Gary North: The Fed is now deflating the dollar, and gold is going to drop.

http://www.lewrockwell.com/north/north615.html

How can he conclude that the Fed is deflating when it is currently lowering interest rates and (if I understand this correctly) bailing out banks from the discount window? This doesn't sound right. What do you guys think?

Hmmnn, he is right, the money supply IS deflating.  And yet the Fed is in the seemingly contradictory policy of lowering interest rates.  Very interesting.  I am going to have to ponder quite a while on this.  I am well invested in gold.  Wondering if I should follow that bit of advice that Mr. North offers.

We saw the same thing in 1930-34. The Fed tried to inflate through credit market but could not find takers.  This is why Bern is trying other schemes.

Here's what I don't get:

I don't buy it either. He makes it sound as if Bernanke is deliberately contracting the money supply when all indications are he's trying desperately to do the opposite.

I might have believed that deflation was happening despite the Fed's efforts if he had said that. It could be the case that the Fed is trying to inject liquidity and finding the banks unwilling to take the money. Bernanke told Congress his new Term Auction Facility was intended to "reduce the incentive for banks to hoard cash and increase their willingness to provide credit to households and firms". If you are a banker and you think lending at this time is likely to result in the loss of your principle then it doesn't matter what interest rate the Fed offers.

It doesn't take an intentional act by the central bank to "*** the bubble" and bring on the bust phase of a business cycle. When malinvestments accumulate to the point that firms are not profitable and banks are unwilling to lend, it becomes impossible to keep injecting new money into the system through the credit markets. Then the bubble gets pricked whether the central bank is ready or not.

BTW, note Bernanke's use of the word "hoard". Geeze!

North's argument is that the Fed is temporarily failing at expanding the money supply, therefore there will be a dip in gold prices until more extreme measures to inflate are adopted.

What it means is that if you time it right (and I assume he wants to sell you the timing) you can make money by selling gold now and buying it back later. 

jtucker:

We saw the same thing in 1930-34. The Fed tried to inflate through credit market but could not find takers.  This is why Bern is trying other schemes.

Here's what I don't get:

 

Harksaw:

Could you please explain how it is the Fed can try lending out money, presumably at below-market value, and not find takers?

Even at zero percent interest there is still a risk for the bank. Money borrowed from the Fed and lent to the bank's customers might not be repaid.

It is not the case that there are literally no takers. Rather it is the case that the Fed wants to inject money into the system faster than the banks want to borrow it. The malinvestments caused by the Fed's inflation ultimately reduce the average creditworthiness of bank customers; but the Fed needs to keep inflating in order to sustain the boom. 

 Perhaps more significantly, the Fed makes short-term loans and the banks must make long-term loans.

http://fakeben.com/node/64#comments

..."

"The purpose of the FED is to manage the inflation expectations". There. Do you need anything else? If you do, there is something wrong with you. You listen, but you do not hear.

Because FED doesn't want us to think that it is happily inflating away, it lets recessions happen precisely when it thinks that many of us are starting to sense that it is happily inflating away. This recession makes us believe that FED is not all powerful in it's intent to inflate. That sometimes it has to turn around and "help the economy". And we then have a doubt that our future money will be cheaper. Only a fool would believe that. FED IS all powerful to inflate (caveat: only until we hit the wall), and no there is nothing wrong with economy as far as conventional "economy" goes. I have to repeat, that the one and only purpose of the FED is to keep you guessing and fluctuating your opinion between inflation and deflation, when the only possible development of events is inflation, until FED hits the wall. If you were sure, deadly sure that FED is going to successfully inflate, what would you do?

What would you do? Answer this now, before reading further.

