7 Key Points About Deflation 23 comments
Tim Iacono
About this author:- Profile & More Articles
- Tim's blog: The Mess That Greenspan Made
- Subscribe to Iacono Research
-
Font Size:
-
Print
- TweetThis
A few thoughts on the subject of deflation to help you make sense of what has unnecessarily become one of the hottest topics of discussion in recent months, excerpted from the most recent Weekend Update at the companion investment website Iacono Research.
1. The entire discussion of deflation is overrated and attracts far more attention than it deserves. One can discuss the advances and declines of economies and asset classes over the last two decades without once mentioning the words inflation or deflation and do just fine. More than ever before, it seems that deflation is just a word that central bankers and economists whip out as if it were some sort of a trump card that allows them to take extraordinary measures to counteract the bursting of asset bubbles.
That has certainly been the case over the last 18 years in Japan and in the U.S. where extraordinary measures have been taken amid the fear of deflation, either real or imagined. Importantly, these measures were much more effective in the U.S. earlier in this decade when recovering from the bursting of a stock market bubble than in Japan during the 1990s when recovering from the bursting of bubbles in stocks and real estate.
Of course, the recent recovery in the U.S. just led to an even bigger asset bubble which, in turn, is now producing the expected calls for deflation now that it has burst.
In economies around the world today, it seems obvious that falling consumer prices are a natural consequence of the bursting of asset bubbles and the dramatic pullback in demand that results from slower economic growth and, in the period ahead, plunging commodity prices will play an important role as well. Falling consumer prices should not be seen as anything particularly significant, in and of themselves, as they are not the driver of present or future problems.
Of course, falling asset prices are simply the result of the asset bubbles bursting.
More than anything else, falling prices in general are just a symptom of the disease that is modern day monetary policy, contemporary economic thought, and poor regulatory oversight that have, together, allowed and encouraged asset bubbles to expand and burst.
2. It would be the worst blunder in centuries for governments and central banks to "allow" a repeat of the debilitating Great Depression of the 1930s. Simply put, with the absence of a gold standard, you cannot have a deflationary depression unless governments and central banks allow it to happen. Some day they might, but that won't happen anytime in the next five years or so - that would be political suicide when nearly all political leaders around the world continue to believe that Keynesian remedies will still restore health and vitality to the global economy.
3. Don't confuse 1990s Japan with 1930s America - Japan-style CPI-deflation really wasn't that bad. We already have asset-deflation in much of the world and we may well see modest CPI-deflation in the year or two ahead as was seen in Japan in the 1990s. This shouldn't be thought of as being particularly significant - remember that real economic growth in Japan averaged about +1.5 percent in the 1990s and CPI-deflation never exceeded one percent per year. If, on the other hand, we were to see 1930s-style American CPI-deflation of 10 or 20 percent per year - then that would be an entirely different, much more important development.
4. The "aura" of the word deflation and the fear it instills have to do with the workings of a hard money standard from which we departed decades ago. In a hard money standard, the currency was "as good as gold" and serious problems arose within the banking system when consumers came to believe that prices would continue to fall, figuring they'd be better off delaying purchases (this was an all too common event prior to the 20th century when CPI-deflation occurred frequently). We've had nothing but inflation for more than seven decades and this fear of the currency gaining purchasing power over time is sorely misplaced in today's world of pure fiat money - money always loses value in a fiat money system.
5. There are legitimate concerns about Americans becoming much more frugal and less willing to spend as they have over the last twenty years and a prolonged period of weak consumption in the U.S. will place great strains on the economy putting downward pressure on consumer prices. Here too, CPI-deflation would be an after-effect of these potential fundamental changes in the U.S. economy, not the driver. In my view, this will eventually happen, but it is still at least five years away. Contemporary mainstream economic thought posits that all downturns can be successfully countered with easy money policies and this theory will not be completely discredited until we get rip-roaring inflation at much higher rates than what we saw over the summer.
