Infation Vs. Deflation. James Rickards and Harry Dent's Debate at Casey Research Conference

Because I lean to the inflation side of the debate in the most terribly biased way possible, I have shamelessly indulged my tendencies and summarized and paraphrased only James Rickards presentation.  I personally love the art of debate and enjoyed listening to Mr. Rickards as he effortlessly explains complex issues to a largely non-academic and lay-investor audience. The irony is not lost on me that I only quoted Jim.

This part of the debate opens where James Rickards replies to Mauldin’s preamble question “What makes you think the Fed will get out of control?”  Rickards explains that the Fed will unintentionally destroy the currency as they don’t understand the statistical properties of risk.  He used this very useful analogy to demonstrate the Fed’s actions in pursuing more money printing:  The difference between dialing a thermostat and working in a nuclear reactor.  If the house is too warm, you can dial the thermostat down; if it’s too cold you can dial it up.  You can dial a nuclear reactor up or down also, but if you get it wrong you have a catastrophic outcome. Here lies the problem: The Fed thinks their dealing with a thermostat, so they’ll act in good faith but they’re actually playing with a nuclear reactor.  He goes onto say there cannot be deflation the way Harry Dent presents it.  Rickards agrees that deflation is the natural state of the world and left to its own devices, the world would be in a highly deflationary period and he added, “That might not be such a bad thing in terms of future growth”.  He gave two reasons why deflation will not happen:

The first reason: Deflation destroys the banking system.  The Fed was created to prop up the banks and always acts in accordance to support banks.   Some might say with deflation the nominal value of debt goes up and because the banks are creditors, this would be advantageous to them. Rickards went onto say that it’s good for them up until the moment of default. The problem is the nominal value of the debt goes up so high that people default. Default is an instantaneous wealth transfer from the creditor to the debtor, so the disadvantage will then lie with the creditor.  The banks will be destroyed in this case and the Fed simply won’t allow this to happen.

The second reason deflation will not take place is the government will not allow untaxed capital gains.  Rickards likens it to everyone getting a raise in salary.  He said if we have deflation of the kind Harry is presenting, the price of goods and services will go down and at the same nominal income, the outcome will be increased wealth for all. It’s just like getting a pay rise with one important difference.  The government can tax the increased income on a raise, but they haven’t figured out how to tax the deflation. So there are no capital gains in deflationary wealth and that’s another reason why the Fed will not allow deflation. An important thinking point here is that not only do the Fed and the government not oppose inflation, but they are solely responsible for its existence through ongoing debt-backed money creation.

Rickards response to Mauldin’s question if he thinks the government has the “cajones” to put 10 trillion $ more on their balance sheet over 3 or 4 years. James replies there’s a limit to what the Fed can do and what Harry chooses to ignore is that the Fed will soon become a relatively minor player in all this. The cleanest balance sheet in the world and the one that will expand is the IMF. They have the capacity to create SDR’s in unlimited quantities. So the next time the physical crises reaches an acute stage, they’ll just flood the world with SDR’s so you’ll get your 10’s and Trillions to prevent what Harry’s describing. Rickards acknowledged that Harry has got the natural dynamic right in terms of assets bubbles need to be deflated and people in distress will need to sell assets, but he points out what Harry is missing is the "force majeure". He’s underestimating the capacity of governments and their blunt force to dictate the outcome and if the Fed can’t do it, the IMF can and will and already is with its own printing press.

You can listen to the rest of the video for Harry Dent’s response to James.  I personally didn’t have the patience to wade through the ranting, curse words and emotionally charged language of Harry’s presentation.