Guest Post: Why I Still Fear Inflation

Tyler Durden's picture

Submitted by John Aziz of Azizonomics

Why I Still Fear Inflation

Paul Krugman wonders why others worry about inflation when he sees no evidence of inflationary trends:

Joe Wiesenthal makes the well-known point that aside from certain euro area countries, yields on sovereign debt have plunged since 2007; investors are rushing to buy sovereign debt, not fleeing it. I was a bit surprised by his description of this insight as being non-”mainstream”; I guess it depends on your definition of mainstream. But surely the notion that what we have is largely a process of private-sector deleveraging, with government deficits the consequence of this process, and interest rates low because we have an excess of desired saving, is pretty widespread (and backed by a lot of empirical evidence).


And there’s also a lot of discussion, which I’m ambivalent about, concerning the supposed shortage of safe assets; this is coming from bank research departments as well as academics, it’s a frequent topic on FT Alphaville, and so on. So Joe didn’t seem to me to be saying anything radical.


But those comments! It’s not just that the commenters disagree; they seem to regard Joe as some kind of space alien (or, for those who had the misfortune to see me on Squawk Box, a unicorn); they consider it just crazy and laughable to suggest that we aren’t facing an immense crisis of public deficits with Zimbabwe-style inflation just around the corner.

Krugman, of course, thinks it crazy and laughable that in the face of years of decreasing interest rates that anyone would believe that inflation could still be a menace. In fact, Krugman has made the point multiple times that more inflation would be a good thing, by decreasing the value of debt and thus allowing the private sector to deleverage a little quicker.

I remain convinced — even having watched Peter Schiff and Gonzalo Lira make incorrect inflationary projections — that there is exists the potential of significant inflationary problems in the medium and long term. Indeed, I believe elevated inflation is one of three roads out of where we are right now — the deleveraging trap.

In my worldview, this depression — although a multi-dimensional thing — has one cause above all others: too much total debt. Debt-as-a-percentage of GDP has grown significantly faster than productivity:

The deleveraging trap begins with the boom years: credit is created above and beyond the economy’s productive capacity. Incomes rise and prices rise above the rate of underlying productivity. And as the total debt level increases, more and more income that was once used for investment and consumption goes toward paying down debt and interest. This means that inflated asset prices become less and less sustainable, making the economy more and more susceptible to a downturn — wherein asset prices deflate, and the value of debt (relative to income) increases further. Under a non-interventionist regime, once the downturn occurs, this would result in credit freeze, mass default and liquidation, as occurred in 1907.

However, under an interventionist regime — like the modern Federal Reserve, or the Bank of Japan — the central bank steps in to lower rates and print money to support asset prices and bail out failed companies. This prevents the credit freeze, mass default, drastic deflation and liquidation. Unfortunately, it also sustains the debt load — following 2008, total debt remains over 350% of GDP. The easy money leads to a short cycle of expansion and growth, but the continued existence of the debt load means that consumers and businesses will still have to set aside a large part of their incomes to pay down debt. This means that any expansion will be short lived, and once the easy money begins to dry up, asset prices will again begin to deflate. The downward pressure on prices, spending and investment from the excessive debt load is huge, and requires sustained and significant central bank intervention to support asset prices and credit availability. The economy is put on life-support. Debt-as-a percentage of GDP may gradually fall (although in the Japanese example, this has not been the case) but progress is slow, and the debt load remains unsustainable.

A fundamental mistake is identifying the problem as one of aggregate demand, and not debt. Lowered aggregate demand is a symptom of the deleveraging trap caused by excessive debt and unsustainable asset prices. The Fed — and advocates of greater Fed interventionism to support aggregate demand, like Krugman — are mostly advocating the treatment of symptoms, not causes. And the treatment in this case my make the underlying causes worse — quantitative easing and low-interest rates are debt-additive policies; while supporting assets prices and GDP, they encourage the addition of debt. 

All three exit routes seem blocked. So the reality that we are staring at — and have been staring at for the last four years — has been remaining in the deleveraging trap.

