Answers from a Monetary Master

David Galland, Partner, Casey Research

Dear Reader,

I have a treat for you today. In fact, this could be the most useful edition of these Friday musings we'll put out this year.

That's because in it I question the individual who I (and many others) consider to be the leading authority on monetary matters madness working today.

This individual has dedicated decades to understanding the dynamics of an economy and how to create portfolio strategies to take advantage.

In that context, monetary policy currently looms large. Can the US government's policy of creating trillions of new currency units out of thin air really have no negative consequences? Or is it setting the stage for serious inflation? If so, what have the deflationists missed? And if a serious inflation is in the cards, when might it appear?

The answers to those questions are of great importance: they determine the steps we take to position our portfolios for protection and profits.

And I am convinced that the individual I'm interviewing as the core of this edition of The Room has the answers.

My brief interview in a moment, but first, because it's fresh, a quick comment on a trip I took this week.

New York, New York

At the request of my dear partner and Casey Research CEO, the tireless Olivier Garret, I rousted myself out of bed at 2:30 am yesterday in order to catch an early-bird flight to the Big Apple for a full slate of meetings before stumbling back onto a 10:45 pm flight back home. I think the proper term for it is "a long day."

Being a country boy, I enthusiastically avoid large cities. Which may be why the societal aspects of the big city—New York, in particular—caught my attention yesterday.

In no particular order, some observations.

There's a LOT of people crammed into a large space. Environmentalists like the idea of housing density… to wit, that people should be crammed into minimal living space so that large tracts of land can be left as wide-open spaces for the chipmunks to enjoy. Based on that criterion, you have to love New York, a teeming sea of tightly packed humanity that has a population density of about 27,000 souls per square mile. (And you'd REALLY love Bangalore with its 111,000 people per square mile.)

As I wandered about, side-stepping my fellow homo sapiens and dodging the yellow death of New York's infamous cabbies, I found myself thinking that packing so many people so closely together made for a grand social experiment.

For example, in the portico of a building next to a hospital, a relatively well-dressed woman appeared to be napping on the cement. Was she drunk? Dead? In the midst of a stroke? Would any of the masses flowing by stop to see if she needed help? Would I?

For the record, taking my social cue from everyone else studiously ignoring the woman, I too flowed on by. Given that her resting place was next to a medical center, I rationalized that some signatory to the Hippocratic Oath would spot her and render assistance.

(As I have mentioned before, if you ever need help from bystanders in a city, because of the social-cue thing, you have to point to someone in particular, name them by some identifiable feature, such as "You, in the blue jacket," and state unequivocally that you are hurt and need assistance. Otherwise, you could end up as the reference point in an article like this.)

There is a lot of cultural diversity. For starters, your friendly (or not) cab driver may be a Pakistani, a Somali or a Sikh, but you can be pretty sure they won't be from Kansas. Then there's the matter of cuisine. While cabbing it into the city, I took a moment to count the different types of cuisines on offer. Within just a couple of blocks I sighted Chinese, Thai, Mexican, BBQ, French, Jewish, Italian, Greek, Japanese, and a couple of others that slip the mind.

On the one hand, this sort of cultural diversity is kind of entertaining. It's akin to a more grown-up version of that Disneyland ride that swoops one past all the world's marvels to the voices of children droning on about holding hands. On the other hand, history has shown time and again that there are circumstances where cultures clash, at which point living in a place with so much diversity—and being the wrong color of the rainbow—might lead to you taking your own nap on the sidewalk.

But as a one-day tourist, it was "vive la différence" and all of that.

Cities are volatile and unpredictable. Walking down a street, my companion who was peering into the little screen of his smartphone in the quest for an acceptable beanery almost stepped on a garbage bag sitting in the middle of the busy sidewalk.

"Hey! Watch out for my stuff!" came a voice from about six feet away.

Reflexively I turned toward the guy, with a phrase such as, "Your stuff? Why is your stuff in a plastic frickin' garbage bag in the middle of a busy sidewalk, you moron?" But then I noticed he was (a) large, (b) angry looking, and (c) holding a solid-looking cane, and decided a polite smile was more appropriate.

