Posts Tagged ‘Marc Faber’

Does gold hedge against inflation/deflation?

Tuesday, February 2nd, 2010

It is often parroted by mainstream media that gold is a hedge against inflation. Sometimes, you will hear that gold is a hedge against deflation. Also, from our previous article (Will gold mining shares hedge against deflation again since the Great Depression?), we established that even though gold stocks hedges against deflation during the Great Depression, it does not necessarily apply to today’s situation. However, one of our readers said that Marc Faber reckoned that gold and gold stock hedges against deflation.

Isn’t this very confusing? How does gold hedges against inflation and deflation?

The answer is explained clearly in our book, How to buy and invest in physical gold and silver. For those who have not read that book, we will give some hints to the answer.

First, “inflation” and “deflation” are over-generalised words. Gold is a hedge against a narrow subset of “inflation” and “deflation.” The corollary is that in certain cases of “inflation” and “deflation,” you will lose using gold as a hedge. In page 20 of How to buy and invest in physical gold and silver, we have a story of Mr Goldberg who died a miserable man because he had nothing to show for his long-term commitment to gold.

As we said in How to buy and invest in physical gold and silver, the fundamental reasons for accumulating gold as a hedge are:

  1. Lack of confidence in fiat money (to function as money)
  2. Lack of trust in the financial system

Inflation is only one of the possible symptoms of point 1. Likewise, deflation is also one of the possible symptoms of point 2. The implication is that it is possible to see these two symptoms without holding those two fundamental reasons in your heart (i.e. see some forms of price inflation/deflation and yet still trust in fiat money and the financial system). Indeed, inflation has been with most of the world in the past 20 years. Deflation has been with Japan for the past 20 years. That is why there are many people (especially those from the mainstream media) who are deriding gold and gold-bugs.

But any time you have good reasons to lack confidence in fiat money and/or trust the financial system, it will be the time you will want gold as a hedge before the symptoms show up unmistakably as inflation/deflation.

To help you understand, we will give an example. During the Great Depression, banks were collapsing en masse. If your bank fails, then your cash at bank disappears into thin air. If everyone’s cash at bank disappears, then you can be sure there will be falling prices because there will be a sudden shortage of cash- everyone will want to hoard whatever physical cash they have on hand. In such a situation, if you own lots physical gold then you need not fear. You can always go to the Federal Reserve (remember, it was still the gold standard back then) and exchange your gold for physical cash. Or in theory, you can transact in physical gold only.

Today, during the Panic of 2008, banks were dropping dead like flies. That’s also a good reason to own gold or government bonds (we imagine that you can insist that the government pays you the yields with physical cash instead of depositing them at a wobbly bank). But then someone like Kevin Rudd announced that the government is going to guarantee all cash at bank. If there’s going to be falling prices (deflation) and if the financial system is going to function, then government bonds and term deposits will be better than gold. If there’s going to be mild inflation and if everything is going to be fine and benign as in the past 20 years (e.g. no currency crisis, no collapse in the financial system), then cash at high-yield bank accounts will be better than gold too.

Remember. as we wrote in our book (How to buy and invest in physical gold and silver), gold will only do exceptionally well at the extremes.

Here is a quiz question for you: if there’s going to be a collapse in the global financial system (as Marc Faber described as “deflation could only be triggered by one event: a total collapse of the existing global credit bubble”), would you rather own physical gold or gold stocks?

Permanently low interest rates for Uncle Sam?

Sunday, November 22nd, 2009

Imagine you owe a lot of credit card debt. And also imagine you have a prodigal son who blew lots of money away in gambling debts and asked you for a bailout. So, you borrow more from your credit card to help bail out your son. Also, your yearly expenditure is projected to keep on rising.

As you borrow more, more and more of your yearly income is spent on debt repayment. What if, in 5 to 10 years time, half of your annual income has to be set aside for the interest payments alone for your debt? In addition to that, what if you have already made promises to your aged parents that you will be responsible for their aged care expense in that time? Eventually, it will come a time when you have to borrow more and more money to pay the interests on your debt. When that day comes, your debt will explode exponentially.

