Project report on

The case for worldwide

inflation/deflation /hyperinflation and
international gold prices

Done by:
Pankaj salve
Roll no – 852
PGDBM Semester 3

In part fulfillment of the PGDBM Degree

Of
Sydenham Institute of Management Studies
Research and Entrepreneurship
Education
 The case for worldwide inflation/deflation
/hyperinflation and international gold prices

The US economy is now in deflation, as measured by year-over-year declines in the

consumer and producer price indices, it’s difficult to see anything but deflation in coming
quarters because of the huge excess of aggregate supply over demand.
These substantial deflationary forces are at work even in the face of huge monetary and
fiscal stimuli. Many, of course, believe it’s only a matter of time until these stimuli
promote serious inflation. However, before the bank reserves provided by the Federal
Reserve can promote excess demand, they’ve got to get into circulation as money. But
scared lenders and creditworthy borrowers are unlikely to convert massive bank
reserves into money until rapid economic growth resumes. And that, I believe, is
unlikely for many years. Moreover, the continuing decline in bank loan demand
suggests there isn’t much demand for money by creditworthy borrowers. Indeed, money
supply as measured by M2 and the broader MZM measure has been declining recently.
In addition, the recent nosedive in money velocity, the ratio of GDP to the money
supply, indicates that money could expand sharply to restore normal relations, and far
more would be needed to create excess funds and inflation.
Furthermore, if economic growth and loans mushroom, contrary to FED forecast, major
central bankers, with their congenital fear of inflation, will no doubt withdraw much of
that liquidity.
The Fed is in the classic liquidity trap where ample bank reserves and near-zero
interest rates don’t spur money creation and lending. The Fed is pushing on the
proverbial string.
With conventional monetary policy impotent, the Fed has resorted to quantitative
easing. But with all this money, the economy remains weak except for inventory
gyrations. What will happen to the economy and deflation after the Fed stops paying out
all this money?
Furthermore, any liquidity created through central banks is tiny compared to what’s
being destroyed by the world’s deleveraging financial sectors. Securitizations are only
one segment of the previously exploding, now collapsing shadow banking system. Off-
balance sheet vehicles of banks are being eliminated or written down substantially.
Major governments are in the process of increasing capital requirements of financial
institutions, which will slash their profitability and lending.
In the post-World War II era, commercial bank loans and leases have grown rapidly and
only paused in recessions. Now they are turning down decisively.
Financial asset deflation in stocks in the 2000-2002 years and again more recently as
well as the tangible asset deflation in houses, has sired a consumer saving spree along
with other forces that are generating CPI-style general deflation. Protectionism resulting
from the deflationary, high unemployment global economy may spur competitive
devaluations—currency deflation that leads to retaliation and slows worldwide growth.
That would enhance other forms of deflation.
Inflation
Inflation is always a monetary phenomenon. Since the printing press, it has in all times
and in all places been the inevitable consequence of creating large amounts of money,
not backed by any commodity, such as gold.
Now we are in a period of deflation, with falling prices. Government will do what it feels
it has to do to fight deflation, because deflation is synonymous with depression, like in
the 1930s. But the only way they know how to solve a problem like this is to throw
money at it. The amounts are in the trillions; nothing is like it in all of history.
If all of this newly created money does not cause inflation, it will be the first time in the
history of fiat money that inflation has not resulted. Based on the lessons of history,
that’s the way to bet.
One of the natural consequences of a dominant world-wide currency, like the dollar,
being created in vast quantities, is that the dollar will fall versus other currencies. The
irony is that right now the dollar is rising against other world currencies. That only
means the dollar is the healthiest patient in the hospital. Why? Other currencies are the
early victims of the inflationary plague.
Americans who earn and spend only dollars will soon see the natural consequences of
inflation, which are rising dollar prices.
What Will inflationary world It Look Like?
Gasoline and other oil-derivative prices will start rising. Oil will go back above $145
eventually. Sometime within the next year you will see oil at $75 to $80 per barrel,
which will put gasoline prices back under $5. Food will get more expensive.
That’s my best guess
The late deflation of 2008 will turn into the great inflation of 2009. In the last months of
2008, the US economy experienced deflation, falling prices. House prices had been
falling for two years and in the last months of 2008, the price of oil and gasoline fall
sharply. The Federal Reserve deflated short-term interest rates, and the average price
of goods in the US fell in October. There may well be wage deflation in early 2009,
mostly in the form of employers not providing the usual cost-of-living increases, and in
lower profits for the self-employed.
Falling demand results in lower prices, but only if the money supply is kept stable. Much
of the $7 trillion spent or pledge to patch up the financial markets has been and will be
money created by the Federal Reserve. Billions of the new dollars are already sitting in
the banks as “excess reserves,” funds beyond the required minima. Bankers have
feared to loan out that money as losses from past bad loans continue to mount.