One doesn't know what would have happened if my companion had actually stepped on the bag or I had expressed my true sentiments, but the fact remains that when you cram so many people into tight quarters, the potential for trouble rises exponentially.

We humans are capable of a full range of emotions, from the sublimely sensitive to the murderously enraged. A simple calculation of the probabilities reveals that the more people you are exposed to during your daily travels, the higher the odds that something unpleasant is going to happen.

The women are stunning (though nowhere near as stunning as my wife, of course). I've never been what some lads might call a "hound," but it's hard not to notice how many beautiful women there are in NYC.

I would guess it's due to the simple reality that a beautiful young woman brought up in a small town in Kansas (not to pick on Kansas, mind you… I always thought Dorothy was a cutie) might come to the conclusion that her beauty might be wasted on Chuck the mechanic and so decide to move to the glamorous big city. Multiply that decision across tens of thousands of backwaters in the US and overseas, and the result is the equivalent of a one-way fashion runway leading into NYC.

As a consequence, the hospitality businesses in New York have their pick of the proverbial litter. Case in point, the waitress in the hotel lobby where we spent most of the day was almost impossibly beautiful (though not as beautiful as my wife, I hastily add). That her uniform was fashioned after lingerie only enhanced the impression.

Of course, especially attractive women are not the only people capable of making the calculation that small towns don't hold the same upside as the large cities. And so it is that so much of the world's intellectual capital is to be found in the cement canyons.

All of which suggests there's a lot of truth in the saying, "If you can make it in New York, you can make it anywhere" because, whether you are a beautiful person or just a particularly bright one, in New York you'll be a very small fish in a very big pond.

Big cities are mind-numbingly complex. Delivering the daily bread to the 8.3 million people living in NYC is a feat unrivaled in human history. Then there is crime prevention, road building and repairs, providing water and sewage, stocking the many shops, mass transit, etc., etc.

That the thing ticks along day after day is a hearty testament to the ingenuity and energy of the human species.

If one were to evict the chipmunks from a large vacant space and sit down to plan out a new NYC, one might question whether it could be accomplished. But I think it could. In fact, I think it would be a simple matter of demonstrating that anyone who helps get it up and running could reap a considerable harvest from that which they helped sow.

Imagine a conversation such as this…

"Hey, how'd you like to be the first guy to set up laundromats in New New York? Or get together with a bunch of your buddies and buy a bunch of cabs? After all, people will need transportation."

Provided the project were properly presented, I think you'd trigger the equivalent of a land rush.

But what about the infrastructure, one might wonder?

I can't see why the founding members of New New York couldn't pool their resources to build out the infrastructure and then charge anyone who wants to use it a toll to recoup the cost and to maintain it over time.

Those who were pondering whether to make New New York their residence or place of business could decide whether the tolls were reasonable and either set up shop or not. Of course, such an organizing entity feels a lot like a city government. To prevent it from degrading into the sort of bloated bureaucracy that now lords it over NYC would require the equivalent of a condominium agreement that clearly spells out the rights and obligations of city managers and residents. And it would limit the city operators to matters directly related to infrastructure with no provisions for limiting the nature of cooking ingredients or the size of soft drinks.

But that's just utopian fantasizing. Back in the real world, the politicos, unions, and faceless bureaucrats will continue to reign unchecked for eternity.

All this complexity leaves a big city vulnerable to a domino-like breakdown. Should some large-scale unpleasantness occur, the steady supply of food might stop, the lights go out, the water run dry, and the volatility and unpredictability blow up into full bloom. Given New York's draconian gun control laws, the average Joe wouldn't stand a chance.

Even though I enjoyed the day in NYC, the visit only reinforced my preference for the countryside, where the interactions with my fellow humans come at a far more leisurely and therefore enjoyable pace.

(Speaking of which, in case you missed it, I recently did an interview from our new home in La Estancia de Cafayate. Like many people, I am not crazy about seeing photos and videos of myself (especially the side shots where my "wattle" is on full display), but I think the discussion about what makes for a high-quality life has some value. Here's the link.)