Well, this is the situation of the United States government. In this story, the prodigal son is Wall Street. The aged parents is the coming unfunded social security and Medicare liability of the US government. As the graph from this news article showed,

Interests on US debt

Interests on US debt

Now, what if you can choose the interest rates of your debt repayment. Obviously, you will select the lowest possible rates in order to reduce your debt burden. This is what the Federal Reserve will have to do. As we quoted Marc Faber in Marc Faber vs Steve Keen in inflation/deflation debate- Part 2: Marc Faber?s view,

By keeping short term rates artificially low and by monetizing the growing fiscal deficits a central bank digs its own grave in terms of its ability to pursue tight monetary policies when such policies become necessary.

The Fed controls the short-term interest rates. It has keep the rates low because by pursuing tight monetary policy now, the short-run cost of servicing the US government’s debt will be significantly increased. As this?news article reported,

A Treasury borrowing advisory committee reported in early November that “approximately 40 percent of the debt will need to be refinanced in less than one year.

If the US wants to pursue tight monetary policy soon, it will have to deal with the short-term government. One way to deal with it is to refinance the government debt with more expensive longer-term treasury bonds. But the further the term of the government debt, the less the Fed has control on the interest rates.

What if, the free market insists that the US government pay higher interest rates? In that case, the Fed will have to buy up the government debt (i.e. print money), which artificially pushes up the government bond prices (i.e. push down the yield on the government debt). This is highly price inflationary, which in turn will make the government debt even more undesirable by the free market. That will result in the Fed having to print even more!

The new defensives- drugs & health care

Thursday, October 1st, 2009

Conventionally, if investors want to be at the most ‘defensive’ (i.e. not take any risk) for their investments, there are no better places than US Treasury bonds. The US is the keeper of the world reserve currency and their Treasury bonds are backed by the full faith and creditworthiness of the US government. By definition, the US government can never default on its debt because it has the full powers of taxation on its people and as a last resort, crank up the monetary printing press of the world’s only reserve currency. In other words, the US Treasury bonds are the safest ‘cash’ an investor can ever get.

But the problem is, under the colossal weight of debt that the US government is going to face (see How is the US going to repay its national debt?) and the commitment of Ben Bernanke towards the idea of debasing the currency (see Bernankeism and hyper-inflation), the safest of ‘cash’ is no longer safe in real terms. The US government cannot technically default on its debt because it can always print money and repay them in continually depreciated dollars. The Chinese government are acutely aware of this (see Nations will rise against nations) and are earnestly diversifying their safest ‘cash’ into other forms of store of wealth. With interest rates effectively at zero (which is below the rate of price inflation) and likely to stay there for a considerable period of time (see Marc Faber vs Steve Keen in inflation/deflation debate- Part 2: Marc Faber?s view), even risk-adverse savers are forced to speculate if they want to preserve the purchasing power of their savings.

So, we have this ironic situation that the most risk-free investments (US Treasury bonds) are actually very risky (currency depreciation through debasement). For US-based investors, Marc Faber reckoned that they are better off risking their wealth in defensive stocks than risking it in ‘cash.’

The question is which sector is defensive?

One sector that Marc Faber has in mind:

Australia’s credit growth is still falling

Tuesday, September 29th, 2009

Marc Faber once said that for an economy that is addicted to debt, all it needs to tip it into a recession is for credit growth to slow down- no contraction of credit is required. Also, as Professor Steve Keen explained, at this stage of the debt cycle, the aggregate spending in the economy is made up of income plus change in debt. In the absence of income growth, a slowdown in credit growth implies declining aggregate spending by the private sector.

Now, let’s take a look at Australia’s year-on-year credit growth (up till July 2009):

Year-on-year credit growth in Australia (July 2009)

Year-on-year credit growth in Australia (July 2009)

It’s now the government doing a bigger and bigger share of the spending.