But some time this year, the trillions of new dollars will start screaming, “loan me out,
please.” Banks have to pay for their expenses, and for that, they need loan income,
since competitive pressures limit how much they can raise from fees. Government
programs to help homeowners with mortgage problems will reduce foreclosures, and
house prices will level off. As the economies of Asia recover, rising demand will pull oil
prices back up. As the US deflation comes to an end, the banks will be tempted to lend
out the unemployed dollars. The federal government will also be pushing the banks to
loan out the funds.

Every bank loan is a creation of money. The borrower now has money, and the
depositors still have their money, so the new loan is a creation of money by the banking
system. The hundreds of billions of dollars created out of nothing by the Federal
Reserve will be multiplied into trillions of dollars created by the banks as they loan out
money.

This vast expansion of money by the Federal Reserve and the banking system is a
monetary inflation that then creates price inflation. Also contributing to price inflation is
an increase in the turnover or velocity of the circulation of money.

The price inflation will first affect the commodity markets. Commodity prices, which had
fallen substantially, will turn around and start climbing again. Copper, for example, fell
from $4 to $1.50 per pound from July to December 2008. The momentum of
development in the Asian economies will require huge amounts of copper again, and
the price will escalate once more.

Gold, silver, copper, oil, and other commodities will rise as their prices are set at
commodity exchanges that can respond quickly to changes in demand. Producer prices
will then start to rise, followed by consumer prices. The surge in prices could be
dramatic.

Many investors, consumers, commentators, and government chiefs will be surprised

and shocked at how inflation will have escalated even before the economy recovers.
Nominal interest rates -- the real rate plus inflation -- will hike up. The exchange value of
the US dollar will plunge. Rather than seeking safety in US Treasury bonds, people
worldwide will be seeking refuge in gold and silver.

The inflation will bring the fall in US real estate prices to a halt, as people seek to buy
land as an inflation hedge. Land speculation will be back, as buyers take advantage of
low-priced land. With rising inflation, renters will seek to become homeowners, and the
government will surely be promoting loans with mortgage assistance. But the
automobile companies will still not be happy, despite the huge bailouts from
government, since slack demand and foreign competition will reduce their ability to raise
prices, except for electric cars, which will be bestsellers if they work.

For the typical American, the coming inflation will reduce the value of their dollars of
savings, and raise the prices of food, housing, and transportation. Wages will lag
behind. Government chiefs will be tempted to impose price controls as well as limits and
taxes on sending funds abroad. Price controls did not control inflation in the 1970s, and
they would fail if tried again.