There are three routes out of the deleveraging trap; liquidation (destroying the debt via mass default), debt forgiveness (destroying the debt via systematically cancelling it), and inflating the debt away. Liquidation in a managed economy with a central bank is politically impossible. Debt forgiveness is politically difficult, although perhaps the most realistic effective bet. And inflating the debt away at a moderate rate of inflation would seem to be a slow and laborious process — the widely-advocated suggestion of a 4% inflation target would only eat slowly (if at all) into the 350%+ total debt-as-a-percentage-of-GDP load.

So why in a deflationary environment like the deleveraging trap would I fear high inflation? Surely this is an absurd and unfounded fear?

Well,  Japan shows that nations can remain stuck in a deleveraging trap for a long, long time — although Japan has had to take to increasingly authoritarian measures such as mandating the purchase of treasury debt to keep rates low and so to keep the debt rolling. Eventually nations stuck in a deleveraging trap will have to take one of the routes out. But while central banks refuse to consider the possibility of a debt jubilee, and refuse to consider the possibility of allowing markets to liquidate, the only route out remains inflation. 

Yet the big inflation that would be required to eject the United States from the deleveraging trap makes creditors — the sovereign states from which the US imports huge quantities of resources, energy, components, and finished goods — increasingly jittery.

According to Xinhua:

The U.S. has long been facing the same problem: living beyond its means. At present, the country has debts as high as 55 trillion U.S. dollars, including more than 14 trillion U.S. dollars of treasury bonds.

And last October:

Economists agree that as the United States’ largest foreign creditor, China should contemplate ways to pull itself out of the “dollar trap,” as the U.S. economy is faltering with its debt piling up and its currency on the brink to depreciate.

China must make fuller use of the non-financial assets in its foreign reserves, as well as speed up the diversification of investing channels to resist a possible long-term weakening of the dollar, said Xia Bing, director of the Finance Research Institutes of the Development Research Center under the State Council.


Zheng Xinli, permanent vice chairman of China Center for International Economic Exchanges, has suggested that Chinese companies boost overseas investment as a way to absorb trade surpluses and fend off the dollar risk.

And it’s not like America’s Eurasian creditors are doing nothing about this. As I wrote earlier this month:

If the exporter nations feel as if they are getting screwed, they are only more likely to escalate via the only real means they have — trade war. And having a monopoly on various resources including rare earth minerals (as well as various components and types of finished goods) gives them considerable leverage.


More and more Asian nations — led by China and Russia — have ditched the dollar for bilateral trade (out of fear of dollar instability). Tension rises between the United States and Asia over Syria and Iran. The Asian nations throw more and more abrasive rhetoric around — including war rhetoric.


And on the other hand, both Obama and Romney — as well as Hillary Clinton — seem dead-set on ramping up the tense rhetoric. Romney seems extremely keen to brand China a currency manipulator.

The Fed is caught between a rock and a hard place. If they inflate, they risk the danger of initiating a damaging and deleterious trade war with creditors who do not want to take an inflationary haircut. If they don’t inflate, they remain stuck in a deleveraging trap resulting in weak fundamentals, and large increases in government debt, also rattling creditors. 

The likeliest route from here remains that the Fed will continue to baffle the Krugmanites by pursuing relatively restrained inflationism (i.e. Operation Twist, restrained QE, no NGDP targeting, no debt jubilee, etc) to keep the economy ticking along while minimising creditor irritation. The problem with this is that the economy remains caught in the deleveraging trap. And while the economy is depressed tax revenues remain depressed, meaning that deficits will grow, further irritating creditors (who unlike bond-flipping hedge funds must eat the very low yields instead of passing off treasuries to a greater fool for a profit), who may pursue trade war and currency war strategies and gradually (or suddenly) desert US treasuries and dollars.

Geopolitical tension would spike commodity prices. And as more dollars end up back in the United States (there are currently $5+ trillion floating around Asia), there will be more inflation still. The reduced global demand for dollar-denominated assets would put pressure on the Fed to print to buy more treasuries.