Can stocks hedge you from price inflation?

Tuesday, September 15th, 2009

Continuing from our previous article, should we buy stocks as a hedge against price inflation? The answer to this question is not so straightforward.

In normal circumstances, some stocks are a good hedge against the garden-variety types of price inflation (or even beat inflation spectacularly) because their earnings power can increase faster than the general rise in prices. But in times of hyperinflation, when the real economy deteriorates, it will be increasingly difficult to find such a business.

First, let’s take a look at the past from this research report,

The 1970s were a period of accelerating inflation and poor equity returns in the US. By December 1980, the federal funds rate stood at 20%, and the ten-year Treasury peaked at 15.3% in September 1981. From December 31, 1968 to December 31, 1981, the S&P 500 returned 1.28 % per annum in nominal terms and -6% in real returns. Put another way, a dollar invested in the US stock market at the end of 1968 twelve years later was worth roughly 45 cents in real terms.


In the US, there is substantial empirical evidence that high inflation is associated with a high equity risk premium and declining stock prices. Bodie (1976) found from 1953-1972 that common stocks were poor hedges against inflation. Cohn and Lessard (1980) also found that stock prices in many industrial countries are negatively related to nominal interest rates and inflation.

It is important to make the distinction between properly anticipated inflation, and unanticipated inflation. If inflation is correctly anticipated and if companies can in fact pass on costs of doing business, then nominal cash flows should be unaffected by a general increase in prices. However, as inflation rises, it tends to become more uncertain and a component of price increases may not be properly anticipated by firms. Blanchard (1993) found that ?an unexpected increase in inflation in year 0 leads to a sharp decrease in stock prices in that year.?

There are a couple of ways to see why price inflation and stock prices are negatively correlated:

  1. In times of high inflation, interest rates are high. Therefore, bonds may prove better value than stocks relatively.
  2. Investors demand higher returns from stocks to compensate against higher price inflation. The lower the price paid for stocks, the higher yield returned by the stocks and thus, the higher the returns on investments.

On the other hand, we have examples in history where hyperinflation do wonders for stock prices. For example, in 2007, Zimbabwe had the world’s best performing stock market- stocks actually rose faster than price inflation:

Zimbabwe Industrial Index up till 2007

Zimbabwe Industrial Index up till 2007

Despite these two seeming contradictory real-life examples, one thing is clear: everything else being equal, unexpected rise in price inflation will lead to compressed valuation of stocks due to a rise in discount rates used to value stocks. In other words, PE ratio can decrease (in the context of rising earnings) even though stock prices can still rise in nominal terms. In the case of the US stock market in the 1970s, this led to negative returns in real terms. But in Zimbabwe’s case, stocks actually had good positive returns in real terms. But make no mistake: as we quoted Marc Faber in our previous article, such positive returns are the result of rising speculative bubbles in the stock market abetted by the printing of money.

If you believe that the (1) US are going the path of Zimbabwe-style money printing and (2) the stock market hit record high due to speculation, does it mean that you should rush to buy any stocks as a hedge?

Here, you have to be careful. The dizzy heights of stock prices in the Zimbabwean stock market have a survivorship bias. With real GDP deteriorating and sky-rocketing unemployment in that country, we are sure many Zimbabwean public companies are dropping dead like flies. That means, there will be many stocks whose prices went to zero. If you happen to hold one of them, you will suffer loss in nominal terms in a hyper-inflationary environment.

Also, stellar stock market performance that are induced by money printing are, at the end of the day, bubbles. Bubbles can easily burst.

Thus, if you are considering holding stocks as a price inflation hedge, you will have to choose the stocks very carefully. The wrong choice will lead to (1) losses in real terms at the very least or (2) a possible wipe-out in the context of a highly dysfunctional economy.

Should you be bullish on stocks?