The US economy experienced stagflation during the 1970s, as unemployment remained

high after the recession of 1973, while high inflation escalated the prices of tangibles
such as gold and land. In December 2008, the main goal of the current and coming
government chiefs is to stop the financial credit crunch, and to that goal they have
thrown or pledged trillions of dollars, but those dollars will eventually come out of hiding,
and so there is just no way to avoid the coming great inflation of 2009.
Gold relationship
Gold is the money people turn to in times of inflation and economic turmoil. Gold is a
means of hedging against inflation. If people are thinking at this moment that gold is not
money, but rather a yellow metallic decoration that people adorn themselves with, then
you are incorrect.
Gold has been a unit of exchange for nearly 6,000 years. Gold and silver were
historically the first relied upon money that agreed with the standards of good money.
Aristotle spoke of reliable money to have the following characteristics.
1. The ability to be durable. It must stand the test of time and not wither.
2. The ability to be portable. Good money needs to hold value in a small space.
3. The ability to be divisible. Real money should have the ability to be divided evenly
and still hold its value. Also known as fungibility. Diamonds are not fungible because
each diamond has it's own value.
4. It must hold a rare value or quality.
Aristotle knew something that most modern day people have no clue about. Fiat paper
currencies around the world do not match the standards of good money put forth by
Aristotle and his predecessor Plato. Paper is paper. It can be made on the spot and
printed at will. Paper is neither rare or durable. The trust that we put into paper is the
only thing giving it value at this point.
A piece of paper with ink stamped on it is essentially what our dollar bill is. That's all. If
someone gave you some a sheet of paper to wash their car, it is the same thing as
receiving a paper dollar. Ink is the only thing making a difference. Both are paper.If
someone gave you oil, silver, copper, or gold to wash their car then it is different. Those
are real assets. It indicates hard work and sweat to bring those assets about.
Our money becomes more worthless each day our government prints more money. A
dollar crisis is happening right now, and most don't know it. Gold and silver were the
first real established currencies that stood the test of time. This is because gold cannot
be printed at will.
Mining companies must do lots of drilling and surveying before actually bringing a mine
online. This takes precious time and resources. Using paper money as currency is a
historically recent thing. There have been hundreds of fiat paper currencies in history
and all of them have failed. Gold and silver coins are the only way to protect yourself
from rising inflation. While paper money falls in value, gold will continue to soar higher.
Gold is in the midst of a 20 year bull market, and there is no near term end in sight. The
gold price has recently hit an all time peak of $1,100/ounce. People turn to gold in times
of economic crises and inflation. Why? Because gold is a safe haven asset and cannot
be inflated. Inflated currency, what is that?
Pretend you are inflating a balloon. The balloon gets so big that it sometimes bursts.
Our government is inflating our dollars in much the same way. Our government is
putting massive amounts of money into circulation. When you have more and more
dollars chasing the same level of goods, you have inflation.
Inflation means printing more money, it does not mean prices have risen. The result of
printing more money is high prices. The best advice I have heard is to get out of dollar
related assets before it is too late.
You should only be invested in gold bullion, silver bullion, gold coins, silver coins, and
mining stocks over the next few years at least. India, China, Arab states, and several
other countries are dumping dollars and buying gold. You decide if it's time to get
invested in gold and silver.
We are staring at a nascent but potentially and probably startling increase in the price of
gold and precious metals mining stocks and warrants. Gold will reach mind- boggling
levels because the actions of our political leaders and their academic and credentialed
enablers are virtually guaranteeing it with their current actions.