6. Here's what I think we'll see happen in the period ahead, timing uncertain:
I do not foresee a Zimbabwe-style "hyper-inflation" on the order of 100, 1,000, or 10,000 percent. The talk of "hyper-inflation" also detracts from the quality of the overall discussion on this topic as, more often than not, there seem to be only the two extremes from which to choose - either 1930s-style deflation or Weimar Germany hyper-inflation. In my view, we are much more likely to first see 1990s Japan-style deflation and then 1970s U.S.-style inflation (absent the wage pressures) which will surely be enough to send the price of gold soaring once again as it did in the late-1970s.
7. At some point there will be some sort of a new monetary order that will forever change how the economies of the world work, hopefully relegating runaway asset bubbles and perpetual inflation to the history books. Ideally, this would be a hard money system of some sort (see this item from last Friday for some hopeful signs that people are starting to think along these lines). I have no idea what this system might look like, how we might get there, how painful that process might be, or how long it might take, but I don't believe we'll see this sort of thing develop voluntarily. It will only occur after the next major inflation crisis, possibly after military action precipitated by competition for energy resources that will be played out as part of the next global economic recovery.
This crisis will likely make the 2008 inflation with $150 oil and $1,000 gold appear tame in comparison.
Related Articles
|
Find People on SA
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largest
increase in followers
in the last 7 days-
1
David Fry
-
2
Philip Davis
-
3
Bill Gross
-
4
TraderMark
-
5
Tyler Durden
Fastest Climbers » -
1
-
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most activeSee all
Instabloggers.
Top Instabloggers » -
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 23 comments:
You are exactly on the mark about asset bubbles. We can ill afford to run an economy on fiat money from one bubble to the next. Does this mean our post industrial economic experiment is a failure? I think so.
We need to get back to real GDP, real jobs, real science and technology; less debt; and a currency backed by something tangible. In the end, I think we will.
Dude, you are singing my song on the fiat currency issue. And, I am not afraid of a little deflation. I am betting and counting on it. I also do not fear inflation, I understand the fiat money supply is falling faster than the Fed can inject new liquidity. And I think this will be a long term trend as asset values continue to drop over time.
I believe, by the time inflation begins to rear it's ugly head, the fed might have marginally more control over the money supply and we will probably be recovering from recession by then. (Timing is everything, of course.) An interest rate hike would then be in order. Our dollar should remain strong through this crisis and beyond.
In the end, I believe we will recover to a tighter money supply and lower, more sustainable global growth not fueled by American credit cards. It'll hurt for a while, but whether Obama is prophetic or lucky, change is coming.
I think this crisis might make the great depression look like pneumonia. It'll be bad and hopefully just avian flu bad...but it could turn into pneumonia.
t
On Nov 19 09:02 AM asbytec wrote:
> Funny how a simple housing market down turn in the US can bring the
> world to it's knees. Imagine the deflation if or when other productive
> assets fail.
>
> You are exactly on the mark about asset bubbles. We can ill afford
> to run an economy on fiat money from one bubble to the next. Does
> this mean our post industrial economic experiment is a failure? I
> think so.
>
> We need to get back to real GDP, real jobs, real science and technology;
> less debt; and a currency backed by something tangible. In the end,
> I think we will.
>
> Dude, you are singing my song on the fiat currency issue. And, I
> am not afraid of a little deflation. I am betting and counting on
> it. I also do not fear inflation, I understand the fiat money supply
> is falling faster than the Fed can inject new liquidity. And I think
> this will be a long term trend as asset values continue to drop over
> time.
>
> I believe, by the time inflation begins to rear it's ugly head, the
> fed might have marginally more control over the money supply and
> we will probably be recovering from recession by then. (Timing is
> everything, of course.) An interest rate hike would then be in order.
> Our dollar should remain strong through this crisis and beyond.<br/>
>
> In the end, I believe we will recover to a tighter money supply and
> lower, more sustainable global growth not fueled by American credit
> cards. It'll hurt for a while, but whether Obama is prophetic or
> lucky, change is coming.