Amusingly, this kind of scenario was predicted in 2003 by Krugman himself!:

The crisis won’t come immediately. For a few years, America will still be able to borrow freely, simply because lenders assume that things will somehow work out.


But at a certain point we’ll have a Wile E. Coyote moment. For those not familiar with the Road Runner cartoons, Mr. Coyote had a habit of running off cliffs and taking several steps on thin air before noticing that there was nothing underneath his feet. Only then would he plunge.


What will that plunge look like? It will certainly involve a sharp fall in the dollar and a sharp rise in interest rates. In the worst-case scenario, the government’s access to borrowing will be cut off, creating a cash crisis that throws the nation into chaos.

This is not a Zimbabwe-style scenario, but it is a potentially unpleasant one involving a sharp depreciation of the dollar, and a significant change in the shape of the American economy (and geopolitical reality). It includes the risk of costly geopolitical escalation, including proxy war or war.

However, American primary and secondary industries would look significantly more competitive, and significant inflation — while penalising savers — would cut down the debt. Such a crisis would be painful and scary, but — so long as there is no escalation — largely beneficial.

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GetZeeGold's picture



Prices are falling up everyday at Wally World.


Comay Mierda's picture

option #4: start WWIII, nuke everyone so the USSA doesnt have to pay them back

Xibalba's picture

Or HAARP them, and blame the weather.

AldousHuxley's picture

after elections, us will invade Iran

oil prices will skyrocket


however, if us wins, then inflation will subside and US deficit will automatically offset

if US loses, then hyperinflation will make Americans slave to Chinese banksters


How much of HAARP is MADE IN CHINA? shit probably broke already.

sumo's picture

Start a war with some oil-rich country.

Make the serfs back home buy war bonds. For the win, people - it's your patriotic duty.

HungrySeagull's picture

Not this time Pyle.

If the Nation was serious about war and the making of, everyone would be assigned a task useful to the Nation. And I mean everyone. Including the blind for parachutes, the deaf for the roaring machinery and the colleges rudely shut with all the staff and body frog marched into Induction.

The Monkey's picture

Problem with price stability - it comes at the expense of interest rate instability, and nominal rates at least, have a bound - on the short end it is zero.

The Fed has helped engineer some inflation with incremental changes in real & nominal rates. Consumers went back to the till, and according to Rasmussen, a full 30% of consumers owe more now than they did a year ago.

Debt is not wealth. Encouraging credit growth from an extremely high base isn't going to bring on the next bull market. But, this is what the central banks do, and they will continue until the minons no longer respond.

The markets are funny. They get really excited about the Fed, but monetary policy has it's limits as they are saying underneath their breath. To maintain this Keynesian charade, we are in need of fiscal policy, but, no one seems to be spooled up on this yet.

When you review charts of the Nikkei, keep this in mind. After fiscal policy bullets ran out, the economy turned down every time.

dick cheneys ghost's picture

Help! Im Printing and I cant Get up........


''The long-standing support from petrodollars for Western financial markets is gradually waning as oil-rich countries favour recycling their windfall revenues closer to home and away from low-yielding developed economies mired in the debt crisis.''

Shizzmoney's picture

Does Krugman buy his own groceries?

Methinks he doesn't eat corn

dlc's picture

Given a choice, neither do cows.

BeetleBailey's picture

Paul Krugman is a government douche.

That he doesn't "see" inflation makes him a total douchedick, not worthy of the sweat off my scrot sac.

Akin to that dickwiiper Greenspan, and now, the assoholic Bernanke, this troika of crap persists to say inflation is "under control" - which is total fucking nonsense.

ANYONE that listens to Pee Krugdouche is a complete nincompoop, and deserves to be trampled on by a herd of horses.


booboo's picture

I would like to coin the term Krugmundum, 

Definition: A financial cunundrum in which Keynesian sycophants find themselves in when after following their remedies for 30 years they are finally trapped in their own asshole.

Pucker time bitchez

unununium's picture

At the first real sign of actual economic growth (as distinguished from bogus "green shoots") inflation will accelerate into the stratosphere.