Sunday, September 13th, 2009

Marc Faber is a well-known contrarian bear. He has such a pessimistic streak in his blood that he is given a nickname of “Dr. Doom.” But many people were surprised that this bear is actually quite ‘bullish’ on stocks. For example, even though he believes that stocks are going to face a major correction soon, he believes that the rally can still have more room to run.

How do you reconcile his bearish temperament and ‘bullishness?’

The trick is to understand that his reason for ‘optimism’ is different from the reason espoused by the “green-shoots-of-recovery” crowd. The basis of his ‘bullishness’ is based on a very pessimistic view of the economy. This Lateline interview sums up his view very well:

As we wrote before in Can we have a booming stock market with economic calamity?,

But as we stressed many times in this journal, it is possible to have economic calamity with booming asset prices, especially stock prices

Based on conventional economic theory, there is no explanation for such a stellar performance for the Zimbabwean stock market when the GDP was collapsing (see Zimbabwe: Best Performing Stock Market in 2007?). A stock analyst using conventional valuation analysis will hard pressed to justify the lofty heights of stock prices.

But followers of the Austrian School of economic thought have an explanation for this illogical phenomena. In a perfect world, every single cent of the printed money will go straight into repayment of debt and thus, wiping out debt obligations, introduce financial stability and not cause price inflation in one swoop. Unfortunately in the real world, the plans of the governments and central banks do not always work out perfectly. In a dysfunctional economy, the massive printing of money can lead to some of them being used for speculations of assets and commodities instead of de-leveraging. As what happened in 2008 (see Who is to blame for surging food and oil prices?), the speculation of the latter can lead to strong price inflation.

In the same way, the current bout of monetary inflation is the cause of the rally in the stock market. In fact, Marc Faber believes that this rally has more room to go beyond the current impending correction. It is possible that the coming correction may not come in the form of tumbling stock prices- stocks may stagnate sideways until the technical overbought condition deflate to a more balanced one.

Today, it is the stock market that gets artificially inflated. Tomorrow, it can be the commodity markets. Now, the question is, should you buy stocks to protect yourself against price inflation? We will look into it in the next article.

Before you short the market with options…

Sunday, September 6th, 2009

After reading our previous article (Time to short stocks in the NYSE?), one of our readers asked us a very practical question on using options to successfully trade the market. For those who are thinking of making their wealth with options, please read and understand what we wrote to this reader:

But one thing you have to bear in mind: learning about the technical aspects of options (e.g. delta, gamma, theta, delta-neutral, options strategy) is the easy part. We have quite a few good book recommendations that can teach you the technical aspects of options very well. The difficult part is to be a good trader. Even if you are an options expert, you will still make plenty of losses if you are a bad trader. On the other hand, if you are a good trader, you can still make good money with the most basic options strategies.

Options is just a tool. A bad trader who uses a powerful tool will lose money regardless of how well he/she understand about the tool. A good trader, coupled with a strong basic understanding of the tool, can make good money.

Options trading is a very vast field of study (for example, the topic of volatility in itself can cover a thick volume). Therefore, this is something that we cannot cover in just one article. For this article, we will give a little preparatory background about options before going into something more practical. For those who are totally uninitiated to options, please read Introducing options as insurance and How not to use options first before continuing.

For budding options trader, the thing to remember about options is: statistically, around 80% of options expire worthless.

  • Therefore, buying options (whether call or put) is likely to result in loss.


  • But the other 20% of options (that are not worthless when they expire) have the potential to yield fantastic profits.

Therefore, buying options allows you to profit from Black Swans. If you have not already, please read Failure to understand Black Swan leads to fallacious thinking. Put it simply, even though you are more likely to lose money buying options, you will make lots of money should you win the unlikely-to-win (based on statistical probability) bets.

  • Conversely, if you write options, they are likely to result in profits.


  • But on the other 20% of options (that are not worthless when they expire) expose you to a contingent liability that can result in substantial loss.