>
> I think this crisis might make the great depression look like pneumonia.
> It'll be bad and hopefully just avian flu bad...but it could turn
> into pneumonia.
>
To get 1970s wage-driven inflation, you need strong unions. Here, in US, I don't see any.
Wrong again, braintrust. The overriding rule is, instead, that all crowded trades lose, and that sentiiment was as crowded as "real estate only goes up", "land, they aren't making any more of it", "tech is the future", etc, etc ad nausem.
The quantity of money doesn't go down in fiat systems. But the *demand* for money is *not* a constant, and it can and does go up, and stay up, for extended periods. Ask the Japanese, or look out your window.
Meanwhile, trying to distinguish between collapsing bubbles as supposedly not monetary and a separate monetary deflation, ignores the reality of different real interest rates in every commodity or asset type or claim. Falling prices of claims against future cash flows are real interest rate increases. There are two things traded in every trade, and only one of them can be that most fetishized commodity, money.
If you want to go back to the economy of 1900, please take a hard look at the historical results of hard monetary policy. Stormy seas of inflation and deflation destroyed businesses, over and over again, as the value of both gold and currency violently changed over time as measured by prices of labor and products. Bank crisis after bank crisis and currency crisis after currency crisis destroyed life savings and made saving and earning interest hazardous. Subsistence farming was considered employment. Want a mortgage? Too bad, build your 500 sf cottage by hand. Want to start a business? Hope you already have money. In hard currency times, the US was what we now call a 3rd world country, with living standards worse than during the so-called great depression.
In a free market, the government cannot dictate how much gold should be worth in terms of labor, products, or resources. They have little control over price stability in gold terms. That's why prices and the currency were so unstable during so-called hard money times. Fiat currency allows policymakers to roughly target the economically maximal 2-4% inflation rate and, more importantly, to keep it steady.
The reforms of the early 20th century, produced the strongest, most dynamic economy the world has ever seen, and those policies were copied by other nations that became destined for success. The results of unlinking currency from prices of volatile commodities speak for themselves, as do the results of hard money policies.
If you think the statistical blips we now call recessions have changed the rules of economics, look around you at the economic prosperity you still enjoy and compare it to the sharecroppers of 1900. Their idea of prosperity is your worst case scenario.
Mild deflation is consistent with economic expansion, at least according to some models (see the von Mises Institute.)
After all, we have had deflation in electronic goods for at least 25 years and that hasn't hurt economic activity in those sectors.
Falling prices can actually stimulate buying. Store sales and common sense tell us that.
The problem is (either hyperinflation or) hyper deflation.
But prices that fall in an orderly fashion because we produce goods more and more efficiently and with more and more technological knowledge and better production methods can be consistent with an expanding economy.
As a commodity, there is nothing special about gold any more. There is no reason to use gold as the commodity to back money even if - for whatever reason - you believed that was a good idea.
Gold worked as a money-commodity because of the human factor and that is the only reason. Fiat money simply acknowledges the self-evident and inarguable truth - that money is a creation of people - and stops messing with the yellow stuff.
There needs to be and will be market discipline on the monetary system - and it will be by governments in concert with the market in a fiat system. Reading these predictions of the demise of fiat currency reminds me so much of my old Marxist friends who used to predict the demise of capitalism. Laissez-faire ideologues have been telling us that with Keynes and no gold we were all doomed - all during the greatest expansion in global wealth in human history.
Then the cockroaches take over and declare victory over humans.
computers became 'cheaper' via the method of moving all our production to China. The Chinese then plan to keep all of this while we look on in horror as they refuse to share computer technology with us prior to the 'military action' the author wrote about, aka, the Apocalypse or WWIII.
