The #1 Reason Inflation Will Win

Dear Reader,

Economist Terry Coxon and BIG GOLD Editor Jeff Clark had some interesting discussions during the recent Casey Research Summit on Navigating the Politicized Economy. They noticed a near-consensus among the speakers that there's no way out for the over-indebted US government – or the Eurozone for that matter – which has consequences for all participants in the global economy. Below, you can read why Terry (and others) are convinced there's no way out, why he's convinced the problem will end in inflation, and what the investment implications are for gold and silver.

How do we profit from that? Even as you receive today's Daily Dispatch, Jeff and I will be flying down to Mexico to look at a silver mine one of our companies recently acquired. Due diligence: pick right and sit tight. That's how we do it – and you can too.

If you want to learn more about the Casey Research process or pick our brains in some other way, please consider joining Doug Casey, our Chief Energy Investment Strategist Marin Katusa, and myself next month in New Orleans. We'll all be speaking at the New Orleans 2012 Investment Conference, which will be held October 24-27. You won't want to miss Doug's debate against James Carville and Charles Krauthammer – it's sure to be a memorable event. The markets are getting really interesting, so you'll be sure to learn a lot.

Sincerely,

Louis James
Senior Metals Investment Strategist
Casey Research

The #1 Reason Inflation Will Win

Jeff Clark: I was struck at our summit by how many speakers have come to the same basic conclusions we have – that there's really no way out of the US debt hole. That has a lot of implications, but first, in your view, how bad is it?

Terry Coxon: It isn't so bad that you should think of it as the end of the world, but there is a lot of trouble stored up, and I think "no way out" describes the situation accurately. Most of our economic trouble has been built up by government actions to solve past problems, and what they've done is to buy time and provide painkillers, but in doing so they've made the problems even worse.

Jeff: Why, specifically, is there no way out?

Terry: Let's start with the Federal Reserve and the money supply. In response to the collapse of the housing bubble and most financial markets in 2008-2009, the Federal Reserve began printing like crazy. The monetary base more than doubled, and the M1 money supply at this point has risen a little over 60%. The reason we haven't seen rapid price inflation is that people are still squirreling away dollars because they're still very worried about the prospects for the economy. But that' not the end of the story. The Federal Reserve will keep printing – as everyone knows by now, Mr. Bernanke has pledged allegiance to the printing press and assured the markets that the printing isn't over and won't be over until the economy revives.

Sooner or later, the Federal Reserve will have created so much cash that many people – maybe most people – will be glutted with dollars, and buying anything will look good compared to holding on to more dollars. At that point, the urge to buy – whether it's capital goods or consumer goods or commodities – will revive the economy, and the recession will come to an end. That will reduce the level of caution people feel to something near normal. The result will be that all of the excess money that has been created since 2008 will come pouring out. For a little while it will look like happy days are here again – the economy will seem to be booming. But then the excess cash will set off hair-curling price inflation. And that's just the monetary side of the problem.

Now look at the budget side of the federal government. They have been operating on the old Keynesian formula of deficit spending to revive a stagnant economy. What Lord Keynes perhaps never considered was that even if that prescription worked – and there is precious little evidence that it does work – there is a limiting factor over the long run. That limiting factor is the ability of the government to service debt that gets larger and larger. The US balance sheet is already at the gateway to the danger zone. When accumulated debt exceeds annual gross domestic product (think of it as annual income for the whole country), that's where governments start to get into trouble in the capital markets.

Now the budget situation – or the debt-financing situation for the US Treasury – has been made exceptionally easy by the exceptionally low interest rates that have been engineered by the exceptionally rapid growth in the money supply. When the economy starts to revive, interest rates will go up, and then the cost to the US Treasury of rolling over its now $16 trillion in debt will become a noticeable element in the overall budget. That pushes the government closer to a debt spiral, where the rise in interest rates makes it more expensive to service debt, which means the debt accumulates even faster. At that point, doubts about the ability of the government to service the debt over the long run forces another kick up in the government's borrowing costs. It becomes a nasty and vicious feedback cycle that is similar to what is going on now in Greece and Spain. This is a predicament the US government is just whistling about. They've closed their eyes to the risk.

So between the built up inflationary pressure that will come roaring out when the economy revives and the constantly growing US government debt, there is no solution to the economy's problems that is politically acceptable.

Jeff: Some economists think we'll eventually grow our way out of this. We're still the superpower of the world and still generate a lot of GDP, so can't growth eventually pay back all this debt?

Terry: In principle, such a thing is possible, but it would require political measures that are impossible. They would have to throw out most regulation of the economy, sell off an empire of unneeded real estate, stop using soldiers, ships, and planes as pieces in a "big boys' really big chess set," and starting saying "no" to the many people – both rich and poor – who now live off the government.

Jeff: Why aren't more economists expressing concern or even outrage over the predicament we're in? It seems so obvious.

Terry: If you studied economics when you went to school, the economics department probably was within a short walk of the science building, where they studied physics and chemistry. That leaves people with the false impression that economics is a hard science like physics or chemistry, where there are clear, proven principles anyone can test and everyone can agree on. In fact, economics today is about where medicine was in the 17^th century, when people were debating whether the blood circulates through the body or just sits there. That was the level of knowledge by the best minds of the day, and it is the level of understanding by economists today. So you shouldn't be surprised that most economists are sure that most other economists are wrong.

