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Weekend Edition

The two most dangerous forces in the market today
Saturday, August 16, 2014

Editor's note: This week, we're featuring an interview with financial expert Jim Rickards. Jim is a financial lawyer with a doctorate and multiple advanced degrees... He's a hedge-fund manager and a New York Times bestselling author. Many media outlets, including the Financial Times, CNBC, the New York Times, and others seek Jim's expertise.
Today, Jim serves as an advisor to the Office of the Director of National Intelligence, which oversees the Central Intelligence Agency, National Security Agency, and 14 other U.S. intelligence agencies. And in the past, Jim has helped the government investigate everything from the stock market "tells" preceding 9/11 to consulting for the Pentagon on the national security risks of financial chaos.
Jim recently wrote what we think is one of the most important books of the year – The Death of Money. In it, he explains the financial turmoil happening today and what it will mean for the world moving forward – and what you can do to protect yourself.
This book is so important, we arranged a deal with Jim and his publisher to give you a free copy. You can get the full details at the end of today's Growth Stock Wire.
We began the interview asking Jim to explain the differences between inflation and deflation – the two most important and combating forces in today's economy. Throughout the interview, Jim explains whether inflation or deflation is the most likely outcome... how to profit in either scenario... the moment when foreign central banks will lose faith in the U.S. dollar... what the current sanctions against Russia mean for the global economy, and many other topics...