Therefore, writing options makes you vulnerable to Black Swans. Put it simply, even though you are likely to make a nice income writing options, you are exposing yourselves to contingent liabilities that can result in substantial losses (if you are not hedged).

In options trading lingo, buying options gives you positive gamma while writing options gives you negative gamma. If you have no idea what “gamma” is, forget about it because it is a specialised jargon used in the options universe. If your options position have positive gamma, you will benefit in sudden increase in volatility. On the other hand, negative gamma positions will benefit from little volatility in the market.

When options traders construct an options position, they are using a combination of buying and writing options to adjust between the positive and negative gamma according to their tolerance for risk and their conviction of the market.

In the current market, if you believe that there’s a likelihood of sudden unexpected increase in volatility, your options position should have positive gamma (e.g. from simple buying of put options to the more complex put ratio backspread). Positions with negative gamma are vulnerable (e.g. writing put options in the belief that a nice gradual up-trend will continue) to sudden increase in volatility. To explain this in more detail, let us give you a few examples:

  1. If you buy out-of-money put options, you are likely to lose 100% of your money, based on statistical probability. But if the market suddenly crashes, you will make many times the return on your capital.
  2. If you write out-of-money call options, you are likely to make a little money most of the time. If the market crashes or rises a little, you will profit a little. But if the market rises significantly (e.g. a stock that receives a takeover bid), you will likely to suffer heavy losses.
  3. If you buy out-of-money call options, you will suffer limited loss should the market crashes. But if the market sky-rocket suddenly (e.g. if the Fed announces that they will drop freshly printed US$100 trillion from the sky via helicopters), you will make big money.
  4. If you write out-of-money put options, you will make a little money if the market rises or falls a little. But if the market crashes, you can lose a lot of money.

That’s all for today on options. If you do not understand what we are talking about, don’t worry. Options traders live in a different planet from the rest of the world.

One final note: in a recent interview, Marc Faber said that he believes that the market will make a big move in the next 10 to 14 days.

Explosive gold price movement ahead. But up or down?

Tuesday, September 1st, 2009

In Marc Faber latest market commentary report, he highlighted the fact that gold prices had been range-bound since February this year. But as the months progresses, the price range gets narrower and narrower:

Gold prices trading range

In technical analysis, this type of price formation is called a “pennant.”. A pennant is like a spring coiled up, ready to jump at any moment. As the price range narrows, it can be interpreted to mean that buyers and sellers are getting more and more polarised and entrenched in their convictions regarding the next move for gold prices.

This means to price volatility for gold will be upon us soon. The question is, which way? Up or down? Marc Faber opined,

I lean toward the view that gold will break out on the upside. The only problem I have, however, is to reconcile my relatively positive view about the price of gold (and other precious metals) with a rebound in the US dollar and a correction in equities. Of course what could happen is first a rebound in the US dollar and a brief correction in gold and equity prices before these short term trends – driven by further monetary easing – reverse, and gold (as well as other commodities) and stocks move up again in tandem.

However, our view is that should the precious metal prices fall (in the context of correction in equity prices and rebound in the USD), the fall may be quite substantial (we could be wrong here). This is because others traders and speculators are also watching the pennant formation in gold prices and should the break-out prove to be on the downside, they’ll be likely to press the “sell” trigger.

Another possibility is that in the coming correction, gold prices and USD may go in the same upward direction. That happened before last year as US Treasuries and gold were rising simultaneously (in the context of capital flight towards safe havens after the collapse of Lehman Brothers).

Ladies and gentleman, what are your bets? Up or down? For options traders, they can bet on both by buying in-the-money call and put options.

Is this a bear market rally or a turning point?

Sunday, May 17th, 2009

The global stock market has been rallying for the past couple of months already. There have been talks of “green shoots” of economic recovery. There are hopes that China’s stimulus spending will bring out renewed demand for Australian commodities. Already, there are reports of record Chinese demand for commodities (see China on buying spree).