And now it's on to the main show.

Answers from a Monetary Master

Terry Coxon, Senior Economist

One of the best things about being a partner in a research firm employing about 40 analysts is that I have unfettered access to really smart people. While we have a great team with expertise across the spectrum, when it comes to monetary matters, my go-to guy is Terry Coxon, a senior editor for our flagship publication, The Casey Report.

For those of you who don't know him, Terry cut his teeth working side by side for years with the late Harry Browne, the economist and prolific author of a number of ground-breaking books, including the 1970 classic, How You Can Profit from the Coming Devaluation.

The timing of Harry's book should catch your eye because his analysis that the dollar was headed for a big fall was spot on. Anyone paying attention made a lot of money.

As co-editors of Harry Browne's Special Reports, Terry and Harry made a formidable team for over 23 years. During this period, the two deeply researched the operating levers of the global economy, with a focus on the nature of money and impact of monetary policy.

And they looked for ways to apply what they learned about the macroeconomics into practical investment strategies, co-authoring Inflation-Proofing Your Investments. On his own, Terry wrote Keep What You Earn and Using Warrants.

Putting his expertise into action, Terry founded—and for 22 years served as the president of—the Permanent Portfolio Fund, one of the top-performing funds in history.

Having Terry on the Casey Research team as a senior economist has been a huge personal boon. By the time you finish reading my brief interview with him, I suspect you'll understand why.

Question: Let's start by defining terms. What exactly is inflation? Most people view inflation as a noticeable increase in the prices of everyday things. How do you define inflation?

The original use of the term in financial matters referred to money, not to prices. It meant an increase in the total amount of money held by the public. Such a monetary inflation can be engineered by government printing or, under a gold standard, by increasing the official price of gold (as in 1933).

Monetary inflation can also be engineered by inventing a new category of legal tender, as in the case of the silver dollars minted in the 19th century. And inflation of the money supply can happen without government tinkering, such as through the discovery and development of new gold deposits (as in the cases of the California and Klondike gold rushes), or through decisions by commercial banks to operate with thinner cash reserves in order to issue more deposits.

Today "inflation" usually refers to price inflation, which is a rise in the general level of consumer prices. That second use grew out of the public's experience of episodes of monetary inflation being followed by periods of rising prices.

Notice that with either use of the word, there is a little mushiness. During some periods, depending on what you include as "money," you may find either an increase or a decrease in the supply of the stuff. Suppose that the supply of hand-to-hand currency goes up while the quantity of bank deposits goes down by a larger amount. Is that monetary inflation or monetary deflation?

And what exactly does an increase in the "general level of consumer prices" mean? There's more than one way to define an index of prices, and there are many ways to tinker with it.

Q. In your view, have the US government and the Fed been following an inflationary policy?

Yes. Since the Lehman swoon in 2008, the M1 money supply (hand-to-hand currency plus checkable bank deposits) has increased by 72%, so the policy is clearly one of monetary inflation. And the Fed is avowedly committed to avoiding price deflation at all costs. They'll do whatever it takes to prevent price deflation, up to and including sacrificing virgins. That deflation phobia is necessarily a commitment to price inflation, and Mr. Bernanke has indicated that consumer prices rising at a rate of 2% per year would be ideal. So either way you define inflation, the Fed is all for it.

Q. Based upon your studies, just how extreme or extraordinary has the inflation been since the beginning of this financial crisis?

A 72% growth in the money supply over a period of five-plus years is a gigantic increase. Take a look at the chart. It shows the annual growth rate in M1 over all five-year periods from 1959 to the present (dates on the chart indicate the end of a five-year period). As you can see, the only episode of monetary inflation that comes close to what is happening now is the money-printing spree of the high-price-inflation 1970s and early 1980s.

Q. How certain are you that the monetary inflation here in the US is going to ultimately manifest as price inflation?

You're asking for a lot when you say "certain"—certainly more than you're going to get from me. But here's why price inflation seems inevitable. The Federal Reserve can easily create more money. There's no limit to that power, as they've already demonstrated. At any hint of deflation, they will produce more cash. They can never know how much new cash would be enough, but because they see deflation as a vastly more serious problem than price inflation, they always will err on the side of too much new money. That attitude is a guarantee of price inflation.

