With commodities now moving down into their three year cycle low I’m hearing more and more talk about deflation. This is complete nonsense. Bernanke had it exactly right when he pointed out that any determined government could halt deflation at will with a printing press. As a matter of fact the only mildly deflationary event we’ve seen since 1932 was a brief period during 2008 and early 2009. Bernanke succeeded in stopping it in its tracks almost immediately with QE1.

QE one end of deflation

In order to experience deflation there must be debt defaults. That’s what happened in 2008. Now however almost all of that impaired debt has been moved from the private sector onto government balance sheets. Unlike a homeowner, governments can print (counterfeit) money at will, so it is nominally impossible for a government that is able and willing to print unlimited liquidity to default on its debt. For any government with a printing press, deflation is a choice not an inevitability.

if you think about it, there is nothing stopping any government from mailing out checks to its citizens. The central bank would simply print the money out of thin air and the government would distribute the cash as free gift certificates to each and every citizen in the country. Impossible you say? Hardly, as we already did it in 2008. Most of you remember it as a $300-$600 tax rebate, but the reality is that it was nothing more than a helicopter drop.

It was intended to stimulate the economy, but what it actually did was generate a massive global inflation. The price of oil surged to $147 a barrel, and food spiraled out of control causing civil unrest in many Third World countries where people could no longer afford to feed their families.

Here is an even bigger myth. Gold does well in either an inflationary environment or a deflationary environment. That is complete nonsense. Gold performs well during periods of economic stagnation accompanied by monetary expansion. The excess liquidity created by central banks ends up sloshing into the commodity markets as there is insignificant economic productivity to soak up the overproduction of money. Like all other assets gold performs poorly during a true deflation.

Over the last 80 years we’ve had one mild deflationary event during the second half of 2008. During that time gold lost over 30% of its value, while mining stocks lost over 70%. If you believe we are actually on the precipice of a deflationary event, gold and mining stocks are not going to protect you.

precious metals deflation

Folks if gold is rising it’s not because it is anticipating a deflationary event. Gold will rise because it is anticipating the monetary response to deflation, which would be ever larger quantitative easing programs.

Since 2009 QE has mostly been focused into the banking sector. This is why inflation has been manifesting mostly in the stock and bond market. However, if deflationary pressures were to intensify I have no doubt that governments would again resort to helicopter drops to put free money into the hands of average citizens and not just the banking elite. If and when they do, it will have the same result that it did in 2008 and the liquidity will again flow into the commodity markets.

I realize that the deflation argument is the sexier theory. It’s like an accident or horror film you just can’t take your eyes off. But make no mistake, deflation is only possible when a government chooses to let the money supply collapse rather than sending out the helicopters.


  1. Chris

    Here are the facts…. Again.
    The rebate checks were only decided upon in Feb 2008. By that time, most of the run-up in Oil had already happened!!!!!!!!

    The Treasury Department ****BEGAN**** making payments on April 28 and most did not receive payments until late spring or early summer, after the oil bubble had pretty much already TOPPED.

    Those are just the facts.

    As I’ve mentioned many times, when the government or Fed panics, people will get scared too. It’s obvious that people SAVED that money because the sky was falling. We had severe deflation just after rebate checks were received.

    1. gary Post author

      Here are the facts. From the beginning of April to the middle of July right as the rebate checks were hitting the mail boxes the price of a gallon of gasoline spiked 50%. The same thing happened to the price of food in the same time frame.

      Absolutely no one saved their $300 check. They clearly used it to buy gas and food and they did so the second they got that check in their hands. This is the same thing that always happens in history when a government suddenly spikes the money supply. People see prices rising so they buy today because they know it’s going to cost more tomorrow if they wait.

      1. Chris

        No it wasn’t early April. I looked it up before I posted last night. According to the US treasury website and WIKIpedia, the VERY FIRST checks were sent out in LATE april, April 28. By the time they started hitting people’s bank accounts it was May. And the last people didn’t receive until late June.

        So pull up a long term chart of OIL. You will clearly see the bull market in oil started at the end of 2001 from a low of $17.12. The blow off top phase in oil began in EARLY 2007!! The sliver of time you are referring to with a spike in gas prices was LITERALLY the last 3% of the entire oil bull market. The price of oil during this very small sliver of the last 2 months of the bull market in oil was $116 to $147.

        I don’t know how you can possibly attribute the rebate checks to the spike in oil and commodities. Anyone who just looks at the chart from 2001 can clearly see there is not only a zero correlation, but a completely REVERSE correlation!!! And then we have a collapse in the market right as the last people get their rebate checks. It shows 100% the opposite of what you are claiming.

