This page has been archived and commenting is disabled.

Rethinking the Inflation vs Deflation Debate

Expected Returns's picture




 

From Expected Returns Blog

The inflation vs deflation debate is one fraught with biases, misnomers, and rigid positions. What I've noticed is that both inflationists and deflationists selectively handpick data to support their respective positions. This is fine and dandy if your goal is to win an argument; but if you want to win as an investor, you must unemotionally interpret data.  

If I had to, I could make a convincing argument in either direction since we are seeing both inflationary and deflationary forces. I don't believe there is much debate on this point. However, the successful investor doesn't tell you what is happening right now. The successful investor is constantly trying to foresee future events using a Bayesian approach to investing, incorporating data on an ongoing basis to adjust forecasts if necessary  

Interest Rates

At the very core of the inflation vs deflation debate are interest rates. Unfortunately, most people misunderstand the relationship between interest rates and inflation.

Interest rates are driven primarily by inflation expectations and default risk. This implies that interest rates can both rise and fall with good reason in both inflationary and deflationary environments. In other words, the relationship between interest rates and inflation isn't so simple as to say lower interest rates equals higher inflation or vice versa.

Inflationists will tell you that low interest rates are inherently inflationary. At the very core of this argument is the fact that low interest rates will induce borrowing, and by extension, speculation. To support their argument, they will show you a negatively correlated inflation and interest rate chart like this:

 

Deflationists will tell you low interest rates not only evidence deflation, but muted inflation expectations. To support their argument, they will show you a positively correlated chart like this:

 

 

As you can see, both deflationists and inflationist can point to statistically and historically valid data to support their respective arguments. Unfortunately, both sides are guilty of showing just a snippet of the overall picture. The inflation vs deflation debate is far more complex and goes well beyond just interest rates.

 

Money Supply and Inflation

Let me preface the following statement by saying I lean heavily towards the Austrian camp. However, there isn't a strong correlation between money supply and inflation in the short-term. This is key to understanding why a hyperinflationary collapse didn't materialize last year when money supply went through the roof.

In the early stages of inflation, money supply often outpaces inflation by many multiples. This was the situation in the Weimar Republic before their hyperinflationary collapse. The following charts taken from Constantino Bresciani-Turronis seminal text about the Weimar hyperinflation, "The Economics of Inflation", makes this relationship clear.

 

 

 

 

 

 

 

Notice that in the early stages of inflation, money supply outpaced domestic prices, import prices, and the dollar exchange rate. However, the situation in the Weimar Republic quickly deteriorated to the point where money supply, domestic prices, import prices, and the dollar exchange rate had a near perfect correlation. The public lost confidence in their currency and prices essentially "caught up" to money supply.

 

In 2009, Ben Bernanke cranked up the printing presses and the money supply expanded at an unprecedented clip, yet there was no hyperinflation. Inflationary forces were certainly concentrated in certain sectors, such as stocks, but on a broad scale, inflation was muted.

 

 

Recently the trend in money supply has reversed. According to John Williams at shadowstats.com, M3 is contracting at the fastest rate on record. This is an apparent victory for the deflationists, right?

Not so fast.

Dollar Exchange Rate

I believe the number one driving force of inflation moving forward will be the dollar exchange rate; and I believe the the loss of confidence in the monetary system as currently structured will lead the dollar down. History shows that the truly monster currency moves are driven by public confidence.

Remember, it was only a year ago that the Euro was the safe haven currency of choice for investors. The recent collapse in the Euro is correctly blamed on the debt crisis in the PIIG nations. However, the debt problems in the Eurozone were well known for years. The only thing that changed was perception.

Perception is the only thing propping up the U.S. dollar. Europeans thought they could waddle through their debt problems unscathed until, well, they couldn't. Americans are similarly inflicted with the head-in-the-sand disease that ignores large-scale funding problems similar to those seen in Greece. The dollar will continue to profit from safe haven capital flows until, well, it doesn't.

Swings in the dollar, and by extension inflation, will be sudden and dramatic, mirroring the confidence of investors. It will therefore benefit people in both the inflation and deflation camps to rethink their respective false assumptions. The fundamentals for dollar weakness have been in place for some time; it is now time for the market to recognize it.

 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Fri, 06/04/2010 - 13:09 | 395160 RickAckerman
RickAckerman's picture

The inflation/deflation debate gets a lot of play on my site and I've been banging the drum on this issue for quite some time. I'm in agreement with Ron Hera: firmly convinced deflation is here and will get worse:

 

http://www.rickackerman.com/2010/06/no-escaping-deflations-fatal-drag-on...

