Inflation vs Deflation

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craig_slater_nl's picture
craig_slater_nl
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Inflation vs Deflation

I have just watched a very good presentation by Nicole Foss on The Automatic Earth Website. The presentation is good and Nicole presents many of the issues similar to here. However, she is convinced that Deflation is the outcome and makes recommendations accordingly, sell assets, cash is king etc.

Clearly, without the monetary interventions and attempts to reflate then deflation of the bubble would be the natural result. However, as this is not the case, I was surprised that she did not address the reasons why she does not believe that inflation/hyperinflation are possible/probable.

Does anybody have any thoughts on what the argument is that discounts inflation as the coming scenario?

Thanks

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craig_slater_nl

craig_slater_nl wrote:

Does anybody have any thoughts on what the argument is that discounts inflation as the coming scenario?

Thanks

Oh yeah............This is probably the most hotly contested topic 'round these parts. Just peruse the boards and you'll see some brilliant arguements for both sides; and some not so brilliant ones too.

I have a feeling that now that you've lit the fuse it's time to sit back and watch the fireworks!!

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Deflation, then inflation

Just attended a Ms. Foss presentation.  She says we'll have inflation, but not until a widespread deflation due to the $4T credit/deriviatives bubble bursting.   In the even shorter term, she says, the dollar will STRENGTHEN due to a flight to safety from the Euro.

IMO, since waiting for the dollar to crash since 2008, I tend to agree with initial deflation argument now.

Then, I think, we'll have a combination of delfation and inflation, maybe hyper stagflation.  The price for things we need to live, food & energy, will be expensive, in terms of purchasing power.   Yet, housing, TVs, and cars will be inexpensive, in relative terms.

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What inflation?

Inflation v. Deflation

The general belief at the moment seems to be that hyperinflation will happen because the Federal Reserve has been printing money to support its quantitative easing program and that this must continue because they have no choice. Either that or the financial system will collapse along with the US dollar. The remedy to protect oneself is to buy gold or other precious metals. I find this puzzling to say the least for two obvious reasons:

1.      

The dollar has been rising since May or more than 15% from bottom to top 2 weeks ago.

2.      

Gold topped in September and fell 20% to a low in the final days of 2011.

A less obvious reason is that gold languished for two decades from 1980 during a period of intense inflation of the money supply. However, it rose strongly during the last decade when money supply rose at an even faster rate until it eventually dipped for the first time in 70 years. I believe that period is over and the trend will now be down again. In fact Gold and the Dow30 have tracked each other pretty well over the last decade. I fully expect both to end up much lower over the next 5 years.

Time will tell whether these movements are new trends or just corrections. I favour the former  for the very simple reason that  40 years of  absolutely unbridled  credit creation (since the un-harnessing of the dollar from the gold wagon in 1971) have led to a series of bursting bubbles over the last decade. It seems to be common sense to me to consider that the game is up. We have been borrowing from the future at a rate that we have become used to and expect as normal but which is not sustainable. If it was, then the economy would be employing more people and expanding faster but it is not doing this.

The future has to be paid back and the only way to do that is by shining the clear light of reality upon the massively overvalued debt assets lurking on the balance sheets of the major banks and financial institutions around the world. That will, of course, result in bankruptcies and huge write downs in values and will be the final catastrophic stage of the deflation.  It will be the way that wealth relativities between the 1% and the 99% (or whatever the figure really is) will be restored. Unfortunately, it will not redistribute wealth  but it will allow businesses and economies to start growing again and put people back into work. Nominal values will be lower all round – house and land prices, financial assets and labour costs because the driving force that kept all those prices high will have disappeared. That driving force is “imaginary money” or credit without backing and which, therefore, has no hope of being paid back. The fantasy is still intact – just – but the signs are all around that the gig is over.

