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inflation versus deflation

(March, 2001)

The question of what type of pricing environment we can reasonably expect in the overall U.S. economy in the months and quarters ahead is germane to the health of the rare coin market.  Historically, as we have expounded within these electronic pages many times in the past, U.S. rare coins have done best in times of noticeably rising prices, i.e., in inflationary times.  Now, anyone who shops for food, heats a home, operates an auto or SUV, pays for life and/or health insurance, pays property taxes, rents or buys a home, in essence, just about all of us, has to look at the government published CPI data with skepticism.  Many of us suspect that this data was overtly manipulated for political reasons during the Clinton Dynasty, but we all want to be reassured now that we are  under new management with Dubya.  However, until new methodologies are employed (and maybe totally new staff), the hedonic adjusted data is going to miss the mark in emulating real life.  As a businessman, I know my costs of operation are going up about twice the purported 3.5% year-to-date 2001 CPI annualized rate in many categories.  But this is the obvious, in-your-face evidence.  Let's look at the not-so-obvious arguments in the other direction before we return to support the argument for rising inflation.

There are equally (and possibly more compelling) arguments on the side of a pronounced deflation in the United States.  I am going to list the most significant ones in order to put them into perspective:

1.  Loss of financial wealth in excess of $4 Trillion since March, 2000 in NASDAQ stocks alone.

2.  Corporate junk bond defaults approaching the recessionary level of 5% to the tune of several $100 Billion lent to evaporating telecom's and's.

3.  Personal bankruptcies in excess of 1 Million filings for the last 3 years during supposedly one of the strongest economies ever.  What percentage/dollar volume of credit card debt and home mortgage debt will go bad during the current recession?

4.  Hundreds of Billions of Dollars lent by the United States directly and through the IMF to such low-grade credits as Russia, Argentina, Brazil, Malaysia, Turkey, etc., etc., etc., that don't have a snowball's chance of ever being repaid.

5.  The greater than 50% probability that we are in a multi-year secular bear market that will diminish U.S. financial wealth by another $4 to $5 Trillion.

6.  Derivative positions on interest rate swings, currencies, equities, and don't forget gold and silver bullion that exceed $100 Trillion that have a better than 35% probability of going the way of Long-Term Credit Management.

These are huge numbers, many times the size of the U.S. economy's annual production of goods and services of some $5 Trillion.  These magnitudes alone and because many of these deflationary areas can be reasonably estimated today, if not in the future, leads me to believe that we are more likely to experience an overall deflation.

I am as tired of being Chicken Little as my peers are of hearing my pronouncements of "The Sky Has Fallen", but the recession we are in (probably since September of 2000) is not going to be mild and short.  The misallocation of resources, in this case capital-money-dollars, has been so extreme in this cycle, that many peg as beginning in August, 1982 (including Sir John Templeton), that the corrective process need be as extreme in magnitude and duration to get back to balance.  People laughed at me when I started withdrawing from the financial markets beginning in the Fall of 1997, but those same people are not laughing today.  What heady profits I left on the table since that time (after 16 years straight of being in equities) have been balanced by dividends, rare coin profits, and the absence of speculative stock margin debt, a tonic absorbed by many latecomers to the Greenspan Bubble.  The late Will Rogers put it so aptly when asked about buying stocks and he smirked that he was more interested in the return of his principal than the return on his principal.

Remember, that we may not see the results of this unprecedented disappearance of wealth or assets immediately, but it is hard to imagine that the net effect on the U.S. will not be a significant retrenchment in most spending for capital investment and consumption.  Nothing is linear in life, not even the NASDAQ, so I think we are in the initial adjustment phase where business activity is slowing faster (due to gross overcapacities) than personal consumption.  The populace is badly spoiled at being able to have every want fulfilled with credit, but as layoffs mount, this avenue for instant gratification will reverse and lenders will tighten accordingly along with borrowers.  And in addition to moving in distinct phases, the painful adjustment period ahead will also exhibit the simultaneous push/pull of inflation and deflation. 

