as 2008 recently revealed. Inflation will come. But any talk of hyperinflation is premature at this point. Deflation is the story of the day.

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About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534


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