Annual growth has been slowing since 1979 just as it did all the way through the 1920s into the Depressionary bottom of 1934. Manufacturing jobs have halved since 1979 and housing starts are back to the level of the early 1920s despite the population of the US tripling since then. The Case-Shiller Composite Home Price Index fell from over 200 in 2006 to less than 140 in 2009 and is still barely above that level.  This happened mainly because of government intervention over many years at the instigation of bankers - in particular, the creation of  the Federal Deposit Insurance Corporation (FDIC 1933),Fannie Mae (1938,) Ginnie Mae (1968) and Freddie Mac (1970). The FDIC is funded to an extent by the banks  - a cheap cost for them to maintain the illusion that the public’s deposits are safe.  Of course, nothing could be further from the truth because already billions have been paid out of the public purse to prevent the banks from falling over. Eventually the deposits of those using the banks will be gobbled up as well. The huge debt burden of mortgages is keeping house prices down and that debt burden is mostly underwritten by Fannie/Ginnie/Freddie which is the government. It is hard to see how home building can take off while prices remain depressed. The US government has been inflating since 1913 when the Federal Reserve was created and the Government began taxing people’s income. How do you think the US was able to afford defence spending that equals the next 8 countries combined defence budgets? Federal outlays (as a percent of GDP) peaked during the Second World War but this did not create inflation because there was so much destruction caused by that war. The same thing has already been happening – the destruction of manufacturing in the US and Europe and its substitution with service industries. Most of these service industries produce nothing but cost – huge burdens from welfare, health, safety and legal costs both in the private and public sectors. The only manufacturing sector that is more or less intact is the military industrial sector which is also a huge cost on the taxpayer for a very dubious benefit.

There is no doubt that the Fed and Treasury have been trying to inflate via quantitative easing but when set against the worldwide debt levels and the inflation that has taken place over almost a century, the present effort is not much more than a fart in a hurricane. Interest rates are at near zero because there is very little private demand  for borrowing and debt investors are clearly happy with the rate offered. If they were not, would it not make more sense to amass cash in the form of greenback notes or gold. Or buy real assets  such as commodities like copper or farmland.  This is not happening because, in aggregate, commodities have been falling (the CRB Index topped in 2008) which again suggests that there is not much demand. The only real evidence of an inflationary breakout is in US equity markets but they are very nervous and seem to me to be driven mainly by trading rather than investment plus a need to find a bit of yield. The market turned up in March 2009 because the mood changed, not because of quantitative easing which had failed to stem the fall all the way through 2008. The KBW Bank Index shows a very modest recovery – far less than the Dow 30 or the S&P 500 - despite the more upbeat mood and the Bernanke/Geithner interventions, which you would have thought could have propelled the banks forward to new highs.

The banks are in trouble and are signaling the next phase of the deflation. Many commentators are arguing that hyperinflation will come after the deflation. That is not a level of pessimism that I am willing to embrace! The deflation will be bad enough – encompassing wealth destruction on such a scale that stock , futures and option markets will take a number of years to regain the trust of investors. Think Japan. So much of the money (credit creation) that has been “printed” (really a computer record entry) by the Federal Reserve to buy debt assets from the Treasury via the banks will simply disappear as the toxic “assets” on bank’s books are written off. What are the “assets” on the Fed’s balance sheet and what is their  marked down value? They certainly are not the same quality assets as they once were. Even if they were all Treasuries, which they are not, the US credit rating has been downgraded which means the quality of the debt has been downgraded. Despite this the yields are still extraordinarily low. Not exactly a sign of inflationary fears. Gold is sending out the same message that fear of inflation is actually quite low. I take a contrarian view to the common view that gold must be held to protect wealth.  I am believe it will deflate too because it will be sold off to cover losses in other markets and to pay off debt. However, relative to other assets it may well remain quite strong – which will only go to show how bad the destruction will be in these other asset sectors.

 

 

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How to keep $?

If one wants to hedge inflation, holding PMs seems like a good bet- physical security issues aside. But during my lifespan, the idea of "holding cash" implied having it in an account, in a bank. It seems that that plan now has  potential flaw - see Cyprus. Keeping money in any kind of account clearly implies some level of counter-party risk in today's environment. So-what is the strategy- a hoard of FRNs in a box somewhwere? How would one hedge deflation, without depending on an external agency of some sort?