I see, you would understand then that the only way for that historical gold chart is to go up and up and up, and the only way for you to win is to use fed's own power against them. You would borrow dollars, and buy gold, and take delivery. And how is FED then suppose to suck the purchasing power out of you? FED can't make gold! Do you understand what would happen if you forever stop trusting FED and instead convert everything you touch to gold? (yeah, I know... Midas. BS story for a different matter). I will tell you what will happen, the communism will fail. The communist US as it is will fail, and might even start trans mutating back to the Republic! Back to the capitalist America that world loved. Because the communist state will have no means to distribute purchasing power as it does now, because it would have no means to obtain it in the first place. It will not be able to inflate. And so to insure it's ability to inflate, FED must pose as if there were risks to economy, so that the thought through you mind is not "FED has no intention to stop inflating, there are no limits to how far fed can inflate, this economy is all plastic-fantastic, a bet on gold is a sure bet for a s long as fed is around", but instead, you start thinking this way: - "FED might have to start deflating, looks like there are limits to how far fed can inflate, this is not a plastic-fantastic economy, I better don't bet on gold". When Keynes said: - "Markets can stay irrational longer than you can stay solvent", he had described exactly how he plans to deal with disbelievers. "Infidels" will be brought to default by intentionally careening the market against a rational bet for a period of time until they either become insolvent due to over leveraging themselves, or until their emotions break-out out of fear, making them to reverse their bets."...

Yep, my thoughts exactly. Do we even know ***all*** the ways Fed can inject money? I agree that Fed should have no problem giving every bank a trillion dollar present, without any need to repay. They'll just shred the paper that shows they ever had bad investments. But the Fed would have a huge problem if everybody knows about that.

It seems that Mises and others had pointed out the weakness of fiat system. It's not that there ever will be not enough money, instead, it's that such a system will end in hyperinflation. 

If the Fed sells anything that it owns the money that it receives disappears. Bernanke has been adding money in one spot and taking it out at another this entire time.  The question is: how long can they keep that up?

Mark B.:

Hmmnn, he is right, the money supply IS deflating.  And yet the Fed is in the seemingly contradictory policy of lowering interest rates.  Very interesting.  I am going to have to ponder quite a while on this.  I am well invested in gold.  Wondering if I should follow that bit of advice that Mr. North offers.

I'm in a similar position re gold. Here's what I'm thinking:

The Fed "sets" interest rates by setting a target rate of return on US treasuries (by buying/selling them to increase/decrease the price and thus decrease/increase the yeild). Treasuries are seen as the zero risk investment (excluding foreign exchange risks) and so are seen as the rate of return on lending money when you remove risk from the equation.

Now, if the Fed lowers it's interest rate targets to 3% but the market as a whole suddenly becomes risk adverse and decides to buy up bonds on mass, then in order to achieve it's target interest rates the Fed may actually be required to sell treasuries in order to achieve it's target interest rate, with the result being monetary contraction - becuase the market moved quicker than the Fed did essentially.... The market is so petrified that the yeild on bonds (and thus "risk free investments") has plummeted to below the Fed's target rate.

However, this is rather a strange situation since currently yeilds are below the rate of inflation. The market is saying one of two things, in that case:

1. We prefer guaranteed small losses to the possibility of making some money but loosing lots of money.
2. We think inflation is temporary and it will drop below the current yeild on the bonds we're buying before those bonds mature

However answer number 1 can't be true. If it was then all these bonds investors would be better off simply holding on to the cash... so the correct answer must be number two. Most market participants believe we're in for deflation (which is understandable - that's exactly what they were taught at university - recessions are deflationary).

However, how long will the market be able to continue buying bonds to drive down their yeild naturally? Unlike the Fed, the market itself only has a limited pool of cash - it can't just create cash out of thin air to drive bond yeilds down... So once everyone is loaded into the wagon and the market stops buying bonds, the Fed then has to inflate in order to keep interest rates low - or it has to change the interest rates.

So short term, yes, we have real monetary contraction. What's the long term picture though?

By the way, there's an extremely well written article which is relevant here on the mises.org site:
  http://www.mises.org/story/2926

This explains the deflationary risks and why this absolutely cannot happen. No doubt Bernake's solutions to the problem will differ quite severely from the Dr Reisman's (which is a shame) but one way or another capital (not debt) is going to have to be injected into the system. I can only think of one way that can be achieved under the present system.