The theory of differential accumulation suggests that growth does tend to be associated with low inflation and stagnation with higher inflation and the currency-corrected, international data more-or-less bear this out. Inflation is essentially constant in a fiat-money world, which is fine. The money economy should anticipate the real economy and the real economy generally grows. So deceleration in inflation is the equivalent of the mild or normal "deflation" and most often this comes when the real economy is starting to outpace the money economy.
However, real, noticeable deflation is, I think, what you would call "hyperdeflation". And hyperdeflation is bad because it is a self-propagating dynamic. Essentially, the price system starts to misprice the economy so consistently that it brings the economy down with it.
deflation is not likely in a fractional reserve, fiat money system. The Fed is currently demonstrating why with massive printing of money and a low funds rate. Maybe for a few months till the stimulus catches up, more likely (as said) a slowing of inflation.
deflation is scary because the system is highly leveraged with fractional reserve and derivatives. reduction in asset values is the main weakness. interesting comment on withholding spending in a deflationary environment; the flip side from 1979 is buy it now before the price goes up again.
I've heard one possibility that an alternate system may grow side by side with the current one and gradually phase it out without the turmoil. e.g. private electronic money / plastic backed by hard assets.
I'm not worried about nuclear war. spent too much time under my desk with my head between my knees waiting.
What worries me is 1) the Fed knowing when to stop to avoid high (maybe hyper) inflation 2) devaluation of the dollar and / or loss of defacto reserve currency status (this lets the US get away with a lot of fiscal irresponsibility) 3) some country wanting to redeem their treasury notes for assets.
The yen carry trade is dead as a sub-1% US Treasury bond sale. The yen is rising in value, Japan's huge exports surplus is dying. These things lead to wars in the past. Only Japan is weak.
The US hangs onto its nuclear arsenal for a reason: it gives us huge veto power over who gets to collect our debts.
The reality is, when most of the major economies of the world were on the gold standard, the result was a series of boom and bust cycles like nothing we have experienced since... for example, the severe economic dislocations occured in 1819, 1837, 1857, 1873, and 1893.
Even with fiat currency, deflation can be an issue because the effective money supply is a function of both quantity and velocity. In short, money that is hidden under a bed and not circulating doesn't prevent a price collapse.
Yes, a reduction in bubble asset prices is a positive and expected part of a bubble popping, but a general price decline is something alltogether different, because buyers stop buying in anticipation of lower future prices, and borrowers default because the real burden of servicing their debt increases... leading to credit defaults, which in turn futher contract the money supply.
Episodes of severe inflation and deflation have both been regularly experienced in gold standard based economies.
On Nov 19 11:32 AM Chris B wrote:
>
> If you want to go back to the economy of 1900, please take a hard
> look at the historical results of hard monetary policy. Stormy seas
> of inflation and deflation destroyed businesses, over and over again,
> as the value of both gold and currency violently changed over time
> as measured by prices of labor and products. Bank crisis after bank
> crisis and currency crisis after currency crisis destroyed life savings
> and made saving and earning interest hazardous. Subsistence farming
> was considered employment. Want a mortgage? Too bad, build your 500
> sf cottage by hand. Want to start a business? Hope you already have
> money. In hard currency times, the US was what we now call a 3rd
> world country, with living standards worse than during the so-called
> great depression.
"I do not know with what weapons the next world war will be fought. But, I am sure the one after that will be with sticks and stones." Albert Einstein
Funny comment about hanging onto our nuclear arsenal to limit who comes calling to collect...LOL
No one wants to go back to 19th century financial regulations. But, no one wants the current regulations, either. Well, when I say no one, I mean me. But, we might need an alternate system to take hold, say 19th century industry and jobs that exist in America and held by Americans?
We really need to base our currency on something. I have no problem going off the gold standard, but we need to peg it's value to something tangible...not debt. Something tangible and grows in value over time would be nice, so as employment increases we can print more money without inducing serious inflation. Oh, I am dreaming again...the Fed actually setting the price of money, again? Someone slap me...