Marc

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Issues related with Inflation and Deflation

Overall it was a nice expalnation by all of you over the important topic Inflation and Deflation. The discussion could be beneficial specially for the newbies. converse

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Inflation

We are an aging society in the U.S.  There will be less demand in the next 15 years.  Commodity prices will fall.  It's already happening.  The dollar is king and will continue to be so.  The coming Day of Depression will happen overnight, just like it did in 1929.  The stock market will crash and many will be left with little.  2015 will not be a good year.  Think 2008 on steroids.  This time, it will be worse than the Depression.  There will be a complete "reset."  Not just here in the U.S., but all over the world.  Think "Ferguson" everywhere, especially in large cities.

So...my vote is "Deflation."    

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General

It's not about inflation and deflation as David Lichtenstein says, it's more of a temporal issue this time. The Americans need to bring back their faith in their own country... Here is what else he said: 

General's picture
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Inflation vs Deflation

It has been well over a year since I've commented, but I was right...it's "Deflation."

We're actually in a depression...world-wide, but nobody is admitting it yet.  It won't be long now, before the tires come off our economy!  Negative rates in the EU are having a very detrimental affect on banks and forcing folks into the casino of Wall Street.  It's a total b.s. effort to screw the little guy in an effort to make everything seem better than it actually is.  The Goldman Sacs Gang (Dragi and rest) are talking up a big bunch of b.s., but nothing is working.  Trillions spent by Feds across the globe have done absolutely nothing to restore order to the financial system; instead...they have bungled it up, and the result will be the coming "reset" of all world economies and disorder by the lower and middle class.  

If the banks go bust, so go the people who have money in them.  There is not enough insurance to go around or additional government debt to fix the problem!  

Cheers!

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Deflation then Inflation or Deflation then Deflation?

Ok I get the deflation part. Under the current system, all money is loaned into existence and when the bubble pops, massive defaults will cause the departure of trillions in computer entry currency to the great central bank in the sky. Less money pursuing the same amount of stuff is deflation, right? Close enough and in PP speak that's the "Ka"

Panicking central banks, spurred on by panicking politicians will attempt to reach back into the sky, fire up the whirlybirds and drop as much counterfeit money as they possibly can, all over us. This is the part that causes the hyperinflation "Poom" right? I hope I have that right. 

But hold on a minuet-The amount of currency created by open market operations and QE is actually tiny by comparison to the exponential growth of the money supply through the "money multiplier" in the fractional reserve lending system. At a time like that, who is going to borrow all that money? Not me! I wonder if amid the riots in the streets we will fail to witness huge numbers of former employers, newly unemployed themselves, sitting on the sidewalk saying, "Ka...Ka...Ka..." 

If, after QE 7 or so, some sorry chump does borrow some of that worthless money, will it not just be blowing air into into asset markets in another non-recovery recovery? That is a type of inflation - it's what we have now, and though we do have a real problem with some seriously increasing costs, it is not Weimar wheelbarrow time.

I'm truly indebted to gold bugs like Peter Schiff and Mike Maloney who continually provide valuable education on money and economics (these guys are my free market gurus) but as far as hyperinflation, I'm just not seeing it. What am I missing?

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Same question as above: "How To Keep $?"

I don't think anyone knows for 100% sure if it will be deflation, hyperinflation, or deflation then hyperinflation, or another combination of some sort, and in exactly what order. Valid arguments for all the different scenarios have been made by people like Schiff, Maloney, Dent, and Martenson. No one knows for sure how this will play out, and only time will tell who was right. The point is to prepare for all simultaneously, and keep a close eye on things so that if one scenario begins to manifest more than the others you can then reposition accordingly.

Thus, going back to the "How To Keep $?" question that was never answered, I think this is the critical question and I would love to see a good answer to it. If we are to hold a good chunk of cash for possible deflation, that can be risky if it is in the banking system and the banking system collapses. I'm therefore concerned as to what to do as obviously keeping a good chunk of cash at home is also risky. If you are lucky enough to live near private vaulting services that are out of the banking system then that is maybe an option. Maloney describes using this option for himself in his "Silver Shortage: The Breakdown with Mike Maloney" YouTube video, however he seems to only be doing this for a small amount of emergency cash funds and not for larger investment "dry powder" cash. 

