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Deflation and Gold Bugs Print E-mail
General Investing Articles | Written by Robert Prechter |

Deflation and Gold Bugs

By Elliott Wave International's Robert Prechter, Prechter's Market Perspective
Oct 28, 2005

Some things never go out of style, including good interviews. Let's look back one year in time to Bob Prechter's Theorist of October 2004. In it, he published an interesting interview he did with Chris Oliver, the Money Editor of The South China Post. Here's an excerpt:

Questions and Answers from October 2004

Q: Can the Federal Reserve prevent deflation?

Bob Prechter: No. We have a huge bond market of $30 trillion, which is debt already created. If bond investors came to believe that the Fed would begin printing money and throwing it around, what would they do? They would sell every bond they've got, which would lead to a decrease in the supply of credit because bond prices would fall and interest rates would rise. So there aren't any alternatives to deflation.

Q: What will be the outcome of deflation?

Bob Prechter: The ultimate result is going to be a worldwide depression. There were deep depressions in the 1790s, the 1840s and the 1930s, and I think the next one is already under way. It started in 2001. We've had one or two every century, and we are headed into one now.

Q: Gold bugs say we are in an inflationary era and that this is backed by the rapid rise in the price of the yellow metal from $250 an ounce in 2001 to above $400 recently.

Bob Prechter: They didn't say it at the low in February 2001, when gold was a buy at $250. The fundamentals were all bearish then, and even gold mines were hedging for further decline, which never came. Fundamentalist arguments don't get you in at a bottom or out at a top. They often set traps so you'll do the wrong thing.

Q: But doesn't the gold rally predict inflation?

Bob Prechter: Think about this: Gold is trading exactly where it was in 1996 despite massive credit inflation over the past eight years. Why is that? I think the gold market understands the difference between credit inflation and currency inflation. A reversal in credit expansion – which is inevitable — will crush prices for everything, and the gold market knows it. The gold bugs' theory is that an increasing money – actually credit — supply should be bullish for gold and silver. But it hasn't been bullish for 24 years, so why is it bullish now? Look, I might be wrong on my current outlook for gold. In 1995, in At the Crest, I called for the bear market to end about New Year's Day of 2001, and it ended that February. So I'm somewhat conflicted. But that doesn't mean that the bulls' arguments are any good. We have heard them at every gold top since 1980 and opposite arguments at the lows. People have a psychological imperative to come up with reasons to be bullish at tops and bearish at bottoms. Market analysis is a subtle and difficult craft. You can't just look out your window and assume the obvious. That's not to say the obvious never happens, but when it does, it's luck.

Q: If the forces of inflation in real estate and consumer prices have been going on for decades, why should we believe they are now about to reverse?

Bob Prechter: The answer is that the wave patterns in the stock market tell you when confidence is likely to be strong or weak. The bull market of the 1990s was a period of high confidence. Many people were willing to extend credit, and many others were willing to borrow. As soon as the trend turned down, it told you that people were becoming more defensive, more protective of what they have, more conservative financially. In the long run, it means a trend towards less extension of credit and less assumption of debt. It will eventually mean the net retirement of debt.

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