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Deflation: Great for Gold

At last year's New Orleans Conference, we had a chance to chat with ultra-deflationist Bob Prechter. Prechter, author of a brilliantly written book called Conquer the Crash, believes that asset prices across the board (stocks, gold, real estate, etc.) are due for an enormous meltdown. He correctly points out how record high fiscal and consumer debt combined with record low savings rates have created various bubbles in several asset classes. After laying out his compelling case for a deflationary depression, Prechter explains why gold and silver will not serve as safe havens for the bloodbath he envisions. In the next few paragraphs, we will clearly and concisely explain why Prechter's argument is flawed and why gold and silver should indeed be big winners in any upcoming deflation.

For purposes of this discussion, let's define inflation/deflation in terms of rising/falling prices rather than a higher/lower money supply. Many of our fellow bears recognize that a crisis is coming, but no one seems to agree on whether it will look like the inflationary 1970s or the deflationary 1930s. Both camps have good arguments. Those who predict inflation point to a reckless Federal Reserve and compare our situation to Argentina or Weimar Germany. Those who see America approaching the tipping point of deflation/contraction take a look at the amount of credit outstanding in the world and correctly observe that it takes more and more debt to produce the same amount of GDP - "pushing on a string" if you will. Finally there is a third camp that seems to think that we will have inflation in commodities while at the same time deflation in financial assets.

Prechter is clearly in the second camp and suggests investing in "cash" despite the Dollar's shaky fundamentals. He correctly shows how holding cash during a period of falling prices creates amazing investment opportunities once the bear market has wreaked its havoc. His book goes through every investment class and tells how it performed during the Great Depression. Stocks, corporate bonds, real estate, collectables and commodities are all categorized as investments that did not perform well in the 1930s and should therefore suffer dearly in the upcoming crisis. The only investments that shined during the Depression were cash and cash equivalents such as gold. (Because at the time, the US Dollar was fixed to gold) However today, since there is no official link to the US Dollar, gold is lumped into the "commodities" category and deflationists will tell you to avoid owning shares in mining companies like the plague.

The lumping of gold (and silver) into the "commodities" category is where we believe the deflationists' flaw lies. Precther and his deflationist brethren should understand that unlike the 1930s when the US Dollar was literally as good as gold, the greenback today is nothing more than an IOU backed by the full faith and credit of our government. Their suggestion to hold cash during the upcoming crisis is wise, except we believe the correct form of cash to hold is gold and silver, not dollars.

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