Currency Traders Strengthening Price of Gold

The US dollar has and continues to be pummelled by currency traders because they
see the US Treasury and FED working overtime to deliberately devalue the dollar in
response to politicians who think that spending money the country doesn’t have on
programs it doesn’t need is the answer to the continuing economic malaise. Setting
interest rates at near zero percent obviously exacerbates the dollar problem.
Carry Trade Supporting Price of Gold
The dollar has now replaced the Japanese Yen as the favoured currency of the carry
trade. Borrowing US dollars at nominal interest rates is the hedge fund manager’s most
obvious go-to strategy. Currency traders will be most reluctant to allow a sudden rise in
the US dollar to cut the legs from beneath the carry trade of which they are participants.
Consequently, there is little reason to think a rise in the US dollar will interfere with the
consistent and persistent rise in the price of gold.
Supply and Demand Ratio Increasing Price of Gold
Couple these currency issues with the limited supply of above-ground gold and the fact
that mine production has been reducing year over year and the inevitable consequence
is demand exceeding supply resulting in gold being bid to ever higher prices.
Loss of Safe-Haven Status for U.S. Dollar Supporting Price of Gold
Perhaps the most significant new factor in the gold price equation is that the US dollar is
no longer perceived as the automatic safe haven harbour for concerned investors
around the globe. While this statement cannot be made definitively, the fact is we are
already a long distance from the fall of 2008 when global investors reflexively flocked to
the US dollar as a safe haven in the face of the global financial turmoil.
Increased U.S. Budget Debts Strengthening Price of Gold
Needless to say, skepticism about the merits of the dollar mounts monthly. The actions
of the US administration and Congress place it on an unprecedented spending binge
organized by the Treasury and FED which dishes out vast quantities of new digital
dollars designed to mop up the flood of new and maturing debt. This revolting process
is causing foreign central banks to rapidly lose their appetite for US Treasury bonds.
The expanded FED balance sheet coupled with monetizing debt inherent in quantitative
easing is the boogeyman of international finance. That leaves us with gold, the only
safe haven refuge of undisputed value. It is real money, and everyone knows it
instinctively. That is why many foreign central banks are quietly and actively
accumulating it. Investment buying, especially by the big money players as represented
by central banks, sovereign wealth funds and leveraged hedge funds inevitably spring
into the purchase mode whenever price weakens, even modestly. They provide a floor
price for the metal on its inexorable trek northward. This means I can invest with
confidence knowing that major pullbacks almost certainly will not happen. Moreover, if
and when they occur, it will be purely a very temporary, brief and shallow phenomenon.
My sense is that it will be in orders of magnitude far greater than most analysts allow
themselves to state or believe. We frequently see price projections of 20 or 50 percent
higher than today. Some even allow themselves to suggest that gold will double in price
before it has reached its cycle high. We may even see a rare analyst allow himself to
speculate that gold prices may find and end at the $3,000 an ounce level. Of course a
few discredited gold bugs suggest numbers even greater.
It is because an affinity for and an understanding of the political mindset causes me to
understand what decision makers will do…and why. Because a politician follows the
political calendar, s/he only concerns himself/herself with the time horizon leading to the
next election. Anything requiring decisions beyond the date of the next election will be
the responsibility of whoever is on the next watch. If the politician in office today is in
office after the next election, a shrug of the shoulder indicates that worries of that kind
can be dismissed for now to be dealt with later.
So major and difficult, but necessary, decisions are inevitably deferred. In their place
spending money gives the appearance of concern and of doing something to fix the
apparent problem. Aren’t those elected officials doing what we elected them to do? It
certainly looks as if they are. More cynical observers would characterize these actions
by the political class and their senior bureaucratic minions as buying time hoping that
something positive might magically emerge. Those who are super cynical would even
conclude give-away programs are designed simply to bribe the voters in order to curry
goodwill for another term at the levers of power. What all this means is that there is no
discipline or inclination to do anything of real value in fixing the core economic and
financial problems. That being the case, new programs, more spending stimulus and
money creation will always be the order of the day. Hence the currency will devalue and
investors will find gold as their best safe-haven refuge. The dollar will devalue because
massive dilution caused by incessant money creation allows future obligations to
become more manageable – for government – because it is the only way that it can
meet its future obligations for employee pensions, accumulated debt, Medicare and
social security.
