Hyperinflation or Hyperdeflation? We'll Find Out Soon

08/30/2012 10:30 am EST

Focus: MARKETS

While governments around the world try to dig out of the hole that was once a vibrant global economy, cheap-money policies are accelerating the digging rather than the filling, warns Doug Casey of Casey Research in an interview with The Gold Report.

The Gold Report: There will be a Casey Research Summit on "Navigating the Politicized Economy" in Carlsbad, California in September. Investors from around the world look to these summits as future road maps for investing pitfalls and opportunities.

The thesis behind the Summit is that governments have made a Faustian bargain—a pact with the devil—that saves the empire with overspending, but drives it to the brink of collapse by creating fiat currencies. Doug, where in that story is the economy currently?

Doug Casey: It's extremely late in the day. Since World War II, and especially since 1971 when the link between the dollar and gold was broken, governments around the world have accepted the Keynesian theory of economics, which boils down to a belief that printing money can stimulate the economy and create prosperity.

The result has been to create huge amounts of individual and government debt. It has become insupportable. All it has done is purchase a few extra years of artificial prosperity, and we're heading deeper into a very real depression as a result.

Let me define the word "depression." It's a period of time when most people's standard of living declines significantly. It can also be defined as a time when distortions and misallocations of capital—things usually caused by government intervention—are liquidated.

We have been consuming more than we have been producing and living above our means. This has been made possible by:

  • borrowing against projected future revenues
  • using the savings of other people

The whole thing is going to fall apart. A new monetary system of some type is going to have to necessarily rise from the ashes. That's a major theme in the conference that's coming up.

The Gold Report: Will more quantitative easing (QE) give us another couple years of artificial prosperity?

Doug Casey: Most unlikely. We're at the end of the story, not the beginning. More QE—I hate to call it that because it's really just printing money. I hate euphemisms, words that are intended to make something sound better than it really is. Euphemisms, like exaggerations, are the realm of politicians and comedians.

Anyway, the next round of moneyprinting is going to result in radical and rapid retail price rises. There is no prosperity possible from this—rather the opposite.

The Gold Report: Last time we spoke, you said that we are entering into a depression greater than in 1933. Can you describe how it might be different?

Doug Casey: What we experienced in the 1930s was a deflationary depression where billions of dollars were wiped out with a stock-market collapse, bond defaults, and bank failures. Inflationary money that was created since the formation of the Federal Reserve in 1913 was wiped out. Prices went down.

This depression will be different because governments have much more power. They'll try to keep uneconomic operations from collapse; they'll prop them up, as we saw with Fannie Mae and General Motors (GM). They'll create more money to keep the dead men walking.

They won't allow the defaults of money market instruments. They will make efforts to maintain the dollar mark on money market funds. They'll attempt to keep building the pyramid higher. It's foolish, indeed idiotic. But that's what they'll do.

The Gold Report: Which they've been doing by printing money. The first rounds of moneyprinting have gone into the banking system, but the banking system has not allowed it to trickle back out into bank loans. Does that open the possibility of deflation if money is not moving out into the general economy?

Doug Casey: That's right. The government created trillions in currency to bail out the banks. The banks have taken it in to shore up their balance sheets, but they haven't lent it out because they're afraid to lend, and many people are afraid to borrow.

That currency is basically in Treasury securities at this point. Although money has been created, it's not circulating.

At some point, it's going to move out. One consequence of this is that interest rates have been artificially suppressed, so that retail inflation is running much higher than interest rates are compensating for it.

At some point, rather than sitting on hundreds of billions of dollars that are going to be inflated from under them, the banks are going to do something with that money. It will go out into the economy. Retail prices will start rising.

The Gold Report: Do we need to see another round of moneyprinting to put us over the brink into a collapse? Or will it happen even if they don't print more, because it's currently sitting in the banks?

Doug Casey: They actually don't have to create more money. It's just a question of whether the banks start lending it and people start borrowing it. Another possibility is that the foreigners holding about $7 trillion outside the US get panicked and start dumping them.

I don't see any way around much higher levels of inflation—unless, of course, we have a catastrophic deflation, which we almost had with the real estate collapse.

The Gold Report: How much will Europe play into this? It seems its governments are, at least according to the popular press, more exposed to bankruptcy than the US government.

Doug Casey: Europe is a full cycle ahead of the US. Its governments and its banks are both bankrupt. It's a couple of drunks standing on the street corner holding each other up at this point.

Europe is in much worse shape than the US. It's highly regulated, highly taxed, and much more socially unstable. Europe is going to be the epicenter of the coming storm.

Japan is waiting in the wings, as is China. This is going to be a worldwide phenomenon. Of course, the US will be in it, too. We're going to see this all over the world.

The Gold Report: If Europe finally does go over the brink, where it's been headed for more than a year, would that also cause inflation in the US, or would you expect to get catastrophic deflation?

Doug Casey: This is an argument that's been going on for at least 40 years. How is this all going to end: catastrophic deflation or runaway inflation? The issue is still in doubt, although I definitely lean toward the inflationary scenario.

But will it start in Europe? How will it start? These things only become obvious after they happen.

The Gold Report: When you say "lean," are you pretty convinced it's going to be inflationary?

Doug Casey: I think it's going to be inflationary; in the 1930s, it was a deflationary collapse. Governments are vastly more powerful and much more involved in the economy now than they were then. I believe that they have the power to create enough new currency to keep prices from going down. Somehow, moronically, they've conflated higher prices with prosperity.

If we had a completely free market economy, prices would constantly be dropping. That's a good thing, because as prices constantly drop, it means money becomes more valuable. That induces people to save money. When people save, it means that they are producing more than they are consuming—that's a good thing.

The way governments have it structured today, however, prices are always going up. That discourages people from saving, because their money is constantly worth less, which encourages them to borrow. Inflation induces people to try to consume more than they produce, which is unsustainable over the long run.

The Gold Report: You are saying that if the current value of your money is higher than the future value, that encourages borrowing.

Doug Casey: Exactly. I don't see any possible happy ending to this. We're approaching the hour of reckoning.

The Gold Report: You have said that the titanic forces of inflation and deflation are fighting an epic battle that leads to extreme market volatility. But I am looking out there this summer and thinking it's pretty calm.

It seems like a very slow recovery. Gold is settling around $1,600/ounce. The S&P 500 index is testing the 1,400 mark. Is this just a pause in the epic battle?

Doug Casey: Nothing goes straight up or straight down. I just took a cross-country car trip from Florida, up the East Coast to New York, and then out to Colorado. It was actually rather shocking that many times I had trouble getting a motel room—even in the middle of nowhere. The restaurants were full. The highways were full of cars. It looked more like a boom than a depression.

At the same time, our real unemployment, figured the way they used to figure it in the early 1980s, is about 16% to 20%. People are living off their credit cards. I believe it's the same in Europe.

Subscribe to The Gold Report here...

Related Reading:

Life, the Universe, and Everything

MoneyShow Sentiment Indicator: Cash Is Still King, Fear Queen

Emerging Market You Haven't Considered

Related Articles on MARKETS