We heard of many retail investors piling into the stock market, not wanting to miss out in the turning point. Since the stock market tends to be a leading indicator of future economic activity, many are seduced by the idea that this rally is predicting a turning point in the global economy. Unfortunately, as with many cliché ideas, this is only half-true. This is an example of a mental pitfall called lazy induction (see Mental pitfall: Lazy Induction).

To be more precise, the stock market anticipates but not predicts turning points. What this means is that economic recoveries are followed from recoveries in the stock market, but a stock market rally does not necessarily indicate an economic recovery. A very good example will be the number of bear market rallies in the chart of the Dow Jones from 1929 at Bear market rally on the works?.

Now, let’s take a read at what Marc Faber says about this rally in his latest market commentrary:

The economic news in the world is hardly getting any better, but the rate of economic contraction has slowed down somewhat as the  governments? stimulus packages begin to have some impact and as some replacement demand is starting to support consumption. However, to talk  already now about a sustainable economic recovery seems premature because whereas some sectors (autos) and regions may be stabilizing, others are still in a steep decline.

The global economy are declining, but the speed of decline is not as fast as the second half of 2008. Therefore, this stock market rally is anticipating that this reduction in speed is a turning point.

The next question to ask is this: will the stock market be lower or higher in 2010? Even Marc Faber admitted not knowing the answer to this question. Indeed, it is certainly possible to see another bout of breathtaking crash that can rival the panic of 2008. There can be many possible triggers for that, including:

  1. Collapse of a major European bank. Many big European banks lent so much money to Eastern Europe that their asset books are even bigger in size than the GDP of some European nations! Meanwhile, many Eastern European economies are in serious trouble, which means there will be many gigantic bad debts floating around. The European Union is an economic union but not a political union. Therefore, the European Central Bank (ECB) does not have the same level of authority and political support as the US Federal Reserve. Individual nations using the Euro as their currency cannot simply print money to bail out their financial system because they have surrendered their economic sovereignty to an intra-national authority. To do that, there can be a situation whereby taxpayers of say, Germany, are asked to bail out the taxpayers of say, Spain. Politically, this is too much to ask. Therefore, if a banking crisis is to hit Europe, the political deadlock can result in another panic in financial markets.
  2. Swine flu
  3. Collapse of Pakistan

At the same time, governments are already embarking in massive money printing (quantitative easing), stimulus and bailouts spree. As we said before in Marc Faber vs Steve Keen in inflation/deflation debate- Part 2: Marc Faber?s view,

… while the deflationary pressures will continue, it can be slowed down via unconventional monetary policies (see ?Bernankeism and hyper-inflation?), gigantic fiscal policies, bailouts and even government fraud. The result will be a long drawn out affair, akin to a grinding trench warfare and a war of attrition on the real economy as credit contraction (IOU destruction) collide head on with money printing, massive government spending, stimulus and bailouts.

If government pumps so much money into the financial system, it is only a matter of time before asset prices rise again, not because of improving economic outlook but because of the sheer weight of money. The problem will be massive consumer price inflation once the Global Financial Crisis (GFC) is over, which is a problem for the next generation to solve. The outcome will be what we wrote in Zimbabwe: Best Performing Stock Market in 2007?.

In any case, no matter what happens, the peak of economic boom in 2006/2007 is over and will not be back soon. Investors who are expecting that will be disappointed.

Marc Faber vs Steve Keen in inflation/deflation debate- Part 2: Marc Faber’s view

Thursday, May 7th, 2009

In our previous article, “Marc Faber vs Steve Keen in inflation/deflation debate- Part 1: Steve Keen’s model”, we promised to explain Marc Faber’s view on why inflation (rather than deflation) will be outcome in the years to come. As he wrote in his most recent Gloom, Boom, Doom market commentary,

Now, from the numerous emails I get I have the impression that most investors are leaning toward the view that ?deflation? will be the problem in the future and not ?inflation.? An ?expert? [Editor’s note: For the sake of peace, let us all assume he was not referring to Professor Steve Keen] even opined that whereas it was possible under a pure paper money system (large quantity of banknotes in circulation) to create high inflation rates, this was not possible under an electronic banking system.

