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Why Richard Russell Disagrees with Robert Prechter About Gold, US Dollar

by Brett on August 12, 2010

Like Robert Prechter, Richard Russell is also very bearish on stocks in the near term.  But unlike Prechter, who thinks you should be in 100% cash and short term cash equivalents, Russell thinks this will get you in trouble.

(For a recap of Prechter’s latest predictions, click here).

Richard Russell’s latest outlookCourtesy of KingWorldNews.com:

The specter of deflation is cropping up in many media outlets today. In fact, I’d say that deflation talk has almost become popular. The key question is this — Fed Chief Bernanke is obviously reading and hearing all about the “coming deflation.” What will Bernanke do about it? I think he will fight deflation with all the weapons at his command. And Bennie has a lot of weapons, least of which is printing “money.”

…Then (believe it or not) in the same issue of Barron’s we see an article by my old friend, Robert Prechter, the guru of the Elliott Wave thesis. Robert explains how a great contraction in credit and debt will bring about deflation. Robert notes that the amount of dollar-denominated debt worldwide is some $57 trillion. . . The already-issued debt and potential debt is poised to overwhelm the possibility of management monetization. The Fed’s assets amount to $2.3 trillion, a drop in the global debt bucket.”

Robert concludes his frightening article as follows — “If you are positioned for more inflation — as the vast majority of investors are — you are likely to find yourself on the wrong side of the monetary bet. Positioning for deflation simply means avoiding traditional investments, especially risky debt, and maintaining maximum safety in cash equivalents, held in the safest institutions. If you shed market and institutional risk, you can sail through deflationary times unscathed.”

Russell Comment – Whew, how’s that for a scary contrary opinion? Robert believes that way to safety in a deflation is to have cash, and lots of it. My concern with this approach is that I question the safety of the US dollar (and all fiat money, for that matter). So in an all-out deflation, Robert Prechter will be sitting in all cash or US Federal Reserve notes. But the dollar is collapsing, and with a US that is deflating, none of our foreign creditors will want dollars (in fact, they will be trying to get rid of dollars). With fiat money in retreat all over the world — and currencies devaluing against each other, the world’s peoples will turn to the only money they can trust — gold. I’m aware that Prechter believes gold will be heading down in a deflation, I disagree.

I was there during the Great Depression, and I can tell you nobody at that time had dollars. But if you did have dollars they were trusted and they were considered as good as gold. Today, it’s different. The very validity of the dollar is in question.

Read the full piece at KingWorldNews.com

The counterargument to the Great Depression devaluation analogy, which I’ve heard Prechter describe to Jim Puplava before on the Financial Sense Newshour, is that the dollar has already been devalued.  The Fed tossed it out the window from 2002-2007.

Prechter argued that because the dollar floats freely against other currencies, it cannot be devalued overnight by Federal edict.

What can the Federal government do?  They can purchase debt – mortgages, long-term government bonds, etc.  But is this inflationary?  Only if they create the “money” faster than it is destroyed via debt deflation.

This is the crux of the inflation/deflation argument: can the Fed “print” faster than credit is wiped out.  In the 07-08 meltdown, we saw over $10 trillion destroyed, while $2 trillion was “printed”.  That money is for now being left in the economy (courtesy of “QE2″).

But it’s not being increased – yet.  And I don’t see it going anywhere unless the old “velocity of money” picks up speed.  Which is not happening (see M1’s downtrend).

The best thing I think we individual investors can do is to form an intelligent hypothesis, and stay mentally alert and flexible about our investment positions.  I am mostly in cash, with a few speculative short positions, because I think this baby is going south into a spectacular deflationary depression.

If we see the dollar turn around and turn south, that may be a cue that things are turning towards the inflation path.  But that doesn’t appear to be happening yet – the dollar may have put in an intermediate bottom of sorts earlier this week.  If the dollar moves higher from here, I’d have to conclude that DE-flation is still in control.

US Dollar Price Chart August 12 2010Source: StockCharts.com (Drawings are mine!)

(And here’s why we think the dollar is the linchpin of the global financial markets).

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Read more on Deflation, Gold, U.S. Dollar (USD) at Wikinvest

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