I believe Chris says he will put out a warning if the banking system is flashing red, so that we might pull funds out in time. I think he used the example of Greece, where he stated those citizens had plenty of warning (years?) before things went bad, yet most failed to act and the rest is history. For us in the US following Peak Prosperity, once we have that level of concern here, in theory we can take action as well before our wealth is potentially destroyed. Although I would like to believe Chris is right that we will surely receive this advance type of warning, I don't trust that this might not be a overnight thing where one day things are fine but the next day you're screwed if your funds are in the bank and it's too late to act. I'm going to assume there's a chance we might not get this advance "warning" and that it would be prudent to take some sort of action now.

Therefore what is a good recommendation to do some preparation for deflation but simultaneously not risk it all being lost to banking collapse? In my personal situation, the answer to this is important to me as I'm looking to fund a future housing purchase in the Bay Area. Obviously with the insane housing bubble we have here right now I'm looking to wait for that next housing correction / bubble pop first (which will be deflationary), and I'd like to have the comfort of knowing my cash funds (my "dry powder") will likely be there when the moment comes where I'll want to access and deploy these funds.

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keeping your cash safe

My answers, in order of my sense of safety, during a deflationary storm:

  • physical cash, along with proof of where you got it, with copies stored elsewhere, so you can sue to get it back if the police confiscate it.
  • short/medium term AAA corporate debt in a company with a very strong balance sheet in a "necessities" industry - avoid manufacturing.   (probably best to "rate" the company yourself; default rates during 1932 on "investment grade" corp debt was about 9.2%.  No AAA company defaulted during the Depression).  If in a brokerage account, make sure your broker isn't engaging in trading activities.  Margin account is probably a bad idea too.  Own actual bonds, not a bond fund.
  • short term US sovereign debt, owned directly by you: Treasury Direct.
  • checking account at a strong local bank

Avoid: muni or state debt, long term govt debt, long term corp debt, accounts at TBTF banks, money market or bond funds or ETFs, esoteric instruments, accounts at any organization that engages in prop trading and/or derivative writing.

Fun paper on historical default rates: http://instructional1.calstatela.edu/jrefalo/fin331/Lecture%20Notes/Historical%20Default%20Rate%20Study%201920-1996%20(Moody's).pdf

I know the ratings organizations are whores these days, but a first cut of corporates rated AAA can then guide you to a quick look at the balance sheet and - just sense if the business provides a product that is a must-have (like soap - consumer staples) or a would-be-nice (like an iphone - consumer discretionary).  Right now, there are only 3: Johnson & Johnson, Exxon, and Microsoft.  Of those three, I'd pick JNJ.  JNJ earned 17 billion last year, and has 26 billion in debt outstanding.  That's Aaa: not likely to default.  Example: JNJ has a 5 year bond yielding 1.67%.  5 year Treasury yields 1.23%.  http://quicktake.morningstar.com/stocknet/bonds.aspx?symbol=jnj.

Armstrong suggests this time around it will be the sovereigns that fail; in a sovereign debt default, there is typically no "recovery" while with corporates, assets are sold and bondholders do get something back.

In a real depression, cash will be king, because everyone will be desperate to pay down debt.  All assets will be sold to make this happen.  Debt gets harder to pay every year in deflation.

While gold promoters like to say that "gold is money", it really isn't, and that will become apparent during severe deflation.  Across the economy, gold will get tossed right off the lifeboat if people are forced to choose between gold bars and the debt underpinning the house, the car, or the family business.  Cash of course can always be used to repay debt, so it is zero risk during deflation.  With an ounce of gold, you have no idea how many payments you will be able to make next month, but with cash, you know exactly, and it will never change.  Risk tolerance goes to zero during big deflation.

Gold did well during 1930s because it was exchangeable by law for a fixed amount of cash.  Gold was money - by law.  It no longer is, and so price fluctuates with demand.  A lot of supply will come on the market in a deflation.  People will simply have no choice.  Gold price will drop as a result.