First, let’s take a look at Professor Steve Keen’s view that the destruction of credit (IOUs) will overwhelm any money printing by the government. As Steve Keen said in “The Roving Cavaliers of Credit”,

To make a serious dent in debt levels, and thus enable the increase in base money to affect the aggregate money stock and hence cause inflation, Bernanke would need to not merely double M0, but to increase it by a factor of, say, 25 from pre-intervention levels.

Our view is that while massive deflation of credit will occur, it will not happen overnight. Instead, while the deflationary pressures will continue, it can be slowed down via unconventional monetary policies (see “Bernankeism and hyper-inflation”), gigantic fiscal policies, bailouts and even government fraud. The result will be a long drawn out affair, akin to a grinding trench warfare and a war of attrition on the real economy as credit contraction (IOU destruction) collide head on with money printing, massive government spending, stimulus and bailouts. In fact, this is what is happening right now in the US as optimism for “green shoots” of economic recovery fuels a rally from the depths of the panic of 2008. To make this saga even more confusing, despite the credit destruction in the second half of 2008, prices on the street have yet to make a meaningful decline. Simply speaking, money ‘printing’ will be spread out over a number of years until deflationary pressure subsides. Thus, Bernanke is not going to increase M0 by 25 times in a flash- he is going to do so over an extended period of time until it is no longer deemed necessary.

Next, credit contraction will not go on forever. As Professor Steve Keen commented before, he expects deflation to end eventually and inflation to return after say, a few (or several or dozen or whatever) years.

Now, we will talk about Marc Faber’s argument. Consider what’s happening as the Global Financial Crisis (GFC) unfolds:

  1. Economy contracts
  2. Interest rates are cut
  3. Fiscal policy is stepped up to assist failed monetary policy (see “What makes monetary policy ?loose? or ?tight??”). Then as Marc Faber said,

    But for the fiscal stimulus to even have a small chance of succeeding at reviving economic activity it has to be larger than the private sector credit contraction.

    With that, he had a chart to show that “US Private Sector Credit Contraction Is Offset by Public Sector Credit Expansion!”

  4. Government spending going up when tax receipts declines.
  5. Upward pressure on interest rates (see “How are governments driving up fixed mortgage rates?”)
  6. Governments forced to monetise debt (i.e. print money, which is already happening in the US, UK and Japan) in an attempt to force long-term interest rates down. See “Why are nothing-yielding US Treasuries so popular?”.

That’s where the crux of Marc Faber’s argument,

And here lies the crux of the problem most deflationists do not understand. By keeping short term rates artificially low and by monetizing the growing fiscal deficits a central bank digs its own grave in terms of its ability to pursue tight monetary policies when such policies become necessary.

If the US Fed failed to tighten monetary policies after the US economy began to recover in November 2001, what are the chances of tight monetary policies in the future (which would significantly increase in the short run the cost of servicing the government?s debt) when both the US government and the Fed will be loaded with toxic assets and burdened by all kinds of other liabilities? The chances of the US government implementing tight monetary policies in the next few years are exactly zero.

But my point is simply this: Once a government embarks on highly expansionary fiscal policies which entail government expenditures vastly exceeding revenues (leading to enormous budget deficits and soaring government debt) and simultaneous monetization (?printing money?), the reversal of these inflationary policies becomes for all practical purposes impossible. Inflation and higher interest rates follow. At this point the reader should clearly understand that any upward pressure on interest rates brought about by the market participants will actually force a central bank that embarked on monetization to monetize even more [Editor’s note: This is the time when money supply will increase exponentially!]. The other point to remember is that the longer an economy does not respond to such ?inflationary? fiscal and monetary policies, the larger the ?doses? will become.

So, by implication, any global recovery from the Global Financial Crisis (deflation) will bring forth another crisis (inflation)!