So much mud (trillions) has filled the reservoirs, that the first rain will cause a flood.

essence's picture

Any article that mentions Paul Krugman and Joe Wiesenthal in the first two sentences is a sign of painful reading ahead.

Aren't there other references you can use to make your point?



catch edge ghost's picture

I actually empathize with the Bernank and Timmeh and all the rest of them. I drove half a day to Reno in 1995. I planned to either win enough to retire or lose it all and bleed out in a motel bath tub.

I didn't keep enough back to rent the bath tub after I had failed - so I hit the road again. I had a bath tub, just a half-day away.


Take the long way home, Ben.

Bennie Noakes's picture

Inflation comes from printing. But right now, interest rates are at multi-decade lows. So governments can borrow whatever amounts they feel they need and they see no reason to print. Inflation is always unpopular, but borrowing carries much less of a stigma. Inflation will not happen until people get worried about loaning to governments and interest rates rise enough to make further borrowing unattractive.

The PIIGS would already have begun printing if they were allowed to. Make no mistake: the things that are currently happening in Greece, Spain, and Italy will eventually happen to the US and Japan. It is just a matter of time.

xela2200's picture

The government does not print money. The FED prints money. The government gets its money from issuing treasuries that right now the FED will have to buy since there are fewer and fewer buyers. Moreover, the FED tells government that they need to restrain themselves. However, with zirp that is like taking a cocaine addict and placing him in a room full of cocaine and asking him to quit.

The FED can either let interest rates rise and impose discipline on government or print to purchase more bonds.

The other aspect of inflation is money velocity which can not be fixed by printing. Other countries are lowering the interest paid on reserves to force them to lend. Here in the US that would be catastrophic since the banks would probably use the money in their trading desks. Do you miss the Steal Glass act?

deflator's picture

Soon as everyone realizes that trading bonds with the government is better than equities... blah, blah, blah.

 I still see inflation because our economic model is debt based not money based. The only thing that qualifies debt as money is confidence. Once confidence is gone that debt can no longer be extrapolated indefintely into the future as successfully as it has for the past 150 years then all dem chickens gonna come home to roost.

The past 150 years of persistent economic growth has been an anomoly in contrast to the rest of human civilization. There has not been anywhere near a 150 year period of persistent economic growth prior to this one. Mankinds confidence in debt money has grown incrementally over the past 150 years. When this bust inevitably occurs, generations will pass before anyone ever trusts debt as money again.

 Like Raul Pal said, "The 70 trillion in G-10 debt isn't the problem per se. The problem is the 70 trillion in G-10 debt is collateral for 700 trillion in derivatives".

FreedomGuy's picture

I used to be a hard core inflationist but I find that the government's or even govenments' abilities to wreck economies and cause deflation may be greater. I tilt toward short term deflation without extreme measures like Bernanke's helicopter drops.

Obama is a fish out of water and he knows nothing about business, economics or even the consequences of his own ideas. If he did he would about face on his healthcare, get the economy roaring and inflating and come back later with that crap. Instead, he is likely to break the economy, drive deflation and even larger uninflateable debts.

Cannot invest wisely anymore because of government interventions. Might as well hit the tables in Vegas. At least the odds are published and clear and the rules are set.

Boilermaker's picture

The FED is only stuck if they care about NOT slaughtering the currency.

Otherwise, they can and will do whatever they damn well please.


SqueekyFromm's picture

I agree with you about Aziz.  I just think there will be a big deflationary occurence first which will scare the crap out of TPTB and cause the printing. My uncle said what will happen will be "New America", where people get a BIG Check (Basic Income Grant) from the government to pay for necessities, and then they can get a job to pay for extras. But he says the government is simply going to have to print currency at some point as the easiest way out. He is in his late 50's and plans on being a traveling singer and poet in New America. Hs is a hoot, but very smart.  