Q. When the price inflation begins, how significant do you think it will be? A little inflation? A lot? Hyperinflation?

Mr. Bernanke will get to visit his ideal world of 2% price inflation, but it will only be a whistle stop. The price inflation that lies ahead will be at least as bad as what happened in the 1970s episode, when the annual inflation rate approached 15%. The money that's already been printed so far may be enough to produce such a 1970s-size problem. And more new dollars are coming, because the Fed won't stop printing until price inflation becomes obvious.

Making matters worse is that the devices for paring down the amount of cash that you need for the sake of convenience—such as credit cards, ATMs and online banks—are now far more widely available and cheaper to use than they were in the 1970s. When price inflation becomes noticeable, people will turn more and more to those devices to reduce their holdings of value-leaking cash. That drop in the demand for money will reinforce the price inflation that originated in the Federal Reserve's increase in the supply of money.

Q. I know it can only be a wild guess, but based on your observations, how long do you think it will take for the price inflation to become obvious?

Within twelve months after you hear that the economy has at last fully recovered from the recession.

Q. What is the biggest flaw with the deflation argument?

Whatever process someone might have in mind as a driver of price deflation, no matter how powerful that process might be, the Federal Reserve has the power and the will to carpet-bomb it with more new money. What the deflationists overlook is that if deflation ever seems to be winning, the Fed will simply extend the game for as many innings as it takes for inflation to win. In a fiat-money system, inflation always gets another chance.

Q. What would make you change your view that price inflation is inevitable?

Brain surgery.

As I know our readers are a curious sort, if you have additional questions for Terry, send them my way at and we'll do a follow-up.

And to stay closely in touch with Terry Coxon's views of the unfolding economy and how to position yourself, check out our special two-for-one offer for The Casey Report and BIG GOLD mentioned at the end of today's missive.

Friday Funnies

Rugged Woman

During her physical examination, a doctor asked a middle-aged woman about her physical activity level.

The woman said she spent three days a week, every week in the outdoors.
When asked for a description of what she did on those days, she said, "Well, yesterday afternoon was typical; I took a five-hour walk, about seven miles, through some pretty rough terrain. I waded along the edge of a lake. I pushed my way through two miles of brambles. I got sand in my shoes and my eyes. I barely avoided stepping on a snake. I climbed several rocky hills. I went to the bathroom behind some big trees. I ran away from an irate mother bear and then ran away from one angry moose. The mental stress of it all left me shattered. At the end of it all, I drank a scotch and three glasses of wine."

Amazed by the story, the doctor said, "You must be one hell of an outdoor woman!"

"No," the woman replied, "I'm just a really, really bad golfer."

Who's on the Job?

COSTELLO: I want to talk about the unemployment rate in America. 
ABBOTT: Good Subject. Terrible Times. It's 7.8%.
COSTELLO: That many people are out of work?
ABBOTT: No, that's 14.7%.
COSTELLO: You just said 7.8%.
ABBOTT: 7.8% unemployed.
COSTELLO: Right; 7.8% out of work.
ABBOTT: No, that's 14.7%.
COSTELLO: Okay, so it's 14.7% unemployed.
ABBOTT: No, that's 7.8%.
COSTELLO: Wait a minute. Is it 7.8% or 14.7%?
ABBOTT: 7.8% are unemployed. 14.7% are out of work.
COSTELLO: If you are out of work, you are unemployed.
ABBOTT: No, Congress said you can't count the "Out of Work" as unemployed. You have to look for work to be unemployed.
COSTELLO: But they are out of work!!!  
ABBOTT: No, you miss his point.
COSTELLO: What point?
ABBOTT: Someone who doesn't look for work can't be counted with those who look for work. It wouldn't be fair.
COSTELLO: To whom?
ABBOTT: The unemployed.
COSTELLO: But all of them are out of work.
ABBOTT: No, the unemployed are actively looking for work. Those who are out of work gave up looking, and if you give up, you are no longer in the ranks of the unemployed.
COSTELLO: So if you're off the unemployment rolls, that would count as less unemployment?
ABBOTT: Unemployment would go down. Absolutely!
COSTELLO: The unemployment just goes down because you don't look for work?
ABBOTT: Absolutely it goes down. That's how it gets to 7.8%. Otherwise it would be 14.7%.
COSTELLO: Wait, I got a question for you. That means there are two ways to bring down the unemployment number?
ABBOTT: Two ways is correct.
COSTELLO: Unemployment can go down if someone gets a job?
ABBOTT: Correct.
COSTELLO: And unemployment can also go down if you stop looking for a job?
ABBOTT: Bingo.
COSTELLO: So there are two ways to bring unemployment  down, and the easier of the two is to have people stop looking for work.
ABBOTT: Now you're thinking like an economist.
COSTELLO: I don't even know what the hell I just said!
ABBOTT: Now you're thinking like Congress.

