Preparing for the Mother of All Deflations

Given data points week after week as shown below for my IDW, I have little doubt but that we have entered a very serious secular debt deflation. This chart was updated after the market closed this past Tuesday. Due to travel and vacation plans, this was the latest I could update this chart before my return home on Saturday. But what you can see very clearly is that my IDW, which includes proxy items for key commodity and global equities, has entered a secular bear market, with the weekly IDW now falling not only through the three-year moving average but also decidedly through the five-year moving average. And this has come despite (or perhaps because of) massive amounts of debt-based money. Keep in mind that debt is the raw material from which the fraudulent money the bankers require us to use these days is manufactured. As of Tuesday, the IDW stood at 139.89. That compares to a three-year average of 153.46 and a five-year average 145.87.
kondratieffMany people, including the likes of Peter Schiff, have dogmatically predicted that hyperinflation would result from massive money printing. But what hyperinflation believers have never seemed to quite understand is that what we are facing is not a hyperinflationary Weimar Republic-like event or a Zimbabwe event. What we have is a debt-based money system rather than simply printing-press money. True enough, debt-based money has artificially stimulated demand in the short run and boosted prices. That was clearly the cause of the housing boom and it was clearly the case that QE1 and QE2 drove prices of commodities and equities higher until 2011, when commodities started a significant bear market while equities, boosted by the Plunge Protection Team, continued to rise higher, thus allowing Wall Street thieves to get ever richer at the expense of the masses.

Kicking the can down the road is even how mainstream economists have described the policy of the Fed and the U.S. Treasury. But only the Austrian economists are aware of the extreme harm that money printing causes. And as Exter understood, debt-based fractional reserve systemic money creation is especially pernicious. And why I believe we are facing the mother of all deflations now is because the Fed has been so “successful” in putting off the day of reckoning since Nixon detached gold from international money in 1971.

One of the major concepts that all Austrians bring to the discussion of harm done to the economy from money creation is “mal investment.” Because the Fed has disallowed price discovery for capital to take place for many decades now, capital has flowed into areas of the economy where it cannot be employed efficiently. The result is money invested in areas that are not profitable. Some outstanding examples of recent years have been the dot-com investment boom and the housing boom. But there have been many more than that, too, that are less spectacular but nonetheless mean society is not enjoying the optimum material well-being over the longer term that it could be enjoying had price discovery for capital—the lifeblood of capitalism—been allowed to exist.

But the damage of the existing system extends well beyond mal investment because the system is a Ponzi-based debt pyramid. When you deposit a dollar in your checking account that dollar can be loaned out as many as 100 times, depending on how reckless and greedy the bankers are. You may recall recently how all the big money central banks objected to Paul Volcker’s recommendation that they add more capital and less debt to their balance sheets? In any event, the problem isn’t only that capital has been wrongfully deployed because interest rates (the price of capital) have been bastardized by the Fed and other central bankers. The problem is that each of those fraudulent dollars appears real to the holders. But that reality becomes something quite different when the debt-based money pyramid begins to cascade downward, as it began to do in 2008-09. I hate to say it, but my IDW is suggesting that the next major downward cascade is about to begin.

John Exter’s debt pyramid shown on your left is inverted to make the point of what happens when the system stops expanding, as the IDW clearly suggests it now has. Note the items at the top of the inverted pyramid are more speculative, less liquid, and thus less essential for securing essentials like food, shelter, and clothing. The items at the bottom of the inverted pyramid are the most liquid, most secure items. Actually, according to Barry Downs, John Exter’s son-in-law, gold, which is at the very bottom, should be outside of the pyramid because ultimately the entire system will tumble down and all that will be left of a monetary system will be gold. (Note that John Exter did not build silver on this pyramid; that will be a discussion for another day.) It’s the concept there that I want to focus on, which is that when the system implodes, the items at the top of this inverted pyramid are frantically sold in order to secure the items at the bottom of the pyramid that are required to secure life-sustaining items.