        1. gary Post author

          Actually the Fed began their shock and awe rate cutting cycle in Sept. 2007. It didn’t save the stock or real estate markets as the bubble had already popped so the liquidity started to flow into the commodity markets. The rebate checks were just the icing on the cake and the last in a series of monetary mistakes that culminated in an inflationary explosion that collapsed the global economy. The world then rolled over into that brief deflationary period from the summer of 2008 to the spring of 2009.

          It’s always inflation first followed by deflation.

          Prez Bush announced on April 25th that the checks would start going out on April 28 so by that time people were already anticipating an increase in their checking account, and studies show that consumers who got their checks as opposed to those who had not received their checks increased their spending by 3.5%. 3.5% of a 44,000 income is about $1300. So middle income families did exactly what I said they did. They spent that helicopter money immediately as it was the only intelligent thing to do as prices tomorrow were going to be higher than they were today.

          1. Chris

            Yea, among other studies that showed the opposite. Of course, anyone in government will want to show you data that what they did is working. Just politics.

            This debate is not about the entire fed policy, it’s about rebate checks specifically. And it’s clear that the commodity bubble was in effect far, far in advance of any thought of rebate checks (helicopter drops). The bubble was already topping by the time the checks reached people’s hands.

            But a future helicopter drop doesn’t have a chance to halt deflation unless it is of ridiculous proportions. Order(s) of magnitude greater than the paultry $300. … in needs to be in proportion to the size of the deleverging that is going on. And I will continue to guarantee most of that money will land in bank accounts….. not at the mall. And that will essentially be just an indirect form of a bank bailout.

          2. Chris

            I just have 1 more thought to close. I think you give the average american (joe the plumber) Far too much credit in their ability to logically think through monetary policy in their spending decisions. Most average Joe’s barely even understand inflation, or how to balance their checking account. What makes you think they will actually think through and deduce that they need to spend this money because it will decrease in value tomorrow? That’s not how inflation takes hold of the general public. People outside of the SMT blog don’t think that way, nowhere near it.

          3. gary Post author

            The average Joe doesn’t have to deduce anything. All he has to do is notice that prices keep going up and it won’t be long before he starts filling up his gas tank when it gets half empty because he sees that prices are likely to be more expensive if he waits till it’s empty.

          4. Chris

            There is only so much gas or food someone is going to buy at one time no matter what happens. The real question is discretionary spending…. And that will not be affected significantly unless the helicopter drops are absolutely enormous. People will pay off bills & debt FIRST.

    1. gary Post author

      There is no question that the world is experiencing deflationary pressures. What I’m saying is that any government willing to use it’s printing press and make helicopter drops can stop deflation instantly.

      The US turned on the printing press in late 2008 and that is why we have no deflation in the US. Granted the inflation has mostly gone into stocks and bonds since 2011 but that is just due to money being treated better in the Fed protected stock market rather than commodities signalling deflation. If stocks have the full protection of the Fed’s printing press then it’s no wonder that the majority of liquidity will flow into that sector rather than commodities where forces are applied to artificially suppress price such as the gold market and recently in the energy market.

  2. Bob UK

    Worth a read:

    Eurozone officially falls into deflation, piling pressure on ECB

    Lower-than-expected figure come as European Central Bank considers a quantitative easing programme to jolt the economy into growth

    UK service sector is also contracting.

    FWIIW I suspect that the ECB will finally have to print… and probably the UK also… so just need to figure out, re Gary’s article, which asset class will benefit from further printing.

  3. alok

    I am not a subscriber but come here often. I think Gary you are good at the charts. Leave the reasons of whether deflation or not to be decided later. The charts will give you a heads up much earlier.

  4. Tenyear

    Good analysis Gary. You are right, that the gov’t can fire up the printing presses to stop deflation. However, that is a merely a policy choice. All the bailouts in 2008-09 were merely policy choices and on the other side were the critics screaming ‘no’ so that our markets could function naturally. I think now we are seeing the deflation as a result of the ending of stimulus and the markets are now correcting naturally. This could be a deflationary event that the gov’t chooses not to intervene with so that the markets can behave naturally. Gold would perform well during a deflationary depression as a store of value and as a fear trade I would think–paying off debt first would be investors first option.

    Who knows for sure. I doubt we see another QE this year unless stocks drop 25% or more.

    1. Bob UK

      I assume you are talking about physical gold and, perhaps, silver?

      Miners – most of whom have lots of debt – would find that debt an enormous burden in any deflationary environment wouldn’t they?

      If gold miners start to go bust wouldn’t they try selling their gold at any price in order to bring in cash – something which we are led to believe that the shale producers in the US, and oil producers in places like Venuzela, are apparently doing or about to do?

      1. Tenyear

        I’m talking about all markets, especially the U.S. I’ve been investing and trading full time in the market for most of my life, and people in the U.S. are asking me if I still believe in the stock market. I give them a long answer, and they give me a short one: “I don’t.” Who can blame them? A market that goes straight up is tough to trust.

