Support for Prechter & Deflation

Check out this article by Adrian Ash: Gold's Big Secret - No One's Actually Buying
No one's actually Buying Gold right now. Not the physical metal (and not the exchange-traded trusts either), not at anything like the rate they were buying a year or six months ago. Instead, this rush differs in kind from the surge of autumn '07 or the panic of late '08. Because it's a rush almost solely in leverage.

Hedge funds and prop desks have been buying Gold Futures and options with virtually free finance. Hence the surge in stocks, bonds and commodities too, of course. Because anything traded on margin looks a safe bet when finance costs you 1% or less per year. And especially when your major funding currency – the long mighty but now tired and emotional Dollar – is universally condemned to fall further.

John Hathaway of Tocqueville Asset Management called a similar rush into gold a case of mistaken identity back in late 2006. "Perhaps hundreds of billions of new institutional money has flowed into the commodity sector," he wrote. "Gold was caught in the cross fire..."

Here in late 2009, however, the institutional money is borrowed, not cash, and the prime brokers (formerly known as investment banks) are doing the lending with government-guaranteed finance. Since the end of August, open interest in Comex gold contracts has swollen by more than one third...the fastest jump since late 2007, back when the Fed began slashing rates, oil vaulted towards $150 per barrel, and the run on the banks really got started.
There's a difference between inflation in assets and inflation in physical assets. The lack of buying signals that the inflation scenario has yet to take hold, and until it does, the threat of deflation remains. Asset inflation, as we saw in 2008, can be wiped out in a matter of months, taking the spillover inflation in real goods and services with it.

I classify cash as a physical asset as well. Note that most of the stimulus is taking place in the form of digital money, not physical money. There hasn't been a huge wave of money printing that will exist no matter what the economy and financial markets do. The money that has been created can and will be destroyed by a deflationary wave.

Kevin Depew has written insightful articles about the simulacra, such as Five Things You Need to Know: The Crisis of the Real, based on Simulacra and Simulation, by Jean Baudrillard. There are four stages in the process of simulacra:
1) Era of the Original
2) Era of the Counterfeit
3) Era of the Produced, Mechanical Copy
4) Era of the Third Order of Simulacra, where the reproduction displaces the original
In the case of money, the real is gold or precious metals. Then comes the counterfeit, the gold notes. Then comes the produced, mechanical copy, fiat currency. In the final stage, the copy displaces the original.

In the digital age, currency traders swap digital conceptions of pieces of paper that do not even exist. As Depew describes it in another article on the topic,Five Things You Need to Know: New Home Sales, (en)Durable Goods Orders, Breadth, The Price Simulacra, Socionomics of Camouflage in the final stage, the simulacra:
has no relation to any reality whatsoever; it is its own pure simulacrum, a copy without a model (perhaps this is where we find ourselves today given the decoupling of paper money and the continuous supply of liquidity and credit to market participants with no underlying attachment other than the promise of a central bank).
To bring it home to the gold article, what are the hedge funds and institutions swapping? Most futures contracts are not delivered, they are settled and new contracts are opened. The central bank pushed a button on a computer and made some 1s and 0s, and that money, which bears no relation to gold or even physical paper dollars, is then swapped between financial institutions who are placing bets on the movement of the price of gold as measured in those 1s and 0s.

People are not buying physical gold, they are buying copies of gold. They are not investing in businesses, they are trading copies of those businesses (stocks). Even GDP is itself a shadow of the real economy.
Due to the way GDP is measured, there are a variety of ways that GDP can increase and perceived economic growth can show up in the statistics without an improvement in the labor market. As I explained in a previous column, imports count against GDP, so if Americans stopped buying imported Mercedes and Nintendos for some reason, this would be reported as incredible economic growth and a vast increase in societal wealth. The reality, of course, is that a complete cessation of import buying would indicate that something has gone seriously wrong with the American economy and the American consumer's ability to purchase goods and services.
Barry Ritholtz has the figures for the second quarter of 2009:
According to Bloomberg, Decreasing Exports subtracted 0.76% from GDP. At the same time, falling Imports added 2.14%. Net contribution of the fact that Imports are free falling twice as fast as Exports are = 1.38%.

If they were both falling at the same rate — if Europe and Asia’s consumers were hurting as much as ours – GDP would have been -2.38%.

If it seems weird to you that the ratio of domestic and overseas shrinking economies and their reduced consumption somehow turned into a positive GDP contributor, well, welcome to the wonderful world of government statistics.

So, a drop in exports:

Plus a bigger drop in imports:

Leads to a smaller trade deficit:

Which equals, in terms of GDP, a growing economy.

Update: I can best sum up my thinking as follows: there is simulated inflation in the simulated economy.

Update 2: Bill Gross' November 2009 commentary is out. These words popped out, given what I wrote earlier today:
Let me start out by summarizing a long-standing PIMCO thesis: The U.S. and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades. Stock and home prices went up – then consumers liquefied and spent the capital gains either by borrowing against them or selling outright. Growth, in other words, was influenced on the upside by leverage, securitization, and the belief that wealth creation was a function of asset appreciation as opposed to the production of goods and services. American and other similarly addicted global citizens long ago learned to focus on markets as opposed to the economic foundation behind them.[emphasis mine] How many TV shots have you seen of people on the Times Square Jumbotron applauding the announcement of the latest GDP growth numbers or job creation? None, of course, but we see daily opening and closing market crescendos of jubilant capitalists on the NYSE and NASDAQ cheering the movement of markets – either up or down. My point: Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up – economies don’t do well, and when they go down, the economy can be horrid.
Read the whole thing.

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