Weekend Reading

Busted! You HAVE to Read This… By now it's starting to leak out in the media, but there was a story this week that should make everyone sit up and take notice. The following is an excerpt from The Atlantic Wire.

Michele Catalano was looking for information online about pressure cookers. Her husband, in the same time frame, was Googling backpacks. Wednesday morning, six men from a joint terrorism task force showed up at their house to see if they were terrorists. Which prompts the question: How'd the government know what they were Googling?

Catalano (who is a professional writer) describes the tension of that visit.

[T]hey were peppering my husband with questions. Where is he from? Where are his parents from? They asked about me, where was I, where do I work, where do my parents live. Do you have any bombs, they asked. Do you own a pressure cooker? My husband said no, but we have a rice cooker. Can you make a bomb with that? My husband said no, my wife uses it to make quinoa. What the hell is quinoa, they asked. ...

Have you ever looked up how to make a pressure cooker bomb? My husband, ever the oppositional kind, asked them if they themselves weren't curious as to how a pressure cooker bomb works, if they ever looked it up. Two of them admitted they did.

The men identified themselves as members of the "joint terrorism task force." The composition of such task forces depend on the region of the country, but, as we outlined after the Boston bombings, include a variety of federal agencies. Among them: the FBI and Homeland Security.

Here's a link to the full article.

Free Pot!

While it's too early to say that it will pass, the Southern Cone country of Uruguay seems set to become the first country in the world to repeal the prohibition on recreational drugs. And I don't use the word "prohibition" lightly. From the beginning of recorded history right up until 1937, you could indulge freely in the leaf. (Some history here.)

While I'm personally not a fan of pot, or any drug outside of a nice bottle of wine, the entire concept of a "war on drugs" is laughable. All it does is push the sellers and users out of the visible economy and lead to the spending of tens of billions of dollars chasing people who can get their hands on the stuff any time they want. Worse, it has caused millions of people to be incarcerated. And in the case of marijuana, for what? Out of fear that they might giggle and raid the refrigerator? Here's one of a number of articles on Uruguay's move.

Kidnapped by a Murder Gang. I recently interviewed a fishing boat captain who was kidnapped by not one, but three serial killers—and, against all odds, survived.

It's a great story. So much so that after hearing it in person, I asked the captain if I could record him telling it, and he agreed.

Here's the link.

Connected to the video presentation, I wrote a special report titled Surviving the Dangerous Next Leg Down in the Global Financial Crisis that draws upon what I think are very useful lessons from the captain's fight for his life.

✓ You can access that report at the end of the video, or go directly to it by clicking the link just below. There's a lot of meat in the report, and a special two-for-one offer for The Casey Report and BIG GOLD at the end of it. But even if you don't take us up on the fully guaranteed offer, I still think you'll appreciate the charts and data in the report. Directly access the special report by clicking here.

And with that, I will sign off for the day and the week by once again thanking you for reading and for being a Casey Research subscriber.

Until next time!

David Galland
Managing Director
Casey Research

Aug 02, 2013
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