  5. Richard

    Junk debt hit a record low yield of 4.77% in June confirming that investors have no fear in the current markets.
    As of July 2014, PIK issuance was $7.48B for the first half of the year compared to $6.7B for 2012 and $12B for 2013. For a comparison, PIK bonds peaked in 2007 when companies issued $11.7B.
    The Barclays high yield index follows the same pattern as the SP500, except it never recovered from the November swoon like the SP500 did. Divergence.
    As of June 2014, deflation was obviously not a concern with investors buying up PIK bonds and other high yield instruments.

  6. Mike R

    What’s deflationary, is the creation of gargantuan levels of debt, that ultimately become impossible to service, even when interest rates have been lowered to near zero. The accumulation of so much debt is in fact not stopped or ‘solved’ monetary printing, and deflation is not instanteously ‘stopped’ by printing, as its a cumulative and on-going effect, and the printing itself is in fact creation of more debt on top of debt.

    The FRN is not money, but someone’s debt. You can put it on the ‘government’s books’ or the FED’s books, but that debt doesn’t just disappear.

    When that debt service becomes so overwhelming, whether its an individual, corporation, business, or country, then quite simply they can’t pay for basic needs, and they eventually do default.

    1. gary Post author

      That’s where I think people are mistaken. If the debt is government debt it doesn’t matter how big it gets it can always be serviced with the printing press. The cost of doing that though is it will eventually destroy the currency and create… wait for it… inflation.

  7. Gary

    Gary, sounds like you’re down on gold for good. In 2014 you told Big Al you felt the bottom was in for gold. I get that conditions change but your views seem to be more reactive today.

    1. gary Post author

      Not at all. Gold is clearly still in a secular bull market. I’m just trying to spot the final bottom for the current cyclical bear market. Based purely on my assumption that the 8 year cycle low probably has more time to run yet I kind of doubt we’ve seen the final bottom yet.

  8. arthurk


    Just a couple of quick observations and a question. First you certainly have the right idea about a choppy market. Since Oct the swings seem to becoming more and more rapidly. I feel like I am getting whiplash.

    Second looking at gold long-term. Someone above mentioned M.Armstrong. His idea is that latter this year investors will start selling bonds and buying stocks (and gold) when the US starts to have inflation/lose confidence in FED. It seems to me that with QE the US was exporting inflation to EM countries and now with no QE we are exporting deflation. Either way US was mainly unaffected so little safe haven demand for gold. Armstrong scenario implies the problems may soon show up in US bonds.

    Question, I was archiving some my files and I noticed that this site was published by Toby Connor as GoldScents. Was there a change in ownership or are you partners?

    Thanks for all your time and effort.

  9. Farmer dave

    Keep in mind that as you talk about monetary inflation as it relates to “commodities”, these commodities’ volumes are as volatile as the money supply (gold excluded). Most of the south is in a 4 year drought leaving cattle numbers at a low it hasn’t seen since the late 40’s/early 50’s. Corn had a couple of poor yield years in the last 5. Cotton had a freaky demand thing going on via China’s stocking up in ’11 and ’12. The fact that now a lot of prices are falling may have as much to do w increased inventory as it does any change in money supply. As for gold miners sitting on a hoard of gold they’re not selling as they speculate on a price increase, I don’t see that happening. My guess is they’re selling it as fast as they can. So my question as to deflation possibilities goes: Gary, what would it take to experience true deflation? Would the government have to will it? Lastly, if foreign governments soaked up or dumped our dollars, can we do anything about it–or are we really in better control that I realize?

  10. K.Gee

    I feel your analysis is confused here and you’re also working with a very short sample of post crisis central bank activity. You’re trying to prove that tackling deflation with QE, means that deflation doesn’t exist?? Japan have just gone all-in QE to battle deflation and the ECB are considering the same move. They are acting to fight deflation and yes, this may postpone the effects for the short-term but I am of the belief that Bernanke and the FED will one day be ridiculed for their actions.

    I believe that you will get your stock bubble highs and I believe that we will see a bottom in all commodities, especially gold but I feel differently as to WHY we get there.

    1. gary Post author

      That’s not what I said. There are clearly deflationary forces in the world. I’m saying that any government that is willing to trash their currency can halt deflation at will.

  11. Flip Oilsands

    I think y’all ought to use the correct terminology. What is being referred to as deflation should really be called dis-inflation or it can be called debt contraction. “contraction” or lowering of asset values that are extraordinarily large due to the pumping of insane amounts of currency into the “more developed” nations money supplies and the irredeemable dollars on the balance sheets of most nations from the conversion of budget surpluses after the Bretton Woods meeting and the ’73 Bilderberg scheme of the Petrodollar. Its not deflation. Its collapse

  12. Pingback: Economics and Investing: - TerraCraft Outfitters

Comments are closed.