Of course - during the reflation phase, gold will do very well.

If you are clever and nimble, you can hold the "cash" assets during the initial deflationary wave, and then switch out to hard assets before the reflation occurs.  Timing might be challenging, to say the least.  :-)  An asset allocation is probably a strategy that would help you sleep better at night.

You might also go short junk debt.  That will be the first thing to blow up in a real deflation.  But that's more of an adventure too.

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KennethPollinger
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Gracias Dave

Excellent post above.  Your assistance in all these matters is outstanding.

Yet, a question.  Wouldn't it be better to wait until a solid market correction/collapse happens to buy those three recommended stocks, that is JNJ, XOM, and MSFT.  Same for metal miners, senior and junior.  I know they are down quite a lot but surely in such an event, they would go down further, no?  And how much further?  Who knows?  Maybe just have "dry powder" ready for that moment?  It's the timing question, I guess.

Again, many thanks for your detailed and careful analyses and comments.  Ken

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bonds, NOT stocks

Ken-

DO NOT BUY STOCKS.  Buy bonds.  Extremely high grade corporate bonds.  They are better than bank deposits since they are backed by a real company with real assets and real earnings.  And you are higher in the food chain with those bonds than you are at some bank with your bank deposits.

And if worst comes to worst and the company blows up - which never happened during the worst year for bonds ever, 1932 - you'll get something out of the bankruptcy.  It won't be a total loss.

The question was, "where do you store your cash during deflation?"  The answer: high grade corporate bonds.  BONDS.  In addition to actual cash, short term treasury bills, and some amount in a local-bank checking account.

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Gold in Deflation

Dave, 

If a major deflation occurs, given that central banks cannot tolerate deflation wouldn't they act to re-price gold at a higher price to 'break' the deflation?

E

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reflation

Eannao-

If a major deflation occurs, given that central banks cannot tolerate deflation wouldn't they act to re-price gold at a higher price to 'break' the deflation?

Well first, the question was, how do we preserve cash during deflation.  Gold isn't the way.  If a real deflationary wave hits, gold will drop.  If you have gold, you will have to grit your teeth and hang on during deflation phase, possibly cursing the goldbug writers who promised you that gold would somehow be a great refuge when prices of everything was dropping.  No doubt they'd blame "manipulation" while the price of gold tracked all the other prices lower.

Its during reflation that gold (and anything else real) will do well.  But there are lots of ways to reflate without going back on the gold standard (i.e. "revaluing the dollar against gold.")  Keen's debt jubilee is one way.  Real helicopter drops of money are another.

If you listen to what they're saying, they've already prepped us for a reflation-by-helicopter-drop.  I see that as the most likely reflation mechanism.

Renewing the gold standard gives a storybook ending to the goldbugs.  When was the last time "the system" did something to make us happy, except as a side effect?

Also, a gold standard takes a huge amount of control away from the central planners, while a helicopter drop leaves the current system in place.

Gold will still do well during the helicopter drops, plus its a great way to retain wealth that's also portable, which is very helpful if your local government starts to get really repressive.  You can't move your house out of a high-tax jurisdiction, but you can easily move your gold.  Related: there is no property tax due on a gold bar.

But I don't think we're going back on a gold standard.  Not unless confidence in the currency (and the government) completely snaps.  And if that happens, I think they'll try to swipe our gold first (or they'll levy a 50% "gold windfall profits tax")  because they have no interest in giving us goldbugs any sort of reward for being right.

China might do it, after their debt problem is fixed.  They seem to be pro-gold.  But only after that debt problem is fixed.

Just an opinion, informed by recent history.

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Reflation

Hi Dave,

the idea of re-pricing gold at a higher price to 'break' deflation doesn't involve returning to a gold standard per se. It involves the Fed (possibly in concert with other central banks) supporting a higher price for gold. I suppose in effect this would be a quasi gold standard.

It is an idea that I have read mainly from Jim Rickards (http://dailyreckoning.com/elites-new-case-gold), but it does seem rather far-fetched now that we discuss it. What seems more likely as you say, is Helicopter Money in some form.

