I want to offer a little praise here for Mish Shedlock, an investment advisor for Sitka Pacific and proprietor of the hugely successful blog, globaleconomicanalysis.blogspot.com. I owe Mish a debt of gratitude as one of the writers who helped me understand our credit money system and anticipate the events of the last couple of years. He was a deflationist back when CPI was ticking in at 12% annualized (June/July ’08), and he has made a series of very prescient market calls.

Robert Prechter of course is the original deflationist who has seen this depression coming since the late 1970s (when he was a lone “bearma bull” and anticipated a great bull market followed by a giant crash and long secular bear market — his mistake was that failed to anticipate just how manic and levered-up society would get in the 1990s and 2000s — he called for a bubble, but not the greatest bubble of all time), but Mish’s writing has been on par with Prechter’s and he has lately bested him when it comes to gold.

I believe Mish has only been following the markets intently since the early 2000s, when he lost his job as a programmer. He used his free time and the internet to educate himself on economics and markets, and thanks to an intelligence uncluttered by a formal economics education or Wall Street voodoo, came to understand that we were experiencing a credit bubble — a business overexpansion and misallocation of resources due to easy access to debt. Debt was cheap because under our fiat money central banking system, bankers had created a cartel for themselves and a safety net. They had a license to blow enormously profitable bubbles and a get out of jail free card in the Federal Reserve, which of course is their own creation. Politicians love this system because it allows them to grow the government at a pace far in excess of the economy, since the Fed can just print money to buy T-bonds.

With his excellent understanding of debt, Mish came up with what I consider to be the best definition of inflation and deflation: inflation is an expansion of money and credit, where credit is marked to market; deflation is a contraction thereof. Rather than looking only at various money measures (M1, monetary base, M2, etc), Mish’s definition is most useful in our system since credit acts like money and dwarfs actual cash.

As Professor Steve Keen has shown, credit expansion precedes monetary expansion. In a fractional reserve world were credit can be created out of thin air with practically no restraints on reserve ratios, commercial banks and other “shadow banking” institutions are in the driver’s seat, not central banking committees. Even as the Fed’s balance sheet (like those of other central banks) has grown from $850 billion in early 2008 to nearly $2.5 trillion today, this increase in cash has been dwarfed by the contraction in private credit (which started out at $50 trillion for the US and is surely much smaller today). This is why cash has been king on Main Street, the recent stock and commodity rally notwithstanding.

Back to the story of the bubble, so long as debt got cheaper and easier, people could afford to take on more, which they did because it allowed them to keep up with their neighbors and feel good about themselves. Also, when credit is expanding, levering up is a fast way to get rich — asset prices soar, since you don’t actually need cash to buy things. A bubble mentality forms: when the only reason to buy a class of asset is because you can sell it to someone else for more (there is no reasonable prospect of sustainable cash-flow), you have a bubble. The bubble bursts when marginal buyers fail to show up and relieve the last round of speculators at a profit, since everyone is already stuffed to the gills with debt and debt-financed assets. When there is nobody left to buy and prices stall, that class of asset becomes a burden (taxes, maintenance, interest), and a crash is imminent. That was 2006 (a clear warning then was the inversion in the yield curve, as demand for credit started to abate and savvy Treasury traders bid up long-dated bonds in anticipation of a drop in short-term rates).

Anyway we all know the story now, but thanks to Mish and others of the Austrian school of economics (Ron Paul, Peter Schiff, Prechter, Marc Faber, Jim Rogers), a large segment of the internet-using public was forewarned. I single out Mish here for praise because he has arguably the best record of anyone for calling the shots since 2007.  Of course he was bearish on stocks going into the crash, but as a deflationist he was also bearish on commodities and foreign stocks and currencies, as was Prechter. Like Prechter, Mish called for a turn in the stock market early in 2009, though Prechter has been more prescient in anticipating its duration and magnitude. Mish was bullish on long-term Treasuries in 2008, when Prechter’s EWI was not, and I was glad to be on his side there.

Where Mish has really stood out has been in his understanding of gold. He has always said that gold is money, and he correctly anticipated its strength during deflation. I understand that this may have come from reading or reading about Professor Roy Jastram’s “The Golden Constant,” a study of 400 years of gold’s purchasing power during periods of inflation and deflation under both gold standards and fiat regimes. Jastram’s conclusion is that gold decreases in real value during inflations and increases in value during deflations — in effect, it acts like money. Now, Prechter has always said that gold is money, and he has always recommended holding gold and silver for the depression, since it is likely that the fiat system breaks down in the advanced stages, but he has failed to anticipate that the precious metals bull market would power through these first years of deflation (though he did anticipate the latest manic phase this fall after gold broke upwards in September).

Now solidly over $1200 per ounce, to my eye the gold market looks like a full-blown mania. DSI bullishness has been over 90% for a month now, and has been over 70% for much of the last six months. There have been no significant corrections. Every commercial break on cable TV seems to have an ad from one bullion dealer or another, and former Nixon plumber G. Gordon Liddy is touting it. That said, even if this parabolic rise is followed by a crash of $300 or $500, gold will likely still be leagues ahead of every other asset class since 2007 or 2000 (if gold hits $700, I bet the S&P will be 700 and oil will be $35 again). It truly is acting like money, high-powered, robust money, and it should continue to increase in relative terms even faster if credit strains worsen, as I think they will in 2010 and 2011. And as the US and other governments proceed in the following years to destroy their currencies through continued war and Keynesianism/Socialism, it will truly be a life-saver.

In addition to his excellent market analysis, Mish deserves our thanks for his consistent efforts to fight the bailouts and other thievery and stupidity in Congress. He has also no-doubt played a strong role in advancing Ron Paul’s bill to mandate an audit of the Federal Reserve and to defend it from those who would water it down.

Mish’s success goes to show the power of a geek with broadband connection. Since the formal education system and old news media have become propaganda outfits for the political and corporate parasite classes, if there is any hope for capitalism and a free and prosperous future, it lies with independent nerds.