Before I have us heading into The Great Depression of the Not-So-New Millennium, let's look at some very strong forces at work to re-inflate the economy and the general level of prices:

1.  Our central banker, Mr. Greenspan, is determined to mitigate these deflationary forces by rapidly slashing the cost of money and standing ready to serve as the "lender of last resort".  Throw good money after bad.  Crank up the printing presses.  Money, in all its diverse forms today, will be allowed to be created in limitless quantities to provide liquidity to a system that risks becoming illiquid at any moment due to the defaults of businesses, consumers, and speculators.

2.  The Government Sponsored Enterprises (Fannie Mae, Freddie Mac, etc.) will continue to expand their balance sheets at a breakneck pace in the pursuit of heady annual bonuses and add Billions of Dollars of fodder to the money supply in the process, outside of the control of the Fed and, currently, Congress.  Up until the point when mortgage defaults start setting new records, of course.

3.  Energy prices are probably headed to the moon in the next decade as the U.S. is caught with its knickers down thanks to the lack of an energy policy during the Clinton Dynasty.  It will take a minimum of 3 to 5 years to bring new oil/gas resource production and electric generating capacity online, so just pray that the missiles don't replace the rocks in the Middle East.  We will pay dearly in many ways for our current biased policy in this region.

4.  Due to the provision of cheap credit for new and refinanced mortgages by Greenspan and the GSE's, residential and commercial real estate prices are now seeing annual gains matching the 1989 / 1990 peaks in the previous cycle of 8% to 10%.  However, as the boom turns to bust, many homeowners are likely to have negative equity in the next several years with minimal 5% down-payments common today.  Sound familiar?

5.  A strong Dollar policy which has conveniently exported our inflation for the last ten years plus is likely to come to an abrupt end as U.S. credits sour along with our stock market and our interest rates attempt to mimic Japanese levels.  Imported goods, those that we are so addicted to, are likely to rise significantly even as overseas exporters strive to hold or reduce prices in the global slowdown, recession, or worse.

6.  Food prices are likely to rise due to the widening threat of contaminated meat in Europe, the reversal in the acceptance of bio-engineered crops, and the re-emergence of severe global weather systems, not to mention the disruptive effects of progressive global warming.

Note how I have failed to quantify the dollar effects of impending inflation while the figures just rolled off my keyboard for the current deflationary forces.  The deflation is here and now (and growing!), and can thus be quantified, while the inflationary elements are building steam.  So we have a true conundrum that defies simplistic analysis, but readily reveals its main components.  Since the elements of deflation appear to outweigh the elements of inflation, current and projected, the question remains how it will affect U.S. rare coins and gold/silver bullion coins and bars.

I think as the financial markets continue to ravage investors' portfolios and nest-eggs, alternative investments will continue to be sought after.  And this means seeking out both neglected and undervalued asset classes.  Think of the historical performance of these rarities that will never be produced again, and think how the number of collectors and investors grows with the population, at a minimum.  While some recent coin shows in 2001 have produced mediocre responses from participants, I think we are still in a transition period.  Long bear markets don't always turn into bull markets in dramatic fashion, the so-called "V" pattern.  (This "V" is now being forecast for the U.S. economy by economists that have been as accurate as Clinton was truthful.)  Gold and silver bullion prices haven't helped, but those markets are not free, they are as manipulated as Wall Street has been for years.  There is abundant, growing, and verifiable evidence to support this thesis.  Bullion prices will eventually aid the U.S. rare coin market, and one more financial upheaval that decimates faith in our markets, our government, and/or the U.S. Dollar will set them free.  Such an upheaval is lurking in the inflation versus deflation conundrum.

We will label the U.S. rare coin market today in a Stealth Bull Market, because overall prices are holding, while specific types and series such as the $2.50 Indian Gold series minted from 1908 through 1929 are doing very well indeed.  Patience serves both collectors and investors well over the years.  This is a time for patience.  Foresight is also invaluable.  Now is a time for being able to recognize that the light at the end of the tunnel is indeed a speeding train.  Buy And Hold ..... an axiom that lends itself more to numismatics today than to any financial asset available.


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