Jeff: So what happens – high inflation? There are some strong deflationary signals in the economy right now.

Terry: Even if there are episodes of deflation, they will just inspire even faster money printing. In the contest between inflation and deflation, inflation always gets another turn until it wins.

Jeff: Good point. Is inflation imminent? The CPI is still pretty low.

Terry: Well, it's never going to be imminent in the sense that today it's not happening and next week it is happening. It's more like a river rising. And when you see the economy start to revive, the rate of price inflation will start rising noticeably in a year or year and a half.

Jeff: This has obvious investment implications.

Terry: Yes. You and your family should think about how to protect yourselves, and the formula sorts out to something very simple. One, you need some gold in your financial life, and two, you don't need any bonds in your financial life.

Jeff: Yes. Anything else?

Terry: Well, those are the most obvious – gold yes, bonds no. You should also keep a good holding of cash in your investment portfolio, because there probably will be one or more replays of what we saw in 2008 and 2009. And when that happens, you will be glad you have cash because you can take advantage of the bargains.

Conventional stocks are a bit of a quandary. On the one hand, the equity market welcomed the restarting of the printing press. On the other hand, the equity markets, as they go up, are diverging from economic reality. So I suggest thinking of a portfolio of conventional stocks as a machine that sits in your office and churns out ten-dollar bills, but eventually is going to blow up. If you want to take the risk that you'll know when to get out, well, at the end of the day, if you're right and you get out in time, you will be glad that you invested in conventional stocks. If you are thinking about a portfolio that you can just put away and forget about, then conventional stocks should not be part of it.

Jeff: Bernanke said the $40 billion of bond-buying every month is open ended, implying it could last awhile. Any sense for how long it goes on before the economy revives?

Terry: Open-ended is an extraordinary thing to announce. The fact isn't surprising, but I am surprised they would 'fess up to it.

The picture I have is someone sitting next to a pile of damp firewood, lighting matches and just throwing them on. Eventually those matches are going to dry out the firewood, and then you will get a big blaze; and that's what the Federal Reserve is doing to the economy right now. The difficulty is that if you're in charge of printing all the new dollars, you won't know that you've printed enough until you've printed way too much.

Jeff: That implies gold and silver prices have a long way to go yet.

Terry: Yes, I certainly believe so.

Jeff: What kind of price levels do you expect?

Terry: The only reasonable thing that I can say is, a lot higher. The reason that it doesn't do much good to put a number on it is that we don't know how long rapid rates of inflation will run.

Jeff: What about gold stocks? If you're lukewarm on the stock market, can gold stocks still do well?

Terry: The basic answer is, if you want to own stocks right now, don't own red stocks, don't own blue stocks, own gold stocks.

Jeff: Silver is considered a monetary metal, too, but is there a scenario under which gold does well but silver does poorly?

Terry: Yes: runaway inflation and a very sick economy that is not consuming a lot of silver. That could leave silver behind, but it would have to be a very ugly economic situation.

Jeff: But wouldn't the Fed just print more money and make silver as attractive as gold?

Terry: Not necessarily. The demand for gold is financial demand, period. Silver is a different story altogether. It is partly financial demand and partly industrial consumption.

Jeff: What odds do you give for something like that happening?

Terry: I don't expect that to happen. If it happens at all, it's years away.

Jeff: So the bottom line to all this is, make sure you own enough gold.

Terry: That's exactly right.

Gold and Silver HEADLINES

Mining Investment to Grow Ever More Complex and Costly, Industry Leaders Fear (Mineweb)

Baker & McKenzie surveyed more than 300 senior mining industry leaders across six mining jurisdictions – Australia, Brazil, Canada, China, Indonesia, and South Africa. The key themes in the study were the complexity of the legal and regulatory environment, political stability, resource nationalism, access to infrastructure, and skilled labor. A common thought expressed by the majority of the respondents across these jurisdictions is that "investing in mining is becoming more difficult and less certain," and they believe that mining sector investment will continue to be more complicated.

This research confirms what other mining industry surveys report. Resource nationalism, named the #1 threat for mining, is expected by the majority of respondents (78%) to increase over the next 20 years. That's why it is so important to understand investor friendliness of any given jurisdiction. And navigating the political landscapes is exactly what we do in International Speculator and BIG GOLD.

Silver ETF Holdings Nearing Record Levels (Silver Institute)

The Silver Institute reports that silver ETF holdings have totaled more than 608 million ounces with a value of US$20.5 billion through September 15. Investors have added more than 32 million ounces to their silver ETF accounts so far this year. Investor demand was one of the most important factors cited in silver's recent price rise.

"Investors and analysts are bullish on expectations that additional central banks will do more to attempt to stimulate economies in order to increase consumption and spur employment, leading to even greater investor attention on the 4,000 year allure of silver as a safe haven and a store of value," said Michael DiRienzo, Executive Director of the Silver Institute.

We agree that investor interest for silver will drive the price higher.

This Week in International Speculator and BIG GOLD – Key Updates for Subscribers

International Speculator

• An exploration-stage company released an updated resource estimate. See our comment.

• Another exploration company from the IS portfolio delivered world-class drill results this week.

BIG GOLD

• One of our Best Buy stocks issued a press release stating a recently granted permit is "still valid" – what's this all about?

• Some very high-grade drill results were released by this silver producer.