Thu, 06/03/2010 - 23:21 | 393636 trav7777
trav7777's picture

Ok...there are several points missing in most commentary here.

The first is that we are in the midst of monetary deflation.  The metrics show this as inarguable.  We are facing an inescapable deflation spiral caused by the fact that as outstanding credit goes away via repayment/default, the compound interest component of existing debt places an exponentially increasing parasitic drag on the money supply.

This is an easy situation to illustrate:  You have borrower A borrowing $100 at 5% simple interest for one year from bank B.  The terms of the loan specify that ONLY dollars may extinguish the debt.  The loan is in functional default as soon as it is made UNLESS another borrower expands the credit/money supply to account for the need of $105 at EOY1.  A must roll his loan, but in doing so, he creates a compound interest obligation which eventually requires interest payment of the ENTIRE $100 after sufficient years.

Yes, it really is this simple.  The government is fighting the urge of the system to deflatively collapse by borrowing money from the Fed (QE) that can only be repaid by rolling ever-more credit, geometrically.

This system worked so long as the aggregate system had growth, more productive output, more people doing more things, all requesting more creditmoney to do it with.

That is the deflation aspect.

On the flipside, what appears to be inflation is not monetary in nature.  It is as a result of DIMINISHING real supplies of energy and declining EROI.  The return on energy invested is astoundingly LOWER now than it was 100 years ago.  Energy supplies we are exploiting are requiring more energy invested...the net return on energy invested is lower.  This means that there is really less energy for more people to try to do more things.

Against this backdrop, the physical supply rates of various commodities are at or have already peaked.  Gold peaked in supply in 2000.  Helium in 2002.  Oil crude & condensate made a peak in 2005, with an all-liquids peak in 2008.  All-liquids is a bit misleading because it includes nonconventionals and shit like ethanol.  But what most people *do not* know about things like tarsands, is that they require massive amounts of NG to be burnt in order to mobilize the bitumen and massive mining and processing facilities to turn it into oil.  The necessary implication of this is that these reserves return far LESS energy on energy invested than do the old conventional fields.  Biofuels may in many cases be net negative in EROI.

High EROI fields were the first to be exploited, high ROI gold reserves went first, high ROI *everything* went first just as the first apples to be picked from a tree are the *lowest* hanging fruit.  Now that fruit is all gone.

We are in system facing terminal supply decline in a number of critical commodities.  Silver, too, appears to have met a production plateau.  What this is telling us is that growth has stopped.  We cannot mine more gold than last year, pump more oil than last year. 

So, less people will be doing less things.  This means deflation in credit but at the same time an increasing climate of *scarcity* of essential physical commodities.  Things which are *not* in supply decline, such as houses or cars, things conjurable into existence via manufacturing, WILL decline in price.  Things NOT conjurable will not.  Any commodity whose supply rate has peaked will hold ground, those whose supplies have not peaked will lose it against a "scarcer" dollar.

This is the source of the paradox we see.

Fri, 06/04/2010 - 01:04 | 393778 jdrose1985
jdrose1985's picture

A lot of people are needlessly being thrown for a loop here. This is very basic, common sense stuff.

 

The question that intrigues me most is will resource demand fall faster than supply once credit deflation really becomes "evident" ie people no longer have access to credit or at least cheap credit in real terms with which to consume resources?

Does exponential math begin to feed on the unfunded liabilities at a pace greater than we exhaust resources, thereby driving down  resource prices even faster?

Is a "permanent" recession in the cards for us? Yes, I think so. The only way I see growth emerging from this is from a much lower global population. This thought has been bothering me a lot lately. 

I'm not sure it is a great idea for me to bring children into the world at this point. My wife is ready to have children but can I bring myself to put this future upon a child? Only time will tell.

I think the answer to nearly everything all hinges on input costs (oil) now that credit metrics are indisputably going negative.

In an environment of "life backwardation" such as Trav aptly named it there will theoretically be more gold available to each individual as not much gold is consumed. Just food for thought.

Fri, 06/04/2010 - 14:55 | 395488 moneymutt
moneymutt's picture

people have brought children into the world in all sorts of rough and turbulent times and they often are just fine...my parents were kids during depression and then a world war and had very poor but happy childhood...those were scary times, especially for people in Europe and Japan - in war zones but still kids do pretty well, even if they will have much less than us, they will be used using water and energy more conservatively. You worst fears may be realized but things may be a whole bunch better also. Besides, if wife wants kids, your choice is clear :) Just morally, I think adoption is a consideration, as you meet your interest in having kids, help some kid(s), and do not add load to the world. Best of luck on such a tough decision.