M2There is one more concept that I think Austrians as a whole have not focused on enough and that is “money velocity.” Perhaps they don’t want to think about money velocity because it was a Keynesian concept. But certainly mass psychology is a non predictable variable that can cause the winds of inflation or deflation to shift, because by money velocity, we mean the rate at which money turns over. If money turns over twice as fast, it is tantamount to the money supply doubling. Well not surprisingly, with more and more middle-class Americans slipping into poverty, they ain’t spending money very quickly. They are holding on to what they have for dear life. They are not buying those items at the top of Exter’s inverted pyramid, in large part I suspect, because they are broke and simply hope to have enough cash from one paycheck to the next to be able to buy their food and pay their rent. So check out the chart above of one major monetary measure by the St. Louis Fed, namely M-2. Charts of other monetary measures for the U.S. dollar look very similar.

So when you combine mal investment with a fraudulent Ponzi debt-based money system and masses of people heading toward or already are experiencing poverty, what is unfolding and was predicted by John Exter many years ago, is now happening in spades. This is, in my view, a very frightening event that is unfolding before our eyes now, but one that has been discussed in this letter many times.

But the big question of course is, what can we do to prepare for the carnage that lies ahead? For example, a look at John Exter’s inverted pyramid suggests that U.S. Treasuries may be one of the last items to enter a bear market. Indeed, as we have seen when the unwinding begins to take place and while the masses still “believe” in the existing monetary system, Treasuries are a “risk off” preference.

Kevin Duffy to the Rescue

Kevin Duffy, who is the partner of Bill Laggner who was recently a guest on my radio show, sent me the following email last week.

Hi Jay,

Yesterday I listened to Bill Laggner’s interview on your show Sep 1st which was excellent, btw. While Bill set the stage for an asset deflation, there wasn’t much time to drill down into applying that scenario to investments. This got my wheels spinning for a possible appearance on your show. Two general ideas:

1) After knocking the cover off the ball in 2007-08, Austrians have a lot of egg on their faces since 2009. The economy recovered, unemployment fell, and the bailouts supposedly worked. U.S. stocks tripled, government bonds rallied, and gold fell from grace. Worse, any Austrian investing in gold stocks or short selling got decimated. What went wrong? What have we learned? Does Austrian economics apply today?

2) If bursting asset bubbles is the most likely scenario, how do investors position themselves? Should gold be abandoned? What are the risks of short selling? Is this an opportunity to make money or just a good time not to lose money?

I have a 100+ slide PowerPoint which I can cull down to about 20 slides for you. This will expand on the two ideas above.



I responded to Kevin that I thought these were the most important financial questions that need to be addressed now. Having a high regard for Kevin Duffy, I have invited him on my radio show next Tuesday to address these very issues. As a newsletter writer, I covet Kevin’s ideas on these questions and I would like to remind you that the last time the markets imploded during the financial crisis, the Duffy and Laggner team registered triple-digit gains. Of course past performance is no guarantee of future performance. But I have known both of these men for more than a decade and they both approach market analysis through an Austrian school lens, which gives them a much better chance at getting it right than others, who are clueless as to the cause of these boom-and-bust disasters. So, I hope you will tune in live to my show at on Tuesday at 3:00 PM Eastern or listen the following day at for the archived Segment One, and I’m expecting that a second segment with Kevin will also be aired exclusively at

About Jay Taylor

Jay Taylor is editor of J Taylor's Gold, Energy & Tech Stocks newsletter. His interest in the role gold has played in U.S. monetary history led him to research gold and into analyzing and investing in junior gold shares. Currently he also hosts his own one-hour weekly radio show Turning Hard Times Into Good Times,” which features high profile guests who discuss leading economic issues of our day. The show also discusses investment opportunities primarily in the precious metals mining sector. He has been a guest on CNBC, Fox, Bloomberg and BNN and many mining conferences.