Deflation, Inflation, Rinse and Repeat

Economists and pundits are spinning their heads in circles, going from inflation worries a few months ago, to deflation worries today, but still fretting about deflation in the future. It’s highly amusing to watch, and points to the perils of static, equilibrium models of the economy.

The issue isn’t one or the other, of course: It’s both. We are going to have material deflation over the next twenty-four months, likely as much as 3% a year, and then we are going to have an inflationary snapback immediately afterwards.

The upshot: Rates will get to nearly zero, and then they will go whipsawing in the other direction within 36 months. That will neatly choke off tepid economic growth while fighting commodity-driven inflation, sucking us back into a double-dip recession around 2011/12. The trouble is, while the Fed will want to cut rates at the time, it will have far less room to move given the its capital needs, so we will have the first high-rate recession –- stagflation –- in thirty years.

Rinse and repeat.

Comments

[thedozer]

I mean in the interest of theory... and economics is simply theory anyway

aren't we always either inflating or deflating things? if we get lucky and land in the middle then we get stagnation...

no pessimism intended

2008 Oct 30 04:54 PM

[Moon Kil Woong]

I think it's premature to call stagflation. History favors many years of tepid to 0 growth like Japan unless our Fed and Treasury are pure stupid (which may be the case). But let's give the new administration the benefit of the doubt for now. It's hard to believe they will be worse than helecopter Bernake who agrees in dumping money all over to deal with crisis and Paulson who's main interest is in giving money to Goldman Sacs directly, paying off Goldman through giving money to AIG so they can pay CDS contracts to Goldman, and guaranteeing their deposits to keep people from running away from them.

2008 Oct 30 11:14 PM

[DaveinHackensack]

When, within the next 24 months, would you suggest starting to short Treasury bonds?

2008 Oct 30 11:25 PM

[Ellen]

from your neighbor over here in Rancho Santa Fe...

24 months is an eon in this highly volatile market. I'm not sure it makes sense to do any positioning for inflation that far off, especially when the only certainty is that there will be many intervening factors between now and then.

But I would like to know how you came up with 24 months and what the indicator(s) will be that will alert you to the change in direction from disinflation or deflation to re-inflation?

Thanks.

2008 Nov 03 02:52 PM