Fri, 06/04/2010 - 00:13 | 393731 moneymutt
moneymutt's picture

not sure if I agree with peak oilish supply side concerns, but I'll focus on something else, what about demand side. Electricity use in US is down due to deflation/credit collapse here, many coal fire plants are idled. So...what happens if defaults rise, economies of worlds constrict, even if supply is decreasing, demand will also be decreasing...even if if energy/commodity costs become a bigger percentage of our household budgets...

 

Fri, 06/04/2010 - 00:52 | 393783 jdrose1985
jdrose1985's picture

Moneymutt, you should head over to the oil drum, plenty of info over there to help you decide one way or the other.

Thu, 06/03/2010 - 22:43 | 393541 Iam_Silverman
Iam_Silverman's picture

Thanks for the new way of looking at the economic future.

One thing that always concerns me is that everyone seems to try make predictions based on the last major depression.  So many things have changed since then, I am not sure that the painful lessons learned during that time may all still be valid.

Case in point - one of my latest reads was the great tome "The Great Depression, A Diary", by Benjamin Roth.  It seems lilke I undergo one case of deja' vu after another while re-reading certain chapters. (I also just finished a 70's version of Ruffs "Surviving the Coming Inflation" and Prechters first (2001?) version of "Conquer the Crash, You can survive and prosper in a deflationary depression".

 

Any way, one comment from the depression diary made me think.  Mr. Roth stated "no-one has any money to spend".  But to go beyond the quote, he was referring to the fact that in many cases the money was tied up within the bank and just plainly not accessable.  Nowadays, who carries cash?  We have debit cards and all of our money is (supposedly) safely insured by the bankrupt FDIC.  Things were so bad that he described how a passbook could be bartered and used for purchases - at a discount of course.  Our general public just no longer revolves around bearer instruments - we have gone cashless.  Other considerations should be made too - we were on the gold standard during that time, we had a manufacturing base, most economic transactions benefitted the micro-local economy for the most part (no WalMart or other international chains) and finally, we were a net producer of petroleum, so the dollar/oil peg wasn't there to prop up our currency on an international front.

 

Do these things matter?  I don't know - but I hope that all of you here with a better understanding of this can relate to me how these things have already been factored into your decision on the prediction of inflation/deflation.

 

As for me, I have hedged both ways.  PM's, cash, long shelf life foods, ammunition, barter tools and lots of books to read for when the volcano blows up and it is dark all day!

Oh, and the one thing that lets me sleep soundly at night - I am completely debt-free.

Fri, 06/04/2010 - 01:08 | 393806 jdrose1985
jdrose1985's picture

Thanks for the post, silverman. I wil definitely check out the Roth book. Reading Grapes of Wrath right now myself. Also experiencing some deja vu.

Nothing wrong with being hedged every which way to Sunday and debt free. I am the same way to a T.

Thu, 06/03/2010 - 19:18 | 392998 LeBalance
LeBalance's picture

If the world's supply of $ is $1000 and I print up $1000, I have just stolen half of all the purchasing power over time.  I pay for my cocaine and hookers upon your back.  This is debasement of the currency and the stated punishment in the CONstitution is Death.  You can see why.

If your total worth is $1M and the total supply of credit is $100T and I print up $10T I have just stolen 10% of your entire worth over time.

If you leave your worth in fiat based assets of any type you are a willing victim.  If you can't see that they are printing $, Euro, Lira, foofoo's and poopoo's, out the yingyang well then you aren't watching.

http://www.sjsu.edu/faculty/watkins/hyper.htm

Q.E.D.

Thu, 06/03/2010 - 19:39 | 393051 ozziindaus
ozziindaus's picture

If the world's supply of $ is $1000 and remains $1000, forget about entrepreneurship, innovation and the general expansion of society. This is feudalism. I don't agree with out of control credit expansion but there is a happy medium somewhere. Neither do I agree with the boom-bust cycles but who was complaining during the party days?

Thu, 06/03/2010 - 21:35 | 393370 LeBalance
LeBalance's picture

/Sheesh/

I responded to your comment:

"If the world's supply of $ is $1000 and remains $1000, forget about entrepreneurship, innovation and the general expansion of society."

and refuted it, with reference.

http://www.zerohedge.com/article/rethinking-inflation-vs-deflation-debat...

Do you wish to respond?  All I can do is attempt to show you that credit is death, expansion of money supply is death, etc.  What say you?

Fri, 06/04/2010 - 07:03 | 394071 LeBalance
LeBalance's picture

You are done.

Fri, 06/04/2010 - 13:24 | 395195 ozziindaus
ozziindaus's picture

Sorry, i had to step into my regular job. I'll take some time to respond in a sec.

