Many compare the current US economic slowdown to what occured (and is still occuring) in Japan. In the 80’s, a massive real estate boom occurred in Japan. Much like ours, excessive leverage and speculation led to unwarranted real estate values, primarily in the commercial sector. The ensuing bank crisis resulted in a recession and deflation that still occurs to this day. The Nikkei stock index had its all-time high on December 29, 1989, when it was at 38,957.44. Today, the Nikkei index stands at about 9800. You got that right. Over the course of 20 years, it fell 30,000 points, which was about 77%. Yikes!

The Japanese were slow to lower interest rates, but they eventually did so, and interest rates are still near 0% in Japan today. The government also wasted a lot of money via various fiscal policies, building the typical bridges to nowhere. Japan’s debt is now 180% of GDP, though both short and long-term interest rates are near zero and no inflation has occurred.

The big difference between Japan and the United States though may be the Japanese savings rate. While public debt exploded, Japan never had a debt issue in the private sector. Japanese private sector savings simply got swallowed up by the growing government debt. People were happy essentially getting 0% on their money. That turned out to be a better investment than putting the money in the stock market. With the highest corporate tax rate in the world and a mountain of other taxes and regulations, Japanese business has been in a state of lethargy for decades now and there’s no going back.

What does this mean? I am not saying Japan-style deflation is inevitable. In fact, I doubt it will occur. No two disasters are ever exactly alike and the biggest difference between us and Japan is that they have savings and we don’t. Their budget deficits were also the result of one-off governmental fiscal policies moves, whereas our impending disasters are due to structural flaws with our entitlement systems.

This means we cannot count on the bond market to be so benevolent to our long-term bonds. The massive supply glut of US bonds, the potential for structural deficit issues (meaning our deficit consistently surpassed economic growth, even in ‘normal’ times), and the lack of private sector US savings means that bond rates may go up. In this case, if everyone can loan to the US government at 6-7%, the stock market will collapse since people can get solid returns with ‘no risk’ in US treasury bonds, and the cost of borrowing for corporations and individuals will be unbearable.

Many believe that in this case, the Fed will choose to expand its ‘quantitative easing,’ essentially printing money to fund the deficit. Again, this isn’t guaranteed, as the Fed may refuse to do so and force politicians to balance the budget.

Inflation is a potential with our deficits, but it’s not guaranteed. It could be that the government succeeds at simply destroying the economy long-term, much like the Japanese did, in a deflationary moment by gobbling up all of the private sector capital. The Fed may not print that much money.

To make money off of a disaster, you need to not only predict economic doom but also know HOW the doom will occur. That is the problem in this environment. We can point to policymaker mistakes and claim they will make society worse off. But to make money off of this, you need to know exactly IN WHAT WAY society will be worse off.

Needless to say, I’m pretty happy about this. As I wrote earlier, I had been piling into silver due to potential stagflation prospects. But is the rise in silver due to this or other reasons? Honestly, I have no idea.

While silver has been up, treasuries have gone down. Investors now are demanding higher yields from the US government. Some believe this is due to the collapse of fear in the marketplace. In the fall, treasuries had unbelievable demand due to everyone wanting a safe haven, and now that people are feeling more comfortable, treasuries are being bid down. I’m not so sure that is true. Treasuries have been consistently selling off since the year began, even in the face of the 25% drop in the market over the first few months.

The bearish explanation on why treasuries are falling is due to people’s fear about the dollar (another explanation for silver going up) and fears of inflation/debt monetization (another reason for silver to go up).

Those that are bullish on the economy may believe silver had just been oversold and was due for a bounce: the gold-silver ratio was way out of whack earlier this year. Another explanation is that all commodities are up due to prospects of economic growth. The USO is up 27% over the past month as well. Silver has many industrial uses, so it is climbing along with other commodities.

It’s not clear what the reason is, but we’ll likely find out over the next couple of years what truly will be driving the price of silver in the near-term.

One favorite way to own gold is through the GLD ETF. This ETF is a holding company which owns gold. Purists do not like the GLD since you technically do not own any gold yourself; you merely hold a derivative of an ETF that holds gold. So if, for whatever reason, the ETF’s gold holdings do not turn out to be as much as advertised, you are out of luck. Such sort of paranoid thinking was merely laughed at a few years ago, but as we have seen with the counterparty risk with Lehman Brothers and these other investment banks/hedge funds, it is not something to laugh at anymore.