As an aside, the recent upturn in gold, oil and many soft commodities could be an indication that we are entering the inflationary phase. Perhaps we won't see the deflationary 'Ka' though it's hard to imagine how we can avoid it considering all of the extra debt we have piled on?

Given the unpredictability, I think the only way is to prepare for both. Gold, cash and patience.

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what's the mechanism?

Eannao-

So let's think through the mechanism for "the central banks supporting a higher price for gold."  That would involve the Fed printing new base money, and buying gold with it.  (How else does one "support" higher prices if not through buying?  Wishful thinking won't cut it, neither will cheerleading, at least not for long.  I must say, I definitely support higher prices for gold.  Does anyone care?  Will that affect the price?)

So the Fed prints money and buys gold until gold gets to their desired price of, say, $5000/oz.

If gold drops below their price, they print more money and buy more gold.  If gold rises above their price - maybe they don't care.  Or maybe they sell gold in exchange for dollars - to "mop up" inflationary effects of all that printing.

I have just described what the Fed used to do during the gold standard.

Or, otherwise known as "central bank price support for gold."  Nobody in their right mind would ever sell gold for less than $5000/oz because you could always take your gold to the Fed, and get $5000 for each ounce.

Set the price too low, nobody will sell you any gold.  Set it too high, and you'll see massive inflation.

British had a problem with that - they set it too low during the 20s, and it caused them a lot of trouble.  Gold fled England.  "Sure I'll trade these pounds for gold."

Lots and lots of people would sell their gold to the Fed, take the money, and buy other stuff with it.  Stuff that had not yet gone up in price.  The Fed would end up with a great deal of gold, and a lot of new money would be dropped into the system, driving up prices of everything.

FWIW, I agree - cash, gold, and patience.

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When the hyperinflation is about to hit...

If it is clear to us that hyperinflation is going to hit (whether it is preceded by a deflation or not) would it make sense to use all of the borrowing power you have to buy hard assets? Like should I have a home-equity line of credit all ready besides signing on the dotted line, and use all my credit cards or anything else I have available to borrow with and buy - gold, silver, ammo, food - knowing that selling an ounce of gold will be enough to pay off all my debts?

Is this crazy talk? I mean I realize there is risk to being wrong. But let's say it was super obvious. Is there a flaw in this plan?

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Inflation vs Deflation

Having physical gold and silver is a really good idea.  Gold will start becoming more difficult to buy in the near future.  Paper money has no backing, expect for the word "trust" on it.  Once folks lose trust in their governments, Feds, and their ability to make proper decisions (our leaders), money can instantly start losing value.  Our Fed is hiding 4.4 Trillion in debt on their balance sheet with only about 58 billion of assets...not good!  No way for them to pay it off.  That's just a beginning!  Gold will go straight up soon.  I'm not talking about 1,400/oz; I'm talking well over 10,000/oz...maybe even up to 50K/oz.  The Fed can set a gold price of lets say 10K/oz with buy and sell at 10,200 and 9,800/oz respectively and go back to gold back currency.  It's the best way to create instant inflation in our current deflationary (depression) environment.  All nations are in a pickle (Feds) at zero to neg rates (bad deal, neg rates).  There is no way to increase off of zero rates...a constant loop.  Raise rates and the markets crash, lower rates below zero and you have serious problems also.  We are stuck at ZERO interest RATES...and will never get off.  With zero rates comes low growth, which we have in spades, so going back on the gold standard is their best way to get off some.  Will it work...yes, but either way, we're in serious trouble.  Most folks will lose everything they have in savings and 401Ks.  The Feds have screwed us, so...a Brexit.  Have some gold and silver also.  The dollar will eventually tank and you'll lose the majority of buying power.  Gold and silver will help to protect your assets.  When the above happens, SSAN, retirements (esp govt retirements) and savings will become almost worthless...just saying.

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Thanks for reply. And I do

Thanks for reply. And I do hold physical gold and silver now. But I am wondering if it makes sense to borrow when the helicopter drop is about to happen to buy more hard assets. 

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