In true linear fashion, with the blinders forcing a laserlike beam into the distant future, the deflationists have made their case. It won't hold water and certainly won't prepare any active investor for the future. Inflation is caused by two things - and two only!
1. The expansion of the money supply through credit.
2. The movement of that money through the economic system. That movement is velocity.
Put simply, there has to be ammunition and people have to use it. Japan has been mired in a stagnant economy in spite of very easy credit for a number of cultural reasons, none of which apply to the United States or most other developed and developing countries. A rigid corporate structure that doesn't reward or develop entrepreneurship combined with a very conservative aging population has meant that available credit goes begging. That won't happen virtually anywhere else. Japan has always been a one off event.
The fall in prices that's very evident in almost every category is not indicative of longer term deflation. It's a result of the freeze up of the flow of credit through the system and it is a temporary event. The sequence we are going through and will go through moving forward is likely to follow this course...
1. Recognition of the misallocation of assets and the realization that money and wealth has moved from less capable to more capable hands. This process will continue through the Winter of 2009. The surprises continue, but the large players are mostly accounted for and the markets have digested them.
2. An infusion of credit into institutions that have the power to create credit and expand the economy. This has been done (and will be done further) on a massive scale involving TRILLIONS of dollars. It will also involve TRILLIONS of Euros and even Yen (that is an ongoing story).
3. The next step will arrive with the Obama Administration. It will involve very substantial build-out and buildup projects and run close to another TRILLION dollars when all is said and done. This will be accompanied by tax cuts...and the critical pressuring of financial institutions to start the credit expansion process on a huge scale. There is NO shortage of willing borrowers and the money will flow into a small business expansion that will boggle the imagination.
4. Not enough credit and money...don't worry, there's plenty more where that came from.
That outside agency some people need to see for inflation to take place? The Fed. The Fed is going where no central bank has gone before. It has redefined itself in the last two months and is now the buyer of last resort for everything from useless paper trading vehicles to longer term Treasuries. This is a seminal set of events and must inform even the most ideological deflationists that something is very different this time.
The final nail in the deflationist retro vision is the myth of the Great Depression..and how it is coming back to haunt us. A few face offs are necessary...
1. The Fed of the Great Depression era stimulated very haphazardly. The United States labored under the old fashioned notion that deficits and spending matter and that moral hazard was a reality of business life and not merely an overworked phrase journalists throw around. This really put a crimp in ending the deflationary spiral of the time, so there were fits and starts and near recoveries and then severe relapses. Not so in 2008. Moral hazard was dead and buried months ago (at least) and you won't hear much from the Obama Administration about the importance of reducing deficits..in fact, they'll tell us that's irrelevant.
2. The Great Depression era was peopled by and large by individuals and families that abhorred debt and spent sparingly. It was a hunker down society that made do on pitiful amounts of consumables. Imagine that in 2008 and beyond..the American character is ingrained with borrowing and spending and it will manifest itself by a rush towards credit that's going to leave many dumbfounded. Balance sheet pumping will replace this very temporary balance sheet repairing we've seen. This process isn't simply a matter of getting people on their feet again... IT'S A MATTER OF SOCIAL STABILITY. Things will fall apart and anarchy will rule if not done rapidly. This not a society, any longer, that handles NO well.
Relative to other currencies the US$ will hold its own. It will only depreciate in the sense that by mid 2009 it's going to take many more of them to buy the things had on the cheap now. Food will be MUCH more expensive... fuel... resources of EVERY kind and type. The idea that the laws of physics and iron laws of supply and demand for goods and services have anything to do with what we will face soon enough is highly misleading.
The first thaw in credit will be in March or April and it will be a flood by June and July. Fill up your tank with cheap gas now..it's likely the last you'll ever see.
Recommended investments to ease into by Spring 2009:
Disclosure: Long GCS (1000 shares) and SLV (500 shares).