Monetary contraction, deflation and gold

Societies and their economies are complex systems that are not easily explained and whose dynamics are too complicated to be captured by statistical and econometric linear models. These linear models come from the linear nature of human thinking.

I hear people that favor the theory of an imminent sudden inflation as credit and the monetary base expand, and others that believe the only thing we will see is a job-destroying deflation that will only be stopped by a centrally-planed monetary policy.

What I think is that both maybe right. The only question is timing, just the same as the markets. Markets can stay irrational longer than you can stay solvent, says a market saying. The general economy may refuse to follow the path designed by planners because there is more to the economy than just the monetary base plus credit. The economy needs energy to move, and energy can't just be printed. The less energy you have, the more restrictive credit and money become if unstable economic processes are to be avoided. Therefore, the use of credit and money has the effect of a drug for the economy. They can boost it during some period, but the sustained use of those must be matched by an equal sustained use of energy. If no new energy is added to the system, inflation will appear but, at the same time, asymmetric access to credit and money can lead to deflation in those sectors affected by a late access to them. However, this is nothing but transitory, and money will flood the markets like a tsunami as credit is suddenly liberated by banks, usually responding all at once to a fear stimulus.

That is brilliantly described by Mike Maloney at his conference in Puerto Rico. His thesis, which I support, describes a scenario in which first a deflation will occur, and then an inflationary or hyperinflationary process will start some years later.

I think that is what we are seeing now. As I reported, the M1 monetary base is contracting in the Mediterranean countries and credit is inflating the housing bubble in Germany and Austria.

For this reason, gold may go down in the following months and still be an excellent investment, maybe the investment of your life. Do not pay attention to the permabull gang of KWN, they sell bullion, they tell you it is a bargain at USD600 and at USD1900: if it goes down is on manipulation and is forming a bottom, if it goes up then we are days away from going to infinity.

Jim Rogers and Marc Faber, who I regard as two stand-up and achieved investment professionals and honest individuals, have been saying in numerous occasions that gold dynamics are very strange and they expect some kind of important correction. Pay attention to them, they tell you for the sake of telling you. Make a little room in your heart for deflation.