But, I believe the Fed will be all over inflation when it begins to rear it's ugly head, at least to the extent it can be. Let's just hope the timing is right, and we're on our way out of recession by then. The Fed will tighten the money supply and keep the dollar strong, I am sure...at least hopeful. Unlike a lot of folks who blame the Fed for our woes, I have some faith in Bernie.
Folks, in my view, this has little to do with transparency, solvency, or failed mortgages and almost everything to do with keeping control of the money supply. We are over extended in debt and it was bound to correct. Why do you think Greenspan retired at the height of his popularity?
Why do you think a simple US housing market down turn has brought the world to it's knees? It's the money, and the lack of regulator oversight while everyone was feeling richer than we really were.
I share your anxiety about the backing of the dollar. A currency retains value because there are real goods and services that can be bought with it - that is GDP - production! Imagine, for example, a person in another country with a million USD. He can buy US manufactured goods, US produced food and commodities, US real estate, services provided by US citizens, and US investments. His million dollars are worth to him what he can buy with it. Likewise, because others around him face the same opportunity, they are willing to trade locally for his dollars. Currencies from countries with dead economies that produce very little are worth very little. Workers in those countries therefore get very little purchasing power for their labor. Thus currency, and wages, depend on production in the long term.
In the US, we have an economy based on importing all tangible goods in exchange for debt, and employment based on providing services for each other. I'm not sure why foreigners consider the dollar valuable since we don't produce anything for them. Maybe it's habit - a soon-to-end habit.
On Nov 20 05:58 AM Asbytec wrote:
> You know, a lot of folks recite history and different economic models.
> It pays to do so, but has anyone modeled our current post industrial
> economy? Has anyone modeled what happens when we move GDP overseas
> and base our prosperity on debt? Can anyone explain the theory of
> now? Toss in an unlimited fiat money supply and a powerless Central
> bank and see what you get.
>
> "I do not know with what weapons the next world war will be fought.
> But, I am sure the one after that will be with sticks and stones."
> Albert Einstein
>
> Funny comment about hanging onto our nuclear arsenal to limit who
> comes calling to collect...LOL
>
> No one wants to go back to 19th century financial regulations. But,
> no one wants the current regulations, either. Well, when I say no
> one, I mean me. But, we might need an alternate system to take hold,
> say 19th century industry and jobs that exist in America and held
> by Americans?
>
> We really need to base our currency on something. I have no problem
> going off the gold standard, but we need to peg it's value to something
> tangible...not debt. Something tangible and grows in value over time
> would be nice, so as employment increases we can print more money
> without inducing serious inflation. Oh, I am dreaming again...the
> Fed actually setting the price of money, again? Someone slap me...
>
>
> But, I believe the Fed will be all over inflation when it begins
> to rear it's ugly head, at least to the extent it can be. Let's just
> hope the timing is right, and we're on our way out of recession by
> then. The Fed will tighten the money supply and keep the dollar strong,
> I am sure...at least hopeful. Unlike a lot of folks who blame the
> Fed for our woes, I have some faith in Bernie.
>
> Folks, in my view, this has little to do with transparency, solvency,
> or failed mortgages and almost everything to do with keeping control
> of the money supply. We are over extended in debt and it was bound
> to correct. Why do you think Greenspan retired at the height of his
> popularity?
>
> Why do you think a simple US housing market down turn has brought
> the world to it's knees? It's the money, and the lack of regulator
> oversight while everyone was feeling richer than we really were.
1) advances in technology make prices cheaper not cheap workers.
2) scientific and technological knowledge can't be kept secret because the people trying to keep it secret don't understand it well enough to know when it is being leaked to others. Scientists usually wont go along with secrecy and they communicate their discoveries with obscure symbols and hints that political leaders can't understand.
On Nov 19 03:17 PM Elaine Supkis wrote:
> Carey Jim,
>
> computers became 'cheaper' via the method of moving all our production
> to China. The Chinese then plan to keep all of this while we look
> on in horror as they refuse to share computer technology with us
> prior to the 'military action' the author wrote about, aka, the Apocalypse
> or WWIII.