Thu, 06/03/2010 - 20:34 | 393214 FEDbuster
FEDbuster's picture

Then the government should pass "Stimulus 2" where every man, woman and child with a valid social security number receives a $25,000. Visa debit card with a one year expiration date.  Can't be used to pay down debt, purchases only.  That way instead of the government deciding how all the new money is spent, individuals can go on a shopping spree with this deflation prevention plan.

BTW, my two teenage boys already have the money spent, will take about two days to zero out the cards.  It will be kinda like this:

http://www.comedycentral.com/videos/index.jhtml?videoId=24406&title=repa...

Thu, 06/03/2010 - 20:53 | 393267 ozziindaus
ozziindaus's picture

Your Stimulus 2 program will have a two prong effect. 

  1. It would immediately raise prices (dollar depreciation) which, so long as the money remains in existence, would artificially create inflation.
  2. It sends an artificial trigger to commerce to reinvest in non productive venture which BTW got us here in the first place. 
Before you know it, we're worse off than where we were. It's debt that needs to be settled.

Thu, 06/03/2010 - 21:21 | 393334 FEDbuster
FEDbuster's picture

Half of it would go to China and the OPEC nations, who would just lend it back to us (fool me once...).  The other half may move around for awhile in the economy.  Why should Obama and Co. have all the fun of being the first beneficiary of the newly "printed" money?  I know that bailing union pension funds and paying for people's healthcare can buy a few votes, but maybe some of the $25K card recipents will thank them with their votes, too.

As long as the rest of the world keeps wanting our FRNs, let the general population have the fun of spending them.  Kick that can way down the line and party like it's 1999.

Thu, 06/03/2010 - 21:25 | 393348 jdrose1985
jdrose1985's picture

From the vantage point of a store owner, how would you price your goods in this situation?

Interesting line of thought...

Thu, 06/03/2010 - 21:41 | 393392 FEDbuster
FEDbuster's picture

Same as you price them now.  Based on supply and demand, competition, etc...  If you are selling the latest X-box game systems and games mark em up because my boys are coming.  If you are selling $1,000. used cars, business might be slow for the near future.

Since money printing doesn't matter, "Stimulus 2" is the go large and go wide plan we need.  The 125% HELOC was limited to the select few who owned a home (unfair advantage in Barney Franks mind),  with this plan Octomom gets fifteen $25K cards.  If we are going to go down, let's all have some fun for the next couple of years.  Government shouldn't have all the fun.  Let's make this Christmas season one to remember pass Stimulus 2!

Thu, 06/03/2010 - 20:20 | 393178 LeBalance
LeBalance's picture

A static money supply, based on faith, is the start.  Then no one can corner the market on the asset which backs it.  With the money static, saving is required in order for purchase of anything and investments must be well considered.  As one has to tighten the belt to make a purchase of innovation, consumption decreases for a time, proportional to that savings rate.  Then that improvement is purchased (let's say it worked) and the price of a certain good decreases.  That is the benefit of innovation.  The money supply remains exactly the same forever, but by saving and spending wisely (or not), inflation never happens.  Prices decrease as costs of manufacture decrease due to innovation.

There are no business cycles under this system.

In this model the Leech is not present.  But in society the Leech is present.  So I am sorry to say that the War between Leech-Banking and Non-Leech-Banking continues unabated.  Just now and for many years we have been under the Leeches.

For further reading please refer to Ludwig's Site Mises.org and especially to Huerta De Soto's Money, Bank Credit, and Economic Cycles.  It is all laid out in gratuitous detail.

Fri, 06/04/2010 - 14:12 | 395366 ozziindaus
ozziindaus's picture

It is well known that a static money supply is too restrictive for expanding economies. It adds an additional unique problem to the US since the US bares the burden of issuing the reserve currency of the world. A gold standard is one such restriction that has proven to be deficient in a global environment.

I think that is key here. We're not talking about 19th century economics but the complex macro geo political situation we have been in for the past 100 years which exploded after Bretton Woods. Ironically, the BR agreement was doomed to failure at signing.

What a credit based economy allows, (creation of money or inflation), is to pull future demand into the present. Alternatively, it allows production in the present for future consumption. This can not occur, or at least not efficiently, under a static money supply relying on savings alone since it rewards corporations with capital reserves and punishes those without it. That's why I implied that it stifles competition which is mainly driven by innovation and creativity. I agree with the deflationary effects of innovation as you noted but that was not my point. Steve explains this well above. 

