Suddenly, economic pundits are debating two brow-furrowing questions: Should the Federal Reserve hang tough on interest rates to fend off higher price inflation? Or, should the Fed continue lowering interest rates to stabilize a slowing economy?

With the specter of inflation receding, the consensus is rallying behind the risks of recession. Many commentators argue that if the Fed doesn’t act quickly, the nation could even be plunged into a 1930s-style depression. Worse yet, we could be on the brink of the ultimate economic catastrophe — deflation!

Deflation – Bernanke’s Worst Nightmare

Deflation is defined as a fall in the general price levels. And it seems to be Mr. Bernanke’s worst nightmare. As he warned in a 2002 speech: “Sustained deflation can be highly destructive to a modern economy and should be strongly resisted.”

According to him, the sources of deflation are no mystery. “Deflation is in almost all cases a side effect of a collapse of aggregate demand – a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.” And falling prices, we’re told, open Pandora’s box. “[The] economic effects of a deflationary episode…are recession, rising unemployment, and financial stress.”

For the majority, monetary economics is a mystery wrapped in gobbledygook. From childhood to old age, we desire money, work for it, use it, save it, invest it and generally spend our lives agonizing over how to keep what we have and get more.

Yet the masses understand money’s origin about as well as they understand quantum mechanics. With general ignorance about the source and nature of money, any economist worth his salt can easily confuse the public about economic policy.

Deflation – Destructive? Nonsense!

Sustained deflation is highly destructive? Give me a break! Nothing is more nonsensical than to argue that falling prices, per se, are bad for the economy.

Was it a disaster when computer prices fell dramatically over the past four decades? Of course not. The lower the price, the better. The same is true for shirts, TVs, and rutabagas. Consumers win when competition and innovation increase output. And increased output results in deflation – as long as it remains undisturbed by monetary intervention.

Bernanke says that a collapse in aggregate demand causes deflation “in almost all cases.” Piffle! His “almost all cases” really refers primarily to the collapsing demand that apparently caused the Great Depression in the 1930s.

As Murray Rothbard pointed out in his classic America’s Great Depression, demand collapsed because of easy money. The new Federal Reserve had poured easy money into the financial system and created a speculative bubble that the economy simply couldn’t sustain.

In 1929, in a population of 120 million, 30 million families were involved with the stock market, and a million investors were classed as speculators. Of these, nearly two-thirds, or 600,000, were trading on margin, on borrowed funds. That is, they were trading with funds they either didn’t have or couldn’t easily earn.

Does that seem similar to the current real estate market? Millions of individuals have leveraged themselves into homes they can’t afford – all because the central bank created easy credit policies. Like the stock market bubble of the 1920s, the real estate bubble of the past two decades has reached its limit.

At the time, Keynes explained to the politicians that “falling demand” caused the Great Depression. It’s also the argument politicians used to justify massive government spending programs. Mr. Bernanke is following a well-worn path: First pump more credit into an already overheated economy and then, when the bubble bursts, do everything in your power to organize government rescue operations.

History Makes Bernanke a Liar

History also proves that Bernanke’s statement is a fraud when he said that deflation comes from a collapse in demand “in almost all cases.”

For three decades in the 19th Century, from 1865 to 1895, the general price level fell steadily, dropping by almost 50%. Did this sustained deflation “ravage” the American economy? Hardly. The real, inflation-adjusted, per-capita GNP nearly doubled over the same period! For 113 years, from 1800 until 1913, consumer prices in the U.S. fell 42%. That’s an average annual deflation rate of 0.5%. Meanwhile, expanding output created more wealth than ever before in history.

Why didn’t innovation and technological advances continue to drive prices downward in the 20th century as they had in the 19th? Because the politicians created the Federal Reserve.

Given the keys to unlimited credit creation, the Fed put the brakes on good, honest, beneficial deflation, and inflation took over. After falling for over a century, the price trend reversed, and from 1913 through this past November, consumer prices rose 2,048%!

Considering the fact that Mr. Bernanke is determined to fight the downturn with more infusions of “the hair of the dog that bit us,” the long-term danger ahead is inflation, not deflation.

Meanwhile, as Warren Buffett said in his 2006 annual report of Berkshire Hathaway, “Be fearful when others are greedy and greedy when others are fearful.” For the moment, the short-term is gripped by fear, so for us at The Sovereign Society, it is the time to be greedy.

JOHN PUGSLEY, Chairman

From Addison Wiggin at Agora Publishing, writing about the Strategic Investment newsletter, I gather that I am in for many, many sleepless nights, waking up screaming in terror, as he says that there are at least 5 “super-shocks” a-coming in the next 12 months, which will create the “coming stock market apocalypse.”

