Deflation—Here Now, More Coming
Gold under $300, oil under $10-you'd better bet on it.
Inflations have been part of civilization at least since the days of the Hammurabic Code, 40 centuries ago, when wage and price controls were first established. Every period of inflation or hyperinflation has been followed by one of deflation, without exception. Be this a cosmic yin-yang, or sine-cosine in the sky, nobody knows. Perhaps each generation must relearn the lessons from the errors of their grandparents' generation, thus accounting for the periodicity of the Kondratieff, Juglar, and other demonstrable cycles. So where are we today?
Without a doubt, the 1970s was a period of inflation. Indeed, in 1980 most people saw a period of unending inflation. A few even predicted hyperinflation, the supernova of inflation. But in the late '70s, I specifically rejected the possibility of hyperinflation (yet), because that results only from the collapse of political institutions, such as after devastating wars.
To the contrary, I had always felt that the 1970s represented a period of rather routine inflation that would end with a rather routine deflation. And I believe that a deflation began in 1980, at which time gold, oil, real estate (especially farmland), and the Dow Jones Commodity Index reached apogees not surpassed since. The unwashed do not perceive this as a period of deflation, calling it instead in Orwellian fashion a "disinflation"—perhaps unsurprising at a time when President Reagan calls one of his missiles "the Peacekeeper." But here we are, in the fifth year of a deflation that is invisible!
A key perception in understanding the inflation-deflation cycle is that when government creates too much money, more paper chases the same amount of goods, and prices ineluctably rise. An ancillary key perception is that when prices rise faster than income, spending at some point must decline; prices are too high and will then fall of their own weight—a process I believe began in 1980.
The symptoms are numerous for those who would see; it is no accident that we have today what are called "street people" (like the hobos of the 1930s), a "rust bowl" (like the dust bowl of the 1930s), emotional farm foreclosures, soup kitchens, and stubbornly high unemployment. What we make of this is that the basic industry of the United States has been sliding into an ever-deepening depression since 1980—one concealed by an overlay of a dynamically high-growth technology sector that is too young in its cycle to be similarly affected. Strength in high technology explains why a state such as California is doing well, whereas basic industry states, such as in the Midwest, are doing poorly.
I realize that it is a daring and extreme minority point of view to suggest that we are in a deflation, inasmuch as the United States has been conditioned by 50 years of ongoing inflation. Nonetheless, many sound reasons for a deflation can be found. For one thing, there are simply too many commodities. When OPEC got greedy in the late 1970s and raised the price of its commodity too high, the whole world embarked on a frantic search for oil (perhaps condensing 20 years of drilling into a few). Indeed, an oil glut exists today for anyone to see.
A second factor is the historic opening up of the undeveloped world. Though in the '60s it was uneconomic, for instance, to mine huge copper deposits in faraway places due to the lack of financial and transportation infrastructures, that's changed. Mineral deposits are being opened up all over the world, all at once. In other words, a commodity glut can exist irrespective of the excess creation of paper money. That is why copper and sugar prices are so depressed.
Not only are commodity prices under pressure, but so are once-sacrosanct wages. When I began in 1975 predicting lower wages in my book The Invisible Crash, it was perceived as a preposterous prediction. However, wages in the United States have been ascending at an increasingly slower rate in this decade, and I predict they will actually decline sharply. In 1945, US workers were the best educated. This country had the best machinery, cheap capital, cheap land, and a hungry world to feed. Today, developing nations have the education, superior machinery, and the technological know-how that we've given them—and there is no way for our farmers to compete.
Since 1980 I have been predicting that China would go capitalist, and I think the signs are already beginning to emerge. In the last seven years China has been increasing its farm production at an average rate of 12 percent a year, and now it is suddenly the world's largest wheat producer! Have you considered the impact of one-quarter of the human race suddenly dumped onto the world labor market, willing to work for a paltry $2.50 per day? There is simply no way for the American labor force to survive in such circumstances, and all the US labor-union movement has proved is that a beggar mounted will ride his horse to death.
Since 1981 US poultry exports, for example, have plunged 37 percent to 551 million pounds, according to the Agriculture Department, with another 10 percent decline projected for this year. Our pork exports are also expected to plunge by a staggering 50 percent this year, from 1981 levels, while pork imports are expected to nearly double to almost 1 billion pounds from 1981 levels.
The truth is that the American worker, unless he is in some kind of high-technology field, is vulnerable to developing-nation labor competition—in other words, is dead as a dodo. One can throw the US farming industry into the trash can, just as we have lost our television industry and many others.