A nominal dollar which buys much less in the future than it does today is still a dollar.
Unfortunately the holders or recipients of those devalued pieces of paper will find they
are essentially fraudulent promises.
HYPERINFLATION
The main cause of hyperinflation is a massive and rapid increase in the amount of
money, which is not supported by growth in the output of goods and services. This
results in an imbalance between the supply and demand for the money (including
currency and bank deposits), accompanied by a complete loss of confidence in the
money, similar to a bank run. Enactment of legal tender laws and price controls to
prevent discounting the value of paper money relative to gold, silver, hard currency, or
commodities, fails to force acceptance of a paper money which lacks intrinsic value. If
the entity responsible for printing a currency promotes excessive money printing, with
other factors contributing a reinforcing effect, hyperinflation usually continues. Often the
body responsible for printing the currency cannot physically print paper currency faster
than the rate at which it is devaluing, thus neutralizing their attempts to stimulate the
economy.
Hyperinflation is generally associated with paper money because this can easily be
used to increase the money supply: add more zeros to the plates and print, or even
stamp old notes with new numbers. Historically there have been numerous episodes of
hyperinflation in various countries, followed by a return to "hard money". Older
economies would revert to hard currency and barter when the circulating medium
became excessively devalued, generally following a "run" on the store of value.
Hyperinflation effectively wipes out the purchasing power of private and public savings,
distorts the economy in favor of extreme consumption and hoarding of real assets,
causes the monetary base, whether specie or hard currency, to flee the country, and
makes the afflicted area anathema to investment. Hyperinflation is met with drastic
remedies, such as imposing the shock therapy of slashing government expenditures or
altering the currency basis. An example of the latter occurred in Bosnia-Herzegovina in
2005, when the central bank was only allowed to print as much money as it had in
foreign currency reserves. Another example was the dollarization in Ecuador, initiated in
September 2000 in response to a massive 75% loss of value of the Sucre currency in
early January 2000. Dollarization is the use of a foreign currency (not necessarily
the U.S. dollar) as a national unit of currency.
The aftermath of hyperinflation is equally complex. As hyperinflation has always been a
traumatic experience for the area which suffers it, the next policy regime almost always
enacts policies to prevent its recurrence. Often this means making the central bank very
aggressive about maintaining price stability, as was the case with the
German Bundesbank, or moving to some hard basis of currency such as a currency
board. Many governments have enacted extremely stiff wage and price controls in the
wake of hyperinflation but this does not prevent further inflating of the money supply by
its central bank, and always leads to widespread shortages of consumer goods if the
controls are rigidly enforced.
As it allows a government to devalue their spending and displace (or avoid) a tax
increase, governments have sometimes resorted to excessively loose monetary policy
to meet their expenses. Inflation is considered by some another tax on citizens but less
overt and is therefore harder to understand by ordinary citizens. Inflation can obscure
quantitative assessments of the true cost of living, as published price indices only look
at data in retrospect, so may increase only months or years later. Monetary inflation can
become hyperinflation if monetary authorities fail to fund increasing government
expenses from taxes, government debt, cost cutting, or by other means, because:
(1) during the time between recording or levying taxable transactions and
collecting the taxes due, the value of the taxes collected falls in real value to a
small fraction of the original taxes receivable;
(2) Government debt issues fail to find buyers except at very deep discounts
The Monetary Dynamics of Hyperinflation generally regarded as the first serious study
of hyperinflation and its effects. In it, he defined hyperinflation as a monthly inflation rate
of at least 50%. International Accounting Standard requires a presentation currency.
IAS 21] provides for translations of foreign currencies into the presentation currency.
IAS 29 establishes special accounting rules for use in hyperinflationary environments,
and lists four factors which can trigger application of these rules:
1. The general population prefers to keep its wealth in non-monetary assets or in a
relatively stable foreign currency. Amounts of local currency held are
immediately invested to maintain purchasing power.
2. The general population regards monetary amounts not in terms of the local
currency but in terms of a relatively stable foreign currency. Prices may be
quoted in that foreign currency.
3. Sales and purchases on credit take place at prices that compensate for the
expected loss of purchasing power during the credit period, even if the period is
short.
4. Interest rates, wages and prices are linked to a price index and the cumulative
inflation rate over three years approaches, or exceeds, 100%.