Summary of Inflation and Deflation the United States

The following is an excerpt from the March issue of The Morgan Report. This followed a lengthy discussion of how silver and gold both performed during inflationary and deflationary periods. Most of what I wrote was based upon the work of Roy Jastram and his work on Silver the Restless Metal and the Golden Constant.

Excerpt starts here…

Since 1800, the U.S. has had more years of inflation than deflation, 92 versus 53. The record for the two precious metals is remarkably similar. Both lost purchasing power in every inflation in the United States until the last period mentioned, 1951 to 1979, where silver out-performed gold. What adds interest to this similarity is that silver was effectively demonetized in 1834, whereas the gold standard prevailed a century longer. It is true that the U.S. Congress was fiddling with the silver market from 1807 through 1920, but the effect was to put a floor under the silver price, with the gold price being strictly set. And from 1933 until 1975, U.S. citizens could not buy gold.

However, precious metals have a long-standing reputation as hedges against inflation. Jastram writes, “This is not valid based on evidence of a century and a half in the United States and more than three centuries in England. The truth is, in most cases, the two metals, yes, both silver and gold, gained operational wealth in deflations.” From a long-term perspective, gold has held its purchasing power very well in the United States.

The long-term view of silver is different. Silver did fairly well, relative to gold, until 1890. After that, the purchasing power has been erratic. At times, silver’s performed poorly, compared to gold, until the last period mentioned in Jastram’s book, where the silver outperformed the gold by a very wide margin. However, we must be cautious here because so much of the upward move in both gold and silver took place in such a small timeframe.

Before moving from this historical study, I wish to mention a few other items the good professor was able to forecast. Chapter 5 is titled “Silver’s Industrial Revolution.” Jastram recognized that silver was to be a high-tech metal required by industry. I think even he would be astounded to learn that during the past ten years, silver’s use in industry has gone from roughly 35% of the entire annual production in silver, to greater than 50%. Not only that, but it is the fastest growing area of the silver market. The lithium ion battery for laptops will have a competitor and that is the Z power silver zinc battery that I’ve mentioned in other reports.

Apple Computer will be the first company to announce using this new battery. Silver’s use as a biocide continues to grow, being used in washing machines, refrigerators, and a host of other water purification systems, on both an individual and a municipal level. The supply side of silver is likely to decrease from 2009 to 2010, as base metals production will decline during this deflationary environment. As we all know, about 75% of silver is a result of base metal mining. Time and time again, the evidence is clearer and the facts are that silver is absolutely crucial to our way of life. However, it still remains the metal least understood by most of the world.

Now, we must look into the future. Indeed, the future is more uncertain at this point than at any point during my lifetime. My original intent in doing this study was to extrapolate the data so carefully laid by Professor Jastram, and lead you to a very solid conclusion. It is my determination that this cannot be done, because, in most of his study, the metals retain a monetary component, either officially or unofficially. Even the coinage in the United States was silver through 1964. So, I took a step back and evaluated the facts that we do know.

Presently, we have the deflationist Robert Prechter being the best known, and to this audience, perhaps, Ian Gordon or Bob Hoye, but even in this Canadian structure and in these camps, we have different signals. Prechter claims gold is topped and would be a bad investment during the ensuing depression, whereas both Ian Gordon and Bob Hoye extol the virtues of gold and gold only as the place to be during a deflationary period. Certainly, gold stocks play an important part in both of their analyses and, of course, gold stocks, as I’m writing this in February of 2009, really have under-performed the metal.

Gold has maintained. But so far, gold stocks have done poorly and the credit crisis continues taking its effect on the stock market. Silver has not kept up with gold, but has fared better than any of the base metals, thus acting, in my view, as silver would be expected to at this point in time—not as good as gold, but better than anything else in the metals category—showing once again the dual nature of silver being both an industrial and precious metal asset.

My view as to where we are heading actually supersedes both inflation and deflation. My very studied observation is that we are in what Robert Prechter refers to as a grand super cycle. However, my view is that we are at the tail end of the destruction of a currency and these events only take place every 200 to 300 years. This is crucial to know.

As stated in one of my early reports, a hyperinflation is not a function of the amount of money printed. If that were the case, we have more than enough money now to see a destruction in the United States currency. No, it’s a function of confidence and monetary velocity. I believe that over the next year, we’re probably going to see a rally into probably mid March, perhaps as long as into mid April 2009, and then I believe that the deflationary forces are going to be so overwhelming that the only good place to invest will be in cash or just keep accumulating metals and mining stocks on the dollar cost average basis. In other words, accumulate positions slowly over time rather than rush in and try to pick a bottom.

It’s not out of my realm of thinking, but we might see gold touch the major uptrend line before the bull market resumes. That would not invalidate a bull market in gold, it would only confirm it, but it could go lower than it is presently and still maintain a bull market. In fact, most major secular bull markets do test the major uptrend line at least once. Silver has already done this. It has touched the major uptrend line; whether it comes back and we test it or not remains to be seen. It would not be outside of my thinking that it’s actually done it already, preceding gold doing it, and it may not get down into the 880 level or whatever. But, again, the market knows more than any of us.

So, to re-emphasize my conclusion, we are in very, very interesting times and I do believe that the deflationary scenario does have merit at this time but, again, it’s way beyond that. We’re looking at a destruction of the currency. We’re looking at the United States dollar no longer being the reserve currency of the world. In other words, simply stated, we’re looking at a currency crisis.

During a currency crisis, the one thing that you don’t want is the currency that’s being destroyed, which is the United States dollar; you need an alternative currency. The only alternative currencies that I know of that have held up well are, of course, gold and silver. I do believe you need both. I do believe that I could certainly be wrong. Perhaps there’ll be some miracle cure here. I really doubt it, but you don’t need much more than a 10% or 20% protection in order to be well protected if things break down quite substantially for you to come out of this in very, very good condition.

On the other hand, I know many of you are what I call metal heads, like me, and you prefer a higher weighting than that; of course, that’s your personal choice. I’m not going to advocate much more than, say, 20% for most people. There will be a day, in my view, probably in the 2010 to 2012 timeframe, where the dollar just gets to a position where people don’t want it, not only on an international basis with our trading partners, which is already showing up, but also on an individual basis. And this is where you’ve got to be very careful to see what’s going on.

There will be a time when people decide that they’d rather purchase something that’s a hard good that can be stored and maybe bartered later, rather than hold the currency. Again, I don’t think we’re going to see that this year. I think 2009 will be mostly a deflationary year; 2010 is when I expect all of this monetary stimulus and printing of money will work itself into the economy. By that timeframe, it’ll start manifesting in huge increases in inflation. However, it could take off at any time and I’m well aware of that. I do have key indicators that we watch and keep watching. 

It is an honor to be.

Sincerely,

David Morgan

Mr. Morgan has followed the silver market for more than thirty years. He wrote the book, Get the Skinny on Silver Investing. Much of his Web site, Silver-Investor.com, is devoted to education about the precious metals, it is both a free site and does have a members only section. To receive full access to The Morgan Report click the hyperlink.

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