The last chapter discussed an inflationary outcome. In this chapter Let’s examine what may happen if there was a deflationary outcome.

So far, I have only written about an inflationary outcome. I think it is important to look at what would happen in a DEFLATIONARY outcome and what assets would be best to hold in this situation. This topic cannot be spoken about without taking into account the massive amount of debt that is out there and the damage that would be done if that debt pile collapses.  As I have written previously, I am expecting the debt to collapse upon itself at some time in the near future. It is exceedingly obvious that we have been bankrupt (unable to pay our bills without conjuring up cash from nowhere) since at least 2008.

The Federal government has had its bills paid with taxes and a LOT of central bank “printing” since then. This is not just a USA thing, but it is global- at least in developed markets which are actually acting more like emerging economies than the emerging economies themselves. In addition, many cities, states and pensions have been bailed out with massive injections of freshly conjured up cash to kick this epic amount of debt down the road for as long as possible.

Everywhere I look I see a potential black swan. It could be many of our major cities who can’t print money and are teetering on insolvency. It could be major pension plans who were forced to take extraordinary risk to meet their investment targets while the Fed held rates at 0%. It could be a state insolvency- particularly a state that may be out of favor with the ruling party at the time. It could be major corporations that feasted on almost free “money” for over a decade and now that rates are rising may have to pay WAY more in interest expenses on top of rising costs for labor, benefits and input costs.

It could be a commercial real estate sector that is seeing major defaults as I write this, and it probably won’t be getting better anytime soon. Or it could simply be that our regular Joes and Janes are just flat tapped out after trying to retain their lifestyle that they had become accustomed to, and the credit cards are maxed out. Possibly all of the above!

It is always hard to tell which snowflake may start the avalanche but there is an economic blizzard blowing and it’s coming down hard as we speak.

In the past, if we expected deflation, we may have suggested holding longer-term bonds and quality bonds. The idea is that as things crater the Fed will lower rates and the longer-term bonds would benefit. Today I feel the exact opposite of that. Other than traders who are just betting on the next move in the “markets” I believe that the term that best describes most long-term bonds is “return-free risk”. By this I mean ALL long term bonds.  As a matter of fact, the only bonds I believe make any sense as I write this- and by the time you read it the situation may have already changed are extremely short treasury notes or T Bills. At this writing, in June 2023, you can get a 5% rate on a 6- month bill and unless the US Government defaults (I can’t imagine that scenario) we can accurately predict what our price will be at a future date. I believe that anyone who is buying bonds longer than one year is playing with fire.

The reasons are many, but it starts with the inflation, which the government says is 8% BUT in actuality, the inflation rate is higher than 15% according to Shadow Government Statistics where John Williams reports the USA’s own numbers without all of the statistical games being played. There is virtually no chance that almost any bonds could keep up with this type of inflation. Now you may say that in a deflationary scenario inflation would fall hard. Maybe- maybe not.

While demand would likely be crushed for many goods other things- like the necessities of life could skyrocket in price. This is why it would be no surprise to me to see massive inflation in some assets and massive deflation in others.

If we did have a classic deflationary collapse- where all debt-based assets collapse I still believe that bonds are not the safe haven they once were believed to be. The main reason is the gargantuan debts that we have built up are unpayable if our currency retains anywhere near its perceived value. If defaults start to happen it is HIGHLY likely that most people will be looking to dump their bonds- and the lower the quality the quicker they will pull the trigger. A real deflation would make it even harder for those deep in debt to pay the debt and since all assets are collapsing in value the collateral that backed the bonds would be worth FAR LESS than the debt that the bonds represent. How many people, companies, townships, cities and states would walk away from the debt? With this country’s morals I would expect a majority to default.

In a deflation a number of years ago I would have said hold cash, bonds and gold. I would avoid “things” and hard assets because in a deflation all those things would collapse in price. This is what happened from 1929-1937. There has been a significant change to my thinking since then. Now, I would hold certain hard assets that would include necessities of life like food, water, energy, gold, silver, etc.

I would avoid bonds now in either an inflation or deflation because of the lack of return, the possibility of default and a collapsing US dollar. Keep in mind all a bond is, is a promise to repay your money at a future date with some interest being credited.

I believe THE major beneficiary of a deflation would be physical  GOLD bullion. The reason, in this case, is that gold has been money for 5000 years. It has held its purchasing power for 5000 years. It is one of the best performing asset classes of this century. All that is nice BUT the real reason is that GOLD IS AN ASSET AND NOT A LIABILITY. It is something you OWN, and it is not owed back to anyone, and you don’t have to rely on someone else’s “promise” to repay- particularly when the numbers indicate that it is unlikely you will get anywhere near the value you expected even if the bond doesn’t default.   What is the VALUE of a PROMISE that cannot, or will not, be KEPT?

It also pays to keep in mind that the gold and silver markets are small markets. Just a minor move out of debt-based assets into gold, silver and the companies that produce them could lead to massive price spikes. If confidence in the system and confidence in debtors is lost, I believe that most rational people will want assets-not someone else’s liability. It may actually get to a point where ALL that is accepted would be something real for something real.

In a deflationary scenario I would expect that gold would outperform silver because gold’s main attribute is as money while silver- even though used as money has a strong industrial component that would likely be a drag on its price in a deflation. I believe the weakness in silver, if it were to occur, would be short-lived as those with assets start to have a hard time finding or affording gold and the masses move to silver.

Let’s also remember that the central banks have this all planned out. While you and I are left guessing I am sure there are a few who know how and when these things will play out. I have written many times that whether we have inflation or deflation- gold is the asset that should come out ahead.  The reasons are simple. In an inflationary episode the price of all hard assets will rise because the perceived value of the dollar will be falling. In this case gold, silver and most hard assets will see their prices rise and should be a good hedge against the inflation taking place.

In a deflation- while it may seem counterintuitive because the perceived value of the dollar may be stronger- gold would also win because of what I mentioned above. Even with massive amounts of currencies being conjured up out of nowhere there is stress in the banking system and bond “markets”. If there were an actual deflation that was allowed to take place it is likely that most-if not all- confidence in debt-based assets would be lost. It is likely that once a loss of confidence starts it would spread quickly and the rush for the exits would grow exponentially. I don’t think that there are too many places that you could hide in this situation besides gold, silver, and after the dust settles necessities of life and companies that produce such goods.

I would like to reiterate that in a deflation I would hold the gold and silver above ANY asset that would count on my belief in someone paying me back. With the stocks, however, I believe it would be prudent to let the stocks fall because they would all likely be hit for a period of time and then do my research on solid companies with strong balance sheets and in industries that are either recovering or growing. I believe that if there is a stock collapse there will be some hidden gems and also some hidden dangers. The only reason that dangers remain hidden is that most “investors” aren’t looking for them.

Raymond James is not affiliated with Shadow Government Statistics or with John Williams.

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