Another way to make a gold play is to buy gold mining stocks. This avoids the counterparty risks/theft issues outlined earlier. However, it’s not a pure play on gold’s price. Gold miners do well of course when gold is higher in price, but some gold miners are more sensitive to price than others. Because of this, it is important to research the companies and tell how they would be affected under various pricing scenarios.

Call me a skeptic. First, I’ll believe economic recovery when I see it. Predicting economic recovery will just happen is the same sort of hubris Bush had when he believed Saddam’s weapons of mass destruction would be found. Both may never happen. With the anti-business attitude of Washington and the clear threat of higher taxes, true economic growth may never occur in the US again….and even if it does, it certainly won’t be the bullish 4% that Obama projects. Even when the United States was binging on cheap credit in a more business-friendly administration with lower taxes, economic growth was just 3%!

The US debt/GDP is about 80% right now. A $2 trillion deficit, with our GDP of $14 trillion, is about a 14% deficit. Assuming deficits of 14%, and then 12% over the next four years, the debt/GDP will be 143% in 2013 and 252% in 018. This doesn’t even take into account unfunded liabilities like social security and medicare. Also, remember that we have a record amount of consumer and business debt. In other high debt/GDP nations, particularly Japan, their people and businesses are net savers.

Our country will not be able to last with this sort of debt. There is only one cure for this sort of recordd debt: inflation. When the printing presses start rolling, our debt/income levels will drop drastically. When inflation kicks in, the best place to be is in commodities.

I don’t know when the inflation will occur. What I do know is that we, as a society, are in a state of denial right now. Will it be 10 years before the inflation occurs or just 6 months? I don’t know. No one knew when our overleveraged banking industry would blow up, but it did. The same will be said about our societal debt.

Congress and Obama are piling up record deficits and causing our debt/GDP to soar. I do not believe we will be out of this recession anytime soon, especially with the anti-business attitude in Washington. The proposed tax increases either will not happen or won’t put a dent in the deficit anyways. What we are left with is a gigantic amount of US treasuries to hit the market.

Left unchecked, the yields on the treasuries will soar, meaning it will cost more for the government to borrow money. China and other foreign investors don’t have unlimited amounts of money they wish to loan our government, so the natural effect would be higher government interest rates, even higher rates for borrowing on business, and a deeper recession. In this scenario, shorting US treasuries would be the best bet (something I am doing).

However, it’s not this simple. As demonstrated by the Fed yesterday, our government is going to print off money to pay down the debt. Basically, government runs up debt and then prints off money to buy off their debt. Their reasoning is that while this is inflationary, inflation is under control right now…..we’ll see for how long.

What is lying ahead of us is stagflation, a stagflation worse than the late 70’s in my opinion. At that time, silver and gold soared in value, but especially silver. The silver/gold ratio dropped to an all-time post-WWII low. If you think about this, it would make sense since the demand for silver (in terms of production and jewelry purposes) is higher due to the trade down effect. If everyone is poor, people sure won’t be wearing gold jewelry! Silver has both the value as a store of value but will still see demand in jewelry and for industrial uses.

Silver is also well off of its lows. The silver ETF, SLV, is at 13.42 as I write this article and its 52 week range is 8.45 - 19.169. In contrast, the gold ETF is near the high-end of its 52 week range.

As they say in poker, I’m all-in.

As of the time of this article, Gold is around $930 an ounce and the Dow Jones is 6700. At the time of Schiff’s book, gold was around $700 and the Dow 14000 or so. The two are starting to meet in the middle, largely because of the major market drop.

If the 1:1 ratio occured, or even if it was not quite 1:1 but 1.5:1 or even 2:1, it would most likely be a result of movements by both. Something along the lines of $2500-3000 gold and a Dow in the range of 3000-5000 or so. They could even be even with Dow/gold settling around $4000 each.

Many currently price gold in relation to the S&P. That line of thinking ignores perilous times, like the Great Depression and the inflation of Carter’s regime. Given we are likely seeing a combination of each, the horrible unemployment of the recession and the likely inflation and high interest rates due to the government printing money, a repeat of the 1:1 ratio near the bottom is not at all unlikely.