Wednesday, September 17, 2008

The Debts of the World: Hyperinflation Meets Hyperdeflation

I admit I was wrong about gold and continued dollar strength this week. All of the classic history cases have gold rising solely due to hyper-inflation. Most of the gold bug web sites and other subscription channels repeat the hyperinflationary environments astheir textbook cases to go long gold.

I based most of my analysis on the Japanese deflation of the 1990s inthe wake of their market crash. During the 90s gold sold off a little and didn't rise much. This is because in Japan, the process was moreor less orderly and well managed by the government and big banks.

The USA is different. I assumed the Fed and Treasury would be able to manage things in much the same way as the Japanese and hold things off until after the election is finished. Instead, the debt monster has grown so huge that the efforts of the government and banks to gently unwind the beast have failed repeatedly. They know the trend is down and are trying to calm things in an orderly fashion but are losing power. Each time they intervene there is less and less effect. This is the law of diminishing returns.

The catalyst for gold's super rise today was the bailout of AIG latelast night. People got scared that the markets will fall faster and harder down the road. Also, treasuries have reached capitulation.Foreigners are beginning to exit the dollar and focus on protectingtheir own countries' economies.

Conclusion - We are in an environment of both hyperinflation and hyperdeflation. This is normally an impossible thing to achieve. However the USA's unique position as the biggest debtor in worldhistory living well beyond its means is responsible for the current market environment.