In his own interview with Parker, Milton Friedman (Parker 2002, p. 44) characterized the Hayek-Robbins view taught at the London School of Economics as "a picture of incredible darkness." In doing so he echoed his decades-earlier description (Friedman 1974, p. 162-63) of "the London School (really Austrian) view" as a "dismal picture." He found it dismal for teaching, among other things, "that the only sound policy was to let the depression run its course, bring down money costs, and eliminate weak and unsound firms." Although he did not use the term "liquidationism," Friedman read the Austrian view as one that counseled monetary policymakers to do nothing to combat the sharp deflation of 1930-33. Friedman quoted extensively from Robbins' book The Great Depression to support this reading. (He also mentioned Hayek's mentor, Ludwig von Mises, but not Hayek. In the Parker interview and in the Epstein interview quoted at the outset, Friedman did name Hayek as well as Robbins.) At the University of Chicago during the 1930s, by contrast, "[f]ar from preaching the need to let deflation and bankruptcy run their course, they [Chicago economists] issued repeated pronumciamentos calling for government action to stem the deflation".
This debate has suddenly gained relevance again today.
Do we let the profligate, greedy and unwise sink or do we show them compassion, like smokers who get lung cancer, and give them their financial operation that might only be palliative and even prolong their (our) collective financial pain but certainly make our bleeding hearts beat faster?
Our debate. "Brother, do you have any spare change?"
The habit will end abruptly when the dollar is devalued (those nukes will be handy then for defense) and the dollar loses it's de facto reserve currency status. Maybe not in that order.
I believe the answer to the question you posed may lay in confidence. The dollar, being a fiat currency, has no other support mechanism other than confidence the US government will not change the value of it markedly.
Now, one may argue the Fed is violating that confidence by printing money. I might agree except, as I've asserted, the money supply (MZM) is actually falling, or at least the rate of growth is plummeting.
What we do provide to them is dollars...LOL But, that's another topic...getting back to some real production based wealth. so, if the Fed and congress act correctly, that is in our national interest, the dollar should remain a store of value. This is why it appreciates during risk aversion, it has value.
What does worry me a bit, though, the dollar does seem to have some negative buoyancy. When risk appetite heats up, the dollar falls a bit. Still working that one out.
I suspect, I pray, when we get through this crisis, the Fed and congress will be held to account for the price of money. They have lost control through abuse of the lucrative derivative trade (Roche, New Monetarism.)
To prevent further further financial disasters, I believe new regulations will help assure we regain control over the money supply and do not act to decrease confidence in our currency. So, I am cautiously bullish long term. I may have to come back to this post in a year and issue a retraction, but I hope not. :)
There is some discussion about going back to a representative money system. I might just support that. Still working that one out, too.
Well, support for the dollar always earns me some "thumbs downs." :)
I am not sure I understood you correctly, we may be saying the same thing. But, my understanding of inflation is in the supply of money.
For instance, if your dollar is worth 1/35th of a troy ounce, then it takes a 35 dollars to buy something worth one troy ounce of gold. Our gold supply is limited, so if you want to print more money, you must devalue the dollar to, say, 1/40th of an ounce. Now, it takes 40 dollars to buy that same item.
Okay, so that's under the gold standard. But, the concept is supply and demand. More supply, less value...prices rise. But, the value of the item really stays about the same, it's just the number of dollars required to buy it varies.
Are we on the same sheet of music?
Again, I believe the dollar has downward pressure because we've lost control of a sky rocketing supply of money. I'm pretty sure of it, anyway. I also believe the current crisis will relieve us of some of that surplus money despite Fed liquidity moves.
The amount of money lost, the global liquidity including the vast sums born from the yen carry trade, is simply out of the Fed's reach. So, as money, mostly dollars, vanish into thin air the dollar should strengthen.