Interview with Jim Puplava, by Jeff Clark, Casey Research

Jim Puplava has robust convictions….The CEO of Financial Sense News Hour, Jim is a man you should listen to carefully if gold factors in your portfolio or if you are thinking about adding gold anytime soon. In this interview, Jim talks about how the dollar affects gold prices. He discusses whether we are moving into a phase of deflation or inflation and gives his views on what exactly that will mean to gold investors. He discusses the likely impact of inflationary or deflationary forces, which one he believes will win out, and the effect it will have on our economy.

Finally, he makes a very interesting prediction.

Of course, any investor will tell you that deflationists and inflationists have been arguing for years. Each side has data to back up its claims, so investors end up none the wiser and non the wealthier. All the arguing simply causes confusion, and that invariably that leads to inaction.

One thing they can’t argue about though: A defining moment in the deflation versus inflation argument will present itself when our current overburden of debt finally blows up. On the one side, deflationists will point to periods in history where deflation resulted from that overburden. But as always, there’s more to the argument.

Jim emphatically states:

“The outcome depends on whether or not the economy is operating under a fiat currency system, because there’s never been a deflationary depression when one’s been in place.”

Interesting.

When I saw this claim, I wanted to hear more, because deflationary forces seem strong at the moment. I asked Jim for a chat about his viewpoint. I wanted to get as clear as possible as I could about Jim’s thoughts on deflationary pressures, because it has direct and significant implications for investments, including gold, something all my readers care deeply about. Here’s my candid interview with Jim.

Interview: Could Gold Be Tripped Up by a Coming Deflation?

Jeff Clark: For those who don’t know you, Jim, tell us what you do.

Jim Puplava: Basically I head up three companies. We have our own independent broker-dealer; we have a money management firm and we have a media company which produces the Financial Sense News Hour online. I head up those three companies and am the CEO.

Jeff: It’s been four years since the financial crisis, and we’re still debating inflation vs. deflation. I found your claim quite compelling, so tell us what you found in your research.

Jim: Well, why don’t we begin with the financial crisis that transpired between 2007 and 2009? It’s something every investor remembers. The deflationists would argue that in a crisis as big as that, the resulting downturn in the economy is always deflationary. But if we look at that period, the money supply continued to expand. In my opinion, inflation is associated with monetary policy.

Jeff: We should probably define the terms we’re using.

Jim: This is one of the problems we have when talking about deflation. You will often hear, for example, that “housing prices fell by 30%” or the “stock market fell by 40%,” supposedly meaning it was deflationary. But that is a specious argument at best, because if we call the crash in real estate and the stock market deflation, then what would the deflationists argue now that housing is starting to turn around? What would they call the S&P going from 666 to 1,373? It’s up over 100%… is that deflation?

Let’s take the popular definition of inflation – rising prices, which is really a symptom of inflation. During the financial crisis, there were only three months where the CPI was negative. Prior to 2008, the last time you saw a negative CPI was in 1954, when Eisenhower was president! So despite all the claims about deflation, all you would have to do is look at a graph of M1 and M2 and see that the money supply actually expanded during this period. Investors may not recall that in the middle of the 2007-2009 crisis, Bloomberg sued through the Freedom of Information Act and got access to the Fed’s records of exactly what they did. We found out that they either guaranteed, expanded, or backstopped somewhere around $8 to $9 trillion. That can only be done in a fiat money system – something you can’t do with a gold-backed system.

Jeff: Like during the Great Depression?

Jim: Even before that. Step back to 1920-1921… If you look at the statistics during that period of time when we were on an actual gold standard, you saw a huge contraction of GDP and in the price of goods. Here are the actual numbers: between the summer of 1920 and 1921, nominal GDP fell by 23.9%; wholesale prices as measured by the PPI dropped by 40.8%; and the CPI fell by 8.3%. It lasted for roughly two years. I have yet to see anything like this in Japan. I have yet to see anything like this in the United States – despite the credit crisis and all the fallout we’ve had. Furthermore, even in the gold standard we had during the ’20s and ’30s, we had inflation. President Roosevelt devalued the dollar by 60% in March of 1933, and when he repriced gold from $20 to $35, he stopped deflation dead in its tracks. By the end of the month we were experiencing inflation. We were running single-digit inflation rates the very month he did that in 1933, all the way up to 1937, when FDR and the Federal Reserve reversed course. So as a result of the devaluation we got large doses of inflation.

Jeff: So your point is that even though we had a gold standard during the Great Depression, the government found a way to cause currency dilution, AKA inflation.

Jim: That’s right.

Jeff: You brought up Japan; I assume you’re using it as an example instead of the smaller countries because it’s a major economy?

Jim: Yes, exactly. Even though the US dollar is the world’s reserve currency, we have three major currencies where most trade is conducted – the dollar, euro, and Japanese yen. Argentina’s economy is insignificant in terms of global GDP, for example, and they’re constantly printing money, so a lot of people don’t like to refer to small countries like these. I’d like to address Japan, though, because of its unique situation. And I think a graph will best make the point. The following is Japan’s CPI, year over year, going back to 1982. There were brief periods of deflation, about 1% or 2%, and you can see that most of this occurred between 2000 and 2004 and in the credit crisis following 2009 to 2010.

In that period of falling prices, the CPI was only down 1-2%. If we take a look at Japan’s monetary base, however, there was only one period where it actually contracted, and that was between 2005 and 2010. But the period that the deflationists like to talk about – 1989 going forward – Japan’s monetary base expanded every year. Government spending expanded viscerally.

Jeff: And now their debt is among the highest in the world.

Jim: Japanese debt today is roughly 208% of GDP, one of the highest debt ratios in the developed world. But there’s something else that makes Japan unique…If a government expands its spending in order to rectify weakness in the economy, there are a couple ways governments can finance that. They can print money – which is what the Fed has been doing – or they can finance it through the bond market with existing savings. One of the very measures that allows Japan to escape a rather severe deflation compared to what we experienced in the early 1920s following World War I or in the ’30s during the Great Depression was the Japanese savings rate. Going back to when the crisis began in Japan, the savings rate was 18%.

In other words, Japan has been able to finance its deficits internally. Ninety percent of their debt has been financed and held by domestic savings. If the Fed or US politicians financed government spending with existing savings – in other words, took the savings of Americans and financed the deficit – that would not be inflationary. Inflation comes when we get debt monetization, and fortunately for Japan, they were able to finance 90% of their debt expansion internally through domestic savings. The second factor that contributes to what happened to Japan was the carry trade. As a leading export nation, Japan exported a lot of its money to the rest of the world, and it gave rise to the carry trade, in which we were able to borrow in Japan at some of the lowest interest rates in the world. So if Japan instituted capital controls, where the excess reserves of the monetary base were not allowed to leave the country, that money would have been confined within Japan itself, and then you would have had more money chasing fewer goods and services.

Jeff: What about Japan’s demographics? (Next Page)