I know the history of the US where the gold standard and other governmental interventions restricted the money supply for 200 years prior to 1913. This had the effect of keeping inflation (by definition) low but also had the effect on retail price inflation turning negative (deflation due to improvements in technology and supply). Worked well but that’s not my argument. I argue that it can not work in this global environment.  

But let’s take your theory globally. Let’s say there is a strict and finite US dollar supply in which the whole world must hold as reserves for purchases of dollar denominated assets and debt servicing. By virtue of these simple rules, you have just given a major advantage to anyone who holds the dollars at any time. By the same measure, you have put the remaining “serfs” at the mercy of those who can provide the credit. That’s Feudalism.

I might also add that since your system restricts the money supply, banks cannot lend under the same multipliers but instead at a 1:1 reserve ratio. Governments do not create money and neither does the FED. Banks create it, or more technically, YOU create money by demanding credit from the banks.

Don’t get me wrong, I’m not in favor of runaway inflation or unsustainable business cycles but a “notional” gold based money supply or any other with strict restrictions on expansion is equally detrimental to commerce.

All your points are valid and I wish more people adhered to these simple principles and morals within their daily lives but I bet you’d change your opinion quickly if it was forced upon you.

 

Fri, 06/04/2010 - 14:31 | 395421 moneymutt
moneymutt's picture

ozzi - nice analysis

Thu, 06/03/2010 - 19:12 | 392964 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

Boobflation!

This is looking so bad.....I find it amusing that the oligarchs are betting on Hollywood to save their sinking ship.  Fuck them financial pirates!  They ain't getting mine or yours!  Creativity is the essence of the soul; the oilgarchs lack!  'Nuff said.

Thu, 06/03/2010 - 18:53 | 392933 steve from virginia
steve from virginia's picture

 

There is inflation, then there is ... inflation. Right?

Ordinary inflation is an artifact of commercial activity. Commerce expansion funds itself by lending money into existence. As the market for goods increases the amount of funds also increases alongside so that the individual purchasing power of each unit of funds is proportionately diminished. This diminishment in currency value is also inversely proportionate to the increase in the overall value of the commerce being funded.

In other words, as the value of commerce increases, the purchasing power of currency that is used in that commerce decreases proportionately. You have valuable commerce or valuable money, not both at the same time.

Along with market expansion, the type and utility of goods is also increased so that the purchasing power lost in the expansion of the money supply is offset by the increasing utility of the goods. The dollar has less unit purchasing power than did its 1913 gold counterpart, but the 2010 dollar buys goods and services unthinkable of in the earlier period.

Ordinary inflation is the cow pie of progress. As the value of commerce increases in value, the value of money declines and becomes negative. This 'negative' currency value relative to the expansion of commerce is the measure of inflation. As commerce expands by a certain amount, money value declines by the same amount. Inflation is simply big word for growth.

Currently, money authorities are trying to 'reverse engineer' commercial activity by cheapening currency. They can only do this relative to other currencies since promoting commerce is a long term activity subject to inputs of all kinds. Commerce is really a dead duck because of very high input costs.

When commerce diminishes the currency that would be the proxy for it becomes a proxy for something else such as an input. Ordinarily, commerce is far more valuable than any of commerce's inputs. Not so, now. Inputs have become so expensive that commerce is unprofitable so the currency becomes a proxy for the input, in this case crude oil.

Early in the Great Depression, currencies became proxies for gold. Commerce was abandoned in all the advanced countries except in Japan which abandoned the gold standard in the 1920's. Currency arbitrage substituted for normal business activities.

This is also the case now. Currency arbitrage in all its forms has become the substitute for otherwise unprofitable commerce. The dollar/crude peg makes the dollar a defacto hard currency. Note the dollar and 'liquidity' shortages world- wide. People hoard (save) hard currencies making them scarce. As they become more valuable those who sell goods for dollars will accept nothing else. The process amplifies itself. The outcome is a vanishing dollar.

What about central bank printing? Surely that would increase the dollars in circulation?

Adding dollars to circulation without first restructuring the gigantic debt overhang would simply put more dollars into the bank vaults and safe deposit boxes of those with 'first access' to dollars. An outcome of this would be the acceleration of deleveraging to the point where it becomes chaotic. Let me be clear, the Fed is constrained as obvious money printing would trigger 'runs' on any securities that could be changed for dollars. Instead of adding liquidity, the effort would starve liquidity as there are far too many unstable debts for the Fed to 'service' regardless of how fast it prints. Printing would be the invitation to panic and the Fed would be overrun.

A 'subtle' printing scheme would have similar results. Any dollars escaping the liquidity traps would pour into crude oil and other 'investments' to successfully unwind teetering ponzi schemes in these markets. Crude prices would rise rapidly to crash the real economy and destroy commercial demand for crude.