Not only are commodities, energy, and labor under pressure, but so is real estate. Obviously there is no surplus of real estate, because the amount of land is always fixed. But the country as a whole quite simply overbuilt in the 1970s, largely due to inflation and tax considerations (and those might soon be diminished). The resultant oversupply of buildings weighs heavily on many American cities. Price of capital is another consideration. Even here, Japan for example has an interest rate half ours—yet another lower-cost structure that enables them to sell at competitively lower prices.
None of the above sounds as if the United States is headed for an inflation. There will be periods of remission. Indeed, the financial newsletter The Dines Letter, which I edit, turned bullish on gold, copper, oil, and several other of the inflation hedges at the beginning of 1985, because we saw a temporary period of remission that would feature a rally in the inflation hedges. Thus, while I am looking for short-term strength in precious metals and other inflation hedges, by later this decade they will see substantially lower prices. If I'm right on the long-term deflation scenario, then sometime towards the end of this decade we will see gold under $300 an ounce, oil under $10 a barrel, interest rates below 5 percent, and many other now-unbelievable price levels.
During the 1984 presidential campaign Walter Mondale warned that huge federal deficits would drive interest rates higher, and perhaps he lost the election because interest rates fell instead. This is what scientists call an "anomaly," a surprising result in view of the logic. Well, it is no surprise at all to anyone who comprehends that we are in a deflation, which always features declining interest rates. Federal deficits are as big as ever, so why are interest rates declining? Those with in-depth understanding realize that we are in a long-term interest-rate decline, which will feature a long-term bull market in bonds.
But this in itself carries dangers. In 1970 the US government spent 7.4 percent of its budget on interest payments; in 1986 that figure will be 14.7 percent. Huge federal deficits are compounding the increase at a frighteningly exponential rate. How high a percentage of the budget could be allocated to paying interest? Twenty percent? Fifty percent? Surely sometime before we reach the 100 percent level there will be some kind of financial calamity, which, I expect, will start sometime around 1989. The banking system is already feeling tremors.
Now that investors have all learned what the inflation hedges are and purchased them in the 1970s, I doubt that many even recognize deflation hedges: US dollars, Treasury bills and bonds, bank and insurance stocks, stocks in food and soft-drink companies, preferred stocks, utility stocks, and other defensive issues. Unsurprisingly, these groups have all been market leaders recently.
One of the primary beneficiaries of deflation is the financial sector. (Technology is in a separate cycle and not necessarily a beneficiary of either inflation or deflation.) Indeed, it is interesting to observe the current boom in the bank and insurance industries (except the ones that loaned money on inflation hedges: oil, real estate, commodity-related investments). Again, this is confirmation from the world of reality. Some call this process the "deindustrialization of America." It is not. It is an international depression, masked by a technological growth that is shrugging off a deflation because of its own incredible internal energy.
Another profound deflationary phenomenon will be the commencement of what I feel is the coming "robotics age." The truth is, this development trend has already begun. I can foresee that in a few short years the entire computer industry will be a subsection of robotics. There is a factory in Japan, for example, that employs one nightwatchman, and the lights are out, because robots work 24 hours a day manufacturing in the dark. This is the face of the future. How low would human wages have to drop to compete with a robot-operated factory?
True, the robotics revolution should be seen as something in which to invest, and The Dines Letter is intensely interested in this area. But on the larger canvas, what picture is being formed? What will it mean to the concept of having a job? Are we at some nexus in history where we at last have "made it"? Where laboring for our bread is a thing of the past? A point when there is more than enough food for everyone? When having a job will be a tremendous privilege, and when there will be a guaranteed minimum income for everybody?
What would make me think I am wrong about the deflation scenario I've depicted? I expect gold to rally from around $300 an ounce towards the $400 area, but if gold got substantially higher—and especially if it made a new all-time high—gold as a barometer of inflation would suggest that we were headed for another round of inflation, possibly even a hyperinflation. However, I do not expect this to occur. Rather, I look for gold to suffer a decline to under $300 before the period of deflation is over.
On the other hand, I would be convinced that I am right that the United States is in a deflation if, for instance, the inflation rate declined to a minus number! After 50 years of living with inflation, some minus numbers in the inflation rate would convince me I am right about a deflation—and it would, of course, flabbergast the inflationists, who simply would not be able to explain it.
James Dines is the editor of The Dines Letter financial newsletter and the author of The Invisible Crash (Random House, 1975).