Squeeky Fromm, Girl Reporter 

deflator's picture

 "Livin's the hard part man, dyin's easy"-- Charles Manson

Plumplechook's picture

Fuck this is a bizarre post.  All the graphs and economic indicators included here point to the exact OPPOSITE of what this clown Aziz says we should be worried about.    The big worry is still a DEFLATIONARY death spiral due to collapsing demand and mass delevarging.   Did this guy even notice the disastrous consumer spending numbers that came out Monday?

Why the fuck do the Tylers insist on giving Aziz column inches on this site when week-after-week he proves himself all wrong,  all the time.

deflator's picture

 It seems everything is counterintuitive these days, does it not? In Mises day there was a backing of debt with real money like hard assets such as farmland and gold. Today the only backing is confidence. Get it? It isn't a real money game, it is a debt money game and Bernanke and those on the bubble side of his trade could give a shit about your economic indicators.

Poor Grogman's picture

I'm so worried about deflation I'm going to buy heaps of stuff now before the price goes down.??!

What about the cost of printer ink in a "deflationary death spiral"

Will that go up or down?

Please show other examples of deflationary death spirals in fiat currency systems, to end this confusion, in fact just one will do.

Money for nuthin bitchez

The Monkey's picture

Why does it always have to be an apocolyptic deflationary debt spiral? How about a standard goods and services recession that is sharp and especially scary due to it's proximity to the financial crisis and the fiscal implications.

Perpetually avoiding recession is like avoiding a season of the year. There are only so many green leaves that a tree needs, or can support.

hejss's picture

And that is why i fear inflation. The answer so far seems to be to print and at some point markets will have to front run those decisions.

andrewp111's picture

How is the Fed going to inflate without violating the legal limitations on that agency? Unless Bernanke usurps Congress and engages in naked fiscal expenditure, how can he pump enough net financial assets into the private sector to inflate? Short interest rates are already at 0% and  the Bernank could peg the rate at 0% out to 30 years if he wished, but so what? Every T-bond Bernanke buys removes interest income from the Private Sector. Banks will not lend without creditworthy borrowers to lend to. Bernanke could legally buy Fannie/Freddie bonds, but again - so what? The proceeds will still be stuck in the banks. The only thing he could legally buy that would push net financial assets into the Private Sector is gold. If Bernanke bought 100 tons of gold per week, he would boost the price of gold and push a lot of cash out the door. Most of it would leak out of the USA, though, because the USA mines very little gold.

The Monkey's picture

Man, if and when Fed members peruse these boards, they must laugh their asses off.

prodigious_idea's picture

As if Congress is making any effort to monitor, much less regulate the Fed.

Poor Grogman's picture

"violating the legal limitations"

Sigh....Now isnt that quaint?

Kreditanstalt's picture

"Such a crisis would be painful and scary, but — so long as there is no escalation — largely beneficial."

Unless you're one of the creditors - or  you've been a responsible saver and frugal spender...

Then perhaps not really so "beneficial"... 

deflator's picture

 Unless you live in a world where the government is in on both sides of the trade--both creditor and debtor. hmmm... let that sink in.

Flakmeister's picture

If the supply of oil priced in dollars on the open market would be sufficient for a long enough period of time, it is concievable that Ben could judiiciously print his way out of the delevaging that is occuring.... To what end, I do not have a clue....

Since 2009, the price of Brent has acted as the defacto govenor on the world economy. Once Brent trades in the $120-125 range for an extended period, the world economy takes a pause...

Look at the timing of the various "liquidity" measures and the price of Brent...

Ben will not print until after the election, short of some Lehman type event... But he sure as fuck will afterwards and before the Inaugeration...

I figure the dollar has another 10 years before all hell breaks loose with the wildcard being the House of Saud...  YMMV

BigDuke6's picture

It's not deflation we should be worrying about, but inflation.

Global central banks have created enough fiat money to buy every person on earth a 55-inch wide-screen 3D television set.

In our postmodern economy it is difficult to separate the reality of fundamental economic growth from the illusion of central bank-backed prosperity.