It's deflation and no end to it. The Austrians will all cry in their beer when five years passes with massive deleveraging and debt defaults and the world's chances for recovery worse than they are now. The annoyed public can hang the Austrians next to the Wall Street barons on alternate lampposts, they will look good together.

Thu, 06/03/2010 - 23:32 | 393666 trav7777
trav7777's picture

I dunno why you'd want to hang Austrians, Steve.

Nothing any banker can do will reverse an oil well once it passes peak.  This immutable fact is wise for everyone to make peace with.  The laws of physics rule.  Mother Nature bats last and she can read your pitches like she hacked into your brain.  They're going into the cheap seats and there's nothing you can do to stop it.

Your hard dollar concept is an interesting theory with one inescapable conclusion:  as oil supply declines, the amount of dollars in supply must also decrease for the hardness to be maintained.

This is at DIRECT odds with the funding needs of heavily indebted entities such as the US Gov't.  Deflation will destroy them.

Debt, as an institution, has reached an inflection point.  Life is now in backwardation, real things now trade for a higher real price than promises of the same things in the future because the future holds less things.

At some time in the not-too-distant future, a collective Point of Recognition will be achieved and debt-based monetary systems will spontaneously collapse.  This will be the hyperinflationary event, essentially a repudiation of all confidence.  The government may very well need from a balance-sheet perspective to do what FDR did, and effect a brute force devaluation, revaluing the oil peg as it did the gold peg in 1933.  It will be of no avail.

Nothing can stop oil supply from declining once Peak is hit.  The only way to restart growth is for a new, growable energy supply to be discovered, such as sustainable fusion.

But for those gloom & doomers planning to barter ammo, just remember, life goes on.  Find some meaning within yourselves that does not revolve around money.  Like Christianity or not, Paul was correct.

Thu, 06/03/2010 - 23:57 | 393718 jdrose1985
jdrose1985's picture

Like Christianity or not, Paul was correct.

A fool and his money are soon parted. You can't take it with you.

+1

Thu, 06/03/2010 - 20:24 | 393194 ozziindaus
ozziindaus's picture

Well put Steve. Learnt a ton. Keep it up and please post a link to your blog. 

Thanks

Thu, 06/03/2010 - 21:23 | 393346 jdrose1985
jdrose1985's picture

http://economic-undertow.blogspot.com/

Also you can see some of his commentary at the oil drum

Thu, 06/03/2010 - 20:18 | 393170 taraxias
taraxias's picture

I'll keep it real simple for you. In fiat monetary system, DEFLATION IS A MYTH.

Thu, 06/03/2010 - 19:39 | 393053 jdrose1985
jdrose1985's picture

Love your commentary, Steve. Also your blog.

Folks here are about to be blind sided, unfortunately.

Thu, 06/03/2010 - 18:15 | 392843 redbud
Thu, 06/03/2010 - 17:50 | 392773 ozziindaus
ozziindaus's picture

Completely bias report with the use of such terms like "printing press" and "the fundamentals for dollar weakness have been in place for some time; it is now time for the market to recognize it."

The printing press statement is as genuine as any individual asking a creditor for a secured loan without providing any security. Completely false, misunderstood and overused term. The rapid rise in M1 in 2009 was pure liquidity injections secured against "real" assets and by the full faith and credit of the US government. You can despise your leadership but don't discount it's power. The equity market rally from March 2009 was not due to the "printing press" but more as a result of natural market psychology. This pattern has occurred many times before. 

Bond markets dictate the interest rates and as you correctly stated, "interest rates are driven primarily by inflation expectations and default risk". In our current environment, the low interest rates are mainly due to uncertainty in the equity markets or other hard assets such as corporate/municipal bonds and RE. This explains the simultaneous gold price buoyancy. 

On the subject of hyperinflation, another overused and misunderstood term, the factors driving this phenomena are not purely based on the money supply. Sure if every bank account was credited a few hundred grand without any provision to pay it back, then yes that would result in an immediate case of hyperinflation. But you have to ask yourself why this occurred. Such an event will only occur once the system breaks down. So hyperinflation must involve a situation where the masses lose complete confidence in the financial system and government. The US having the burden of issuing the reserve currency of the world must uphold their promise to maintain the dollars value whether they like it or not. There are too many international forces preventing a total collapse of the dollar. 

But what we are experiencing today is something unique. We have low interest rates yet no one can or is borrowing and therefore the money supply (inflation) can not be expanded through the credit windows. This will last as long as there is debt default or as soon as the banks start lowering their lending standards. Two situations unlikely to occur anytime soon. 