 Inflation is generally a condition where prices are going up, and deflation is a situation where prices are going down. That sounds fairly simple and straightforward, but it actually has profound consequences, because what we're talking about are what are called nominal prices... meaning the actual price that you pay for something. So if gasoline is $4 a gallon at the pump, and one day you pull up and it's $4.20, that's 5% inflation. That price went up. And prices can go down. In that example, if it goes from $4 to $3.90, that would be 4% deflation.
These things happen. Sometimes, they happen gradually. It's still meaningful. What a lot of people don't understand is that even mild inflation can erode the value of savings.
 To explain the effect of inflation... Let's say you have a certain number of dollars in the bank. You have a retirement income. You have an annuity. You have a pension. You have a certain check every month – it could be anything from Social Security to withdrawal from your 401(k), etc. – that is a fixed amount of dollars.
But it doesn't mean that that is a fixed value. The value could actually go up, meaning your dollars are worth more in deflation. If you think about it, when prices go down, your dollars go a little further. That's generally a good thing. In inflation, the opposite is true: Prices go up and your dollars don't go as far. That's usually a bad thing. There's more to it than that, but that's a general description.
 Today, one of the hardest and most important questions in economics is which of these forces will prevail. Over the last 60 years – certainly since the end of World War II and beyond – the economy has experienced inflation. Sometimes the inflation is worse than others. In the five-year period from 1977 to 1981, inflation ran out of control. It was 50% during that five-year period, so the value of a dollar was cut in half in the five-year period from 1977 to 1981.
In good times, inflation has been more mild... It might only be 1% a year, which sounds fairly tame. But we've had inflation all the way through. We've had a couple quarters or months of deflation, but they're very rare. Since World War II, we've had almost nothing but inflation.
 But America has had deflation before. From 1929 to 1933, there was a five-year period where deflation was more than 25%. In other words, in that five-year period, prices fell by more than 25%. We have experienced both. But you'd have to be 90 years old to remember that deflation from 1929 to 1933. So virtually everyone alive today has only experienced inflation and not deflation.
 Now, if we knew which way the economy was heading, investing would be a lot easier. In inflation, certain assets do very well, meaning the prices go up – gold, land, silver, energy, hard assets, things like that. In deflation, believe it or not, the thing that goes up is cash. Your cash is actually worth more.
Of course, what central banks are supposed to shoot for is price stability. Where there's no inflation or deflation, prices are constant, and that way we can make investment decisions not based on trying to gain the inflation or the deflation advantage, but just based on the merits of the investments. That's the ideal world, but we rarely ever achieve it.
 The problem today is that the U.S. economy is experiencing both inflation and deflation at the same time. That sounds a little peculiar, but it's actually true when you look beneath the surface.
On the surface, price indices are going up a little bit. They're going up 1% or 2%, which doesn't sound like much. So you would say, on the surface, we have very mild inflation. But that mild inflation is just the net result of two very powerful forces. There's a deflationary force coming from the fact that the economy is in a depression.
 We're in a global depression. Not a recession. A depression, which started in 2007 and will probably continue indefinitely. The natural state of a depression is deflation. The two go hand in hand. People are overindebted, so they sell assets to pay off debt and reduce their balance sheet. When they sell assets, it tends to drive prices down. That puts other people in distress. They sell assets, too, to pay off their debt. Everyone is reducing their balance sheets. The process feeds on itself, and that's called the debt deflation theory of depression.
 On the other hand, we have massive money printing by the Federal Reserve. The Fed has printed almost $4 trillion of new money since 2008. That's normally very inflationary. Certainly, monitors would say that massive money printing, all things equal, would lead to inflation.
So you have a deflationary vector coming from the depression and an inflationary vector coming from central bank policy. The two are pushing against each other, so the net result is not much change in prices, but that's an unstable situation.
 One way to think about it: Imagine you're standing right on the San Andreas Fault and it's not moving that day. You can stand there and say it's stable, but we all know that deep below the surface there are massive tectonic plates pushing against each other.
It may be stable at that point in time, but it's just a matter of time before one of those forces gets the upper hand, the thing snaps, and you have an earthquake that causes massive destruction. That's sort of the situation today, where you have these two forces pushing against each other.
So the question really is, which way is it going to snap? It could go either way. That's what makes it difficult for investors. If I had to bet, I would bet that inflation will probably prevail, and the reasons for that have to do with the effect of deflation on federal finance and sovereign finance in general.
 Deflation makes debts more expensive, makes the real value of the debt higher, makes it harder to pay, and destroys tax collections. It hurts the banks, because people default on their debts, so there are a bunch of reasons why central banks fear deflation more than any other outcome.
Therefore, they must cause inflation, and they do that by printing money. If you print a lot of money and you don't get inflation, then print more... That seems to be the policy of the major central bank. Deflation and inflation are battling each other. The central bank is scared to death of deflation, so it's printing money trying to cause inflation. It will keep doing that.
But what concerns me, or what troubles me, is that in the course of printing so much money to create the inflation, the Fed will actually destroy confidence in the money itself. And that's why in my book, The Death of Money, I talk about lost confidence in currency starting with the dollar, but ultimately including all the major currencies around the world.
Jim Rickards
Editor's note: The Weekend Edition is pulled from the daily S&A Digest. The Digest comes free with a subscription to any of our premium products. If you enjoyed today's interview with Jim, please consider getting a free copy of his new book, The Death of Money.
The book normally costs $20. We only ask that you pay $4.95 for shipping and handling. To learn more about how you can claim your copy now ­­– which also includes a chapter Jim wrote exclusively for us – click here.

This Week's Winners
S&P 500 Symbol Change
Kinder Morgan KMI +12.8%
Monster Beverage MNST +10.1%
Electronic Arts EA +9.9%

Countries Symbol Change
Russia RSX +6.1%
South Africa EZA +4.7%
Thailand TTF +3.9%

Sectors Symbol Change
Biotech PBE +5.0%
Clean Energy PBW +4.3%
Homebuilding ITB +3.9%

Commodities Change
Orange Juice +5.6%
Palladium +3.5%
Natural Gas +0.8%
Date Range:8/7/2014 to 8/14/2014
This Week's Losers
S&P 500 Symbol Change
Computer Sciences CSC -4.2%
Fossil Group FOSL -3.1%
Diamond Offshore DO -2.9%

Countries Symbol Change
Israel ISL -1.8%
Turkey TKF -0.5%
Brazil EWZ +0.6%

Sectors Symbol Change
Oil Services PXJ +0.1%
Big Oil IXC +0.7%
Telecom IYZ +1.3%

Commodities Change
Wheat -4.3%
Live Cattle -3.6%
Lead -3.5%
Date Range:8/7/2014 to 8/14/2014
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