Today's markets are trapped in an Orwellian world of financial repression whereby equity and bond markets are not up, not down, but merely where central banks want them to be.

sessinpo's picture

And I'll take each dollar you print and put it toward all the debt the globe has and you still won't have enough money printed. Takes the air out of the inflation argument.

sessinpo's picture

The other point that argues against inflation is the growing number of NIRP. In other words, inflating isn't working. It isn't boosting economies, production and sales ares still falling worldwide relatively with few specific markets rising because of special circumstances. Banks are having to work harder and harder to keep the wheel turning - even going negative on interest rates.

slackrabbit's picture

All those lines to say two things:

1. Hyperinflation = lots of money printing - Weimer Germany

2. Currency Crises = loss of faith in the currency and hence value  - Argentina


I do beleive that the US may suffer from 2 before Ben starts 1, simply due to the fact that everyone is tired of the fiasco.

Essential Nexus's picture

When was Schiff wrong?

ddtuttle's picture

One thing you're not considering.  

To maintain the reserve currency the US has had to create enough dollars to support nearly all of global commerce.  Over the last 70 years since Bretton Woods, this has become a lot of dollars.  If the world shuns these, they'll all end up in the US banking system (there's nowhere else for them to go), vastly increasing the effective money supply here.  This is not unlike the rejection of a currency in classic hyperinflation.  In this respect our fate is not in our own hands; if the world rejects the dollar, we will be subjected to a high degree of inflation, perhaps something that feels like hyperinflation.

If the world weren't such a mess this would probably be a real danger, but it is just as possible the dollar will be the best currency of many bad ones, excpet gold, of course.

sessinpo's picture

It wouldn't be necessary to print so much. By not printing so much, it would just cause the value of the dollar to be much higher relative to other currencies and relative to the commodities being purchased. In other words, if I were importing (buying) rice from Japan, I would get more tonnage of rice per dollar. An inflated dollar my only buy me an pound of rice, but a dollar with higher relative strength, might buy me 3 pounds of rice.

Secondly, we are in a credit society, thus having actual physical dollars isn't needed for international commerce, only domestic. In the above example. All the dollars I use to buy rice from Japan could be done electronically or on credit. Japan would convert them to Yen anyway for domestic use.

Sandmann's picture

We have Inflation. It is evident in Food, Oils, Metals, Commodities. It flows through Bank trading desks at JP Morgan, Barcap, Goldman and Hedgies and Sovereign OIl Traders. Come Winter it will show up more starkly. The Central Banks have let the Banks "tax" Households through Usury and Commodity Prices to rebuild their sheets. The Public cannot resist because it has Deflation to hold it down. This is Controlled Inflation narrowly channelled instead of Helicopter Administered - it by-passes Labour and rewards Capital.

Hyperinflation is a myth - it is not necessary - that is when money escapes the banking system and in the absence of Derivatives at 10 times global GDP which simply absorb liquidity as props.

Sandmann's picture

Examine the Monetary Transmission Mechanism before spouting schoolboy platitudes.

HungrySeagull's picture

Frankly my dear, I don't give a damn.

Gavrikon's picture

" . . . however, under an interventionist regime. . ."

Aha, and therein lies the crux of the problem.  Under normal deflationary/depression conditions, I would also expect that inflation would not be an issue.  But how will, when and how much intervention will be unloosed at the financial disaster?

skipjack's picture

Just another asinine post - I even give Bernanke credit for recognizing this one.  Inflation right now will kill us faster than deflation.  There is NO growth in income, low profits at only some companies.   Who the hell is going to give out raises for inflation ?  Really ?  Unions are getting busted by cities going BK, workers are being laid off as profit margins fall, retailers are losing sales as the costs of their goods increase, and some yahoo thinks inflation is a good thing in this environment ?


What a waste of a few minutes reading this drivel.

sessinpo's picture

I think the threads where TD has shown support that QE has had less and less of an effect each time it is used (and not operation twist), should tell you that deflation is the problem. They are nearing the point that printing just won't matter any more. The money just goes to service the overwhelming debt instead of circulating throughout the economy.