Thu, 06/03/2010 - 23:56 | 393713 moneymutt
moneymutt's picture

nice, good points....and I'm still stuck on globalness of our situation, which to me, makes hyperinflation less likely, at least initially. Politicians tend to lean toward inflating when they have to choose people pissed off debtors at home and pissed off creditors abroad....but what if foreigners are defaulting on us at same time we are defaulting on them?

Thu, 06/03/2010 - 17:43 | 392762 RSDallas
RSDallas's picture

Nobody explains it better than the Hoisington team.  Check it out at:

http://www.hoisingtonmgt.com/pdf/HIM2010Q1NP.pdf

 

Thu, 06/03/2010 - 17:14 | 392727 exportbank
exportbank's picture

I have a summer place in Canada and spend 4-months in that wonderful country. My property taxes arrived today - UP 6.1% then this afternoon Ontario Hydro arrived and installed a "smart meter" - they assured me that my costs won't go up as long as I don't heat, cool or wash during the daytime peak hours BUT Ontario Hydro coupled with a new tax and a green fee is adding 22% to the cost of electricity on July 1st. Then we have a new HST (harmonized sales tax) starting July 1st that the Bank of Canada says will add .6% to inflation. Cable TV has shot up, the cost of water and sewer has increased by over 15% - I keep looking for deflation in my life - I'm not in the market for a house in Florida and I don't need a new cheap laptop everyday. Oh, I forgot to mention the cost of groceries.

Thu, 06/03/2010 - 23:48 | 393697 moneymutt
moneymutt's picture

Canada is doing much better than US economy right now...you are seeing increase costs cause your housing has not deflated (yet) and your commodity based economy is making good money right now, but also high cost of commodities along with still good demand makes energy etc expensive.

Electricity use in US is down over last two years, many coal plants are being idled...doubt that is happening in Canada...C will like follow our path, but right now you are mix of US 2005 and early 2008, high housing, high commodities, but still pretty decent economy...just wait, things will get cheaper when you break like a stick like us...

Thu, 06/03/2010 - 17:46 | 392767 RSDallas
RSDallas's picture

Rates everywhere are skyrocketing as a result of the anticipated crap and tax scheme gets touted by the current US regime.

Thu, 06/03/2010 - 20:16 | 393164 FEDbuster
FEDbuster's picture

The morons (voters) here in AZ just passed a three year 18% sales tax increase on themselves bringing our rate to about 9.5% depending on the local portion.

Property values have fallen by 40% from the peak, but they will raise the multiplier to insure the tax revenues don't fall.  Government at all levels will be desperate to steal money from the citizenry by any means possible. 

Thu, 06/03/2010 - 16:59 | 392699 jdrose1985
jdrose1985's picture

Read Fed Z1 report

http://www.federalreserve.gov/releases/z1/Current/data.htm

 

this is not rocket science. this is not brain surgery. this is econ 101.

 

 

Thu, 06/03/2010 - 16:45 | 392683 Gully Foyle
Gully Foyle's picture

With pictures, graphs and charts, oh my.

http://www.businessinsider.com/into-the-abyss-the-cycle-of-debt-deflatio...

Into the Abyss: The Coming Cycle of Debt Deflation

Ron Hera

One of the most famous quotations of Austrian economist Ludwig von Mises is that “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

In fact, the US economy is in a downward spiral of debt deflation despite the bold actions of the federal government and of the US Federal Reserve taken in response to the financial crisis that began in 2008 and the associated recession. Although the vicious circle of debt deflation is not widely recognized, precisely what von Mises described is happening before our eyes.

Thu, 06/03/2010 - 17:57 | 392789 dryam
dryam's picture

Most of the money supply comes from debt in a fractional reserve banking system.  The system inherently needs to always move in the forward direction.  When the banks are lending a deposit of $x can expand the money supply 20-30x. When the banks stop lending a deposit of $x can shrink the money supply 20-30x (negative multiplier effect).  Real estate is the worst asset class for a bubble.  It's typically the biggest purchase in everyone's life.  People buy real estate with a lot of leverage.  Banks are inherently leveraged; it's leverage upon leverage.  The losses have been huge to say the least (no one really knows because the government wants to keep it secret).  It only takes a small % of bad loans to put an over leveraged bank out of business (in the real world).  The banks have not recognized most of their losses.  They are still marking-to-fantasy.  By all accounts the real estate has another 20-30% to drop.  25% of home "owners" are underwater.  We haven't started talking about CRE.  So, this all tells me the overall money supply has dropped an unthinkable amount (tens of trillions?).  Once things start deflating it's then a big deflationary spiral with asset prices going down.  I'm on the side of people that think that Bernanke has actually underestimated how much money he thinks he needs to print (btw, no matter how much money he prints, you can't push on a string).