Yikes! For example, right off the bat, he says that there’s “a complete crash in commercial property”, and then there’s the burden of $2.54 trillion in consumer credit debt, which is made startlingly horrifying when he explains that credit card debt alone is already bigger than the amount of money locked up in the subprime loan debacle!

“And remember,” he says, “on credit card debt, you’re talking interest rates three-five times higher”! Yikes! He’s right!

Immediately, my hand flew to my wrist to check for a pulse, as this is the kind of thing that I am sure will kill me one of these days, with just a glimpse of the sheer horror of the economic catastrophe that awaits a pathetic, low-I.Q. nation that thinks that they can painlessly borrow and inflate their way out of any debt, no matter how much.

And speaking of debt, as I recall, total consumer debt is now something like 350% of GDP, twice as high at the height just before the Great Depression, which means a total consumer debt of about $53 trillion in a $15 trillion economy, which comes to a debt of about $530,000 for each and every one of the 100 million workers in the whole country whose job is not a government job! Hahahaha!

And this does not even include any of the $9.2 trillion in principal-and-interest government debt that the non-government worker has to pay for, or any money towards the estimated $60 trillion of accrued liabilities of the Medicare and Social Security programs, or the $3 trillion in federal government spending that is going to take place this freaking year, or the $2 trillion spent by the states this year!

And who in the hell is going to pay, for instance, the interest/profits on a reported staggering, stunning, stupefying glut of $164 trillion in derivatives that are in the banks?

My Freaking Mogambo Head (FMH) actually aches from trying to conceive of So, So, So, So Damned Much Money (SSSSDMM) in the aggregate, so much that America’s 100 million private-sector, non-government workers cannot possibly even pay the interest on it all, which they haven’t been doing for years, anyway, which explains why total debt everywhere, like Old Man River, just keeps rolling along, like a snowball rolling downhill, getting bigger and bigger, which is such a strange mix of metaphors that I realize that I am completely confused and frightened.

To try and get me back to reality, you helpfully ask, “Just how much is that, relatively?” With no facts or figures at hand, I say merely that it is more than I could make in a zillion, zillion lifetimes, for one thing, mostly because I am lazy and I am apparently not worth much as an employee, which could explain why I am always getting fired, and yet it is paradoxically approximately how much money my family wants to spend per freaking month, or so it seems, and when the credit card bills come in the mail, I predictably yell and scream, and make threats, and throw things, but nothing ever changes! And the next month there are MORE charges on the credit card for their stupid visits to the stupid dentist, or their stupid prescription medications, like money grows on trees around here!

Mr. Wiggin wisely decides not to get into the middle of a domestic squabble about money, and says merely that $2.48 trillion is “more than China makes in a year. It’s more than the entire United Kingdom’s GDP. And more than the GDPs of Italy, France, Canada, Spain, Brazil, or Russia.”

As interesting as that is, he notes with a mocking tone that seems jarringly at odds with the horror of it, “Only they’re making that money. We just owe it.” Hahahaha! That’s right!

But to show you that Mr. Wiggin does not just sit around all day thinking of clever, mocking things to say about the utter insanity of it all, he then shows us that not all art is painted with a brush, as he says, “Here’s a picture for you: If the market today falls as fast and as far as it did in 1987, you’ll see more than 3,000 points erased from the Dow alone. In a single day.” Yikes!

And as terrifying as that is, according to Mr. Mortgage at mrmortgage.typepad.com/blog/, who has been looking at the same spreadsheets at the NewYorkFed.org site, 89% of all Alt-A mortgages (a market that is a step above the subprime market and is 50% bigger than the subprime market) are now underwater, meaning that the owners owe more than the house is worth! Wow! 89% of people with above-subprime mortgages owe more than the house is worth! And looking at my watch to get the correct time, by this time it’s probably all of them that are upside down!

And how do we know this? Well, if you are like me, you take the easy way of finding out by letting Mr. Mortgage do all of the work! And sure enough, he obligingly looks at the Loan-To-Value ratio, essentially comparing what the house is worth on the open market, versus what is owned on the old eyesore that needs paint and somebody to get up off of his Big Fat Mogambo Butt (BFMB) and mow the damn yard.

But stripped of the esthetics of the appearance of the lawn, this ratio is combined into the “Average Combined LTV of Purchases,” which is helpfully explained in all capital letters, and in parentheses, “(NEGATIVE EQUITY)”, just so you don’t miss the significance.

This seems a good time to mention that you should be selling your house and buying gold with all your money, and if the kids have to miss a few meals or if they have to sleep in the car because I cannot afford an apartment big enough for all of us but it is perfectly cozy enough for me, that is the price you are willing to pay. You will thank yourself later!

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Editor’s Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning and other fine publications. Click here to visit the Mogambo archive page.