Who is borrowing from the banks?  Credit is evaporating.  I see the fractional reserve banking system clearly moving backwards.  I own a lot of gold, but I'm also holding a lot of USD's for the deflation that I see coming in the money supply over the shortrun.

Thu, 06/03/2010 - 23:44 | 393691 moneymutt
moneymutt's picture

agreed, is your name Mish? he also sees credit collapse shrinking money (credit/debt) being deflationary, cash being strong in short term but still like gold.

Thu, 06/03/2010 - 19:30 | 393026 ozziindaus
ozziindaus's picture

Right on. 

Thu, 06/03/2010 - 21:12 | 393297 dryam
dryam's picture

Hugh Hendry - paraphrasing "there is a shortage of dollars", "what if the $50 trillion of debts outstanding is U.S. is not matched by $50 trillion in assets if the assets have now lost value"

http://www.youtube.com/watch?v=owH4vyyCeSA&feature=related

Thu, 06/03/2010 - 17:45 | 392764 redbud
redbud's picture

I think the crisis will end up a slow slide as the result of voluntary abandonment of credit expansion. By states, companies, students, consumers, and finally the federal government.

Responsibility requires budget-cutting. Over time, Americans will act more responsibly and we will have deflation.

Though folks say deflation punishes savers, a lack of inflation helps incomes and savings go farther.

American ingenuity will prevail. Collapsing time or costs is a proven business value. 

 


Thu, 06/03/2010 - 23:02 | 393590 trav7777
trav7777's picture

If you believe that then you don't understand the nature of debt.

Debt has an interest component.  If the money supply does *not* expand, then interest claims begin to exponentially become a larger and larger share of the eating away of the aggregate monetary base.

Without *additional* lending at beyond the prevailing interest rate, the money supply death spirals.

It would behoove EVERYBODY to understand what we who speak of this mean by it.  ONLY growth in credit can prolong the system and it is *required*, not optional.

Austerity means a monetary collapse.  Via deflation.

The ONLY way to stop this if credit cannot or will not grow is via brute force devaluation.  In the end, the deflation and inflation arguments end in the SAME PLACE.

That is why I do not understand why people fight over this.

Thu, 06/03/2010 - 23:41 | 393685 moneymutt
moneymutt's picture

what is the same place, currency had less buying power?...

I agree with your debt analysis, but when a debt bubble bursts, doesn't that mean assets get cheap, cash is king?

Also, I really wonder about the global thing. An individual country that is in big debt to mostly foreigners can default, by stopping payment, or by inflating their currency, if the debt is in their currency. If the debt is not in their currency, like say the owe dollars instead of Kroners, then they default.

So in this case, Iceland real estate, cost of labor etc deflates, but cost of anything imported increases. Zimbabwe defaulted on foreign debt by inflating their currency, it was harsh, but then voila, no external nor internal debt, and voila, they had jubilee and now are doing okay. There is also Argentina, had deflationary crash and then currency lost value compared to imports.

But WTF happens if the whole world has debt bubble more or less burst at same time....sure it will be somewhat rolling, but not over many years, but more like in 6 months to a year at best, just as currency fluctuations that took two years now happen in weeks. So whole worlds debt defaults essentially all at once...what happens?

 

Thu, 06/03/2010 - 18:55 | 392939 jdrose1985
jdrose1985's picture

Though folks say deflation punishes savers, a lack of inflation helps incomes and savings go farther.

Whoever says this must be comedian. You may have 0% Fed Funds Rate and if CPI growth is negative 4% you have 4% real interest rate. People are too funny when they fail to think outside of box.

Now fire up that bowl, son.

 

Thu, 06/03/2010 - 16:33 | 392661 Mitchman
Mitchman's picture

Query:  Since the computation factors of CPI have changed over time, which version are you using for tracking the 10-year?  Clearly, the Reagan era CPI might give a different result than the current version.

Thu, 06/03/2010 - 23:32 | 393664 moneymutt
moneymutt's picture

good question..Mish has a nice alternate to CPI that includes a better more accurate component for increase in the cost of housing..

Thu, 06/03/2010 - 16:14 | 392618 bull-market_3.0
bull-market_3.0's picture

um

the years for Diagram 1 go 1913,1914,1915, 1912, 1918

wtf?

Also Diagram 2 says "1913-1" which doesn't look like what happened in diagram 1. What's going on?

Do NOT follow this link or you will be banned from the site!