Revisiting the Inflation / Deflation Debate

You know, it is very pleasing to me that the readers of my site are not just concerned about trading, about market direction or perish the thought, stock picks. I myself have less and less patience for people who only care about the trade, as if the system that the trade relies upon is going to be there forever. A lot of readers of my site care deeply about the macro fundamentals that serve as the canvas upon which all the other stuff is painted. There is no more important macro fundamental than the dynamics at play between inflation and deflation. This from a blog reader:

"...Inflation after all, is what is happening now. Never mind general prices. They will follow one day after the trade is well in progress. [--Gary]
Principally you may be right. But as Prof. Fekete says, when it takes more credit dollars to produce one dollar of GDP, an economy is devouring itself. We have long passed that point, and I don't think the system is fixable with today's tools. A complete overhaul is required. That inflation is baked into the cake is a given with today's printing orgy. Problem is real deflation can be much faster and more vicious than inflation, because it is a natural reaction over which the banksters have little control. So while inflation is certainly programmed and on the way, deflation might kill the economy first, before inflation ever has a chance to manifest itself in a serious way.

Could you address that question also?
Thanks, Peter"

I am not an economist. I am a business person and a stock trader. Oh, and I happen to be honest about what I see and have seen for many years going wrong in the macro global economy. And I am talking decades, going back to the mid 80's. As the owner of a US manufacturing business; I have watched the global economy stacking itself against me little by little and through various means over the entirety of this time. This constant pressure has forced progress upon me and my company and this progress has been a really good thing.

But I have also carried forward the issue of what the hollowing out of the United States, a great industrial superpower, will do to the country as a whole. The idea that we can consume our way to prosperity has been a constant slap in the face to members of the US manufacturing sector. My company, with its focus on technology and its niche in the vast 'service' industry, health care, has survived. But many less scalable and adaptable companies and industries, have gone the way of the Dodo Bird. That is fine I suppose, in the name of progress, in and of itself. But to think that productivity can be replaced with consumerism has been a recurring slap in the face to people who lost productive jobs in service to this utter, failed mess we now find ourselves with.

I agree with Peter, that we are long past the point of devouring ourselves. We have long since eaten our seed corn in a pathetic attempt to keep up the illusion. I will leave the inflation/deflation mental masturbation to the intellectuals and academics because we really are in uncharted waters, and there is a gaping hole ripped in the hull. Nothing is going to work and the only question is which poison will win out. Deflation is and has been trying to happen for many years. Inflation has been promoted by policy for many years. That is all we really need to know and it is why, dialing back down to the micro, I am a gold stock trader. As long as the system remains intact and lurches forward, they stand to be the big winner for all the reasons I have put forth and continue to put forth in my newsletter.

Meanwhile, here is something I wrote on deflation back in 2004. Again, it is written by a business person, not an economist. I don't see any reason to change my thinking now. I have said all along, that the next real deflation will be the last deflation and the end of the current system. I am not prepared to definitively state whether I believe there is one more inflationary kick save in the making or not. But the system is going to end, sooner or later. Meanwhile, I for one move forward with that depressing fact in mind, as I have for decades. From the article:

The well-spring of productivity has been drained by ever larger government and spending. Not only has productive value been drained, but the spending has continued right off the balance sheet and into mind boggling debt. Thus, a deflationary spiral could only be painful now. The same entities that have told us they will defend us against it are the ones who made it malignant to begin with. I can't help thinking of the Jungian "shadow"; the longer it is denied, the more fierce it will ultimately be in exacting revenge for that denial.

I have read respected analysts who believe deflation is on the doorstep, others who believe it has virtually no chance of occurring while the Fed is on the watch, and yet others who see inflation leading to deflation or visa-versa. I regret to say that what I see, as a member of the real productive economy, is a blow-up of some kind either way as a virtuous continuum of productivity has been destroyed. Furthermore, with the debt levels off the charts and an electorate more concerned about George Bush's IQ or John Kerry's backbone, we are in no position to deal with it either.

To think, it didn't have to be this way.

I hope this at least partially answered your question Peter. Also for reference, regarding deflation being 'much faster and more vicious than inflation', subscriber 'J' addresses Bernanke's predicament nicely. I added his thoughts at the end of a previous post.

Comments

[rick12345:]

The US government has undoubtedly anticipated a certain amount of deflation as a result of the economic downturn. To combat this they have injected huge amounts of new money into the economy, with the desired effect of buffering the country against falling prices. Whatsmore, they will endevour to buy up government bonds in an attempt to freeze the overnight interest rate at a low level, for the short term at least.

Apr 26 07:13 AM

[Bjarne Jensen:]

What is, Jungian "shadow"? A note about lost industries: There is a big difference between losing jobs makeing buggy whips VS. losing jobs makeing cars, or refrigerators, etc. The first is inevitable and good business the second indicates a loss of our "industrial superpower" status. I agree, we have lost the 'economic highground' and the standard of living that goes with owning the high ground. Unfortunately, I am afraid that while the Fed & Treasury probably know we've lost the high ground, the American public will soon learn it.

Apr 26 09:31 AM

[MGA_1:]

We've had manufacturing deflation for years, but I think monetary inflation since around 2001 - just look at the price of real estate & especially gold. I wouldn't look much farther than the fed and also govt with the disabling of lending policies for the reason.

Starting in '08 I really think we were seeing the beginning of a 1930's style deflationary downturn which was really probably necessary to clear out all the bad debt - that was until the govt got involved.

It's difficult to predict the deflationary/inflationary outcome because it's entirely dependent on govt intervention - it really has nothing to do with economics. If the govt decides to continue printing trillions of dollars the inflationary cycle will begin anew. Argentinian hyperinflation is not an impossibility. The thing to watch for is direct purchase of Treasury Bills by the fed. If this begins in earnest we will move down the slippery slope of an inflationary recession.

Apr 26 11:14 AM

[Gregman2:]

"...we are long past the point of devouring ourselves. We have long since eaten our seed corn in a pathetic attempt to keep up the illusion." This is one of the more intelligent pieces I've read. Denial, indeed. Our problem is, as a country, we [and our leadership] do fully
grasp the nature of debt and debt service and the threat it has posed to our system. Debt deflation is real. And it is likely to force a total re-thinking of the neoclassical approach.

Apr 26 01:18 PM

[felixd:]

Your fears are justified, even understated. The currrent US budget now about to be approved still carries the rosiest of all assumptions that growth will appear in qtr 3 and accelerate in qtr 4.Assumptions for growth next year are 3%. The rub of course is that those assumptions are now hopelessly optimistic, which means the buget defict is going to be much larger than you report. Borrowing costs can only grow as govt receipts come in far lower than govt now assumes. To be sure, we are in for one rough ride when we face the unavoidalbe choice of cutting spending, raising taxes even more, and/or inflating away our debt, all while we attempt to or find some other foreign rube to buy about a $1 trillion a year in bonds....each year.. for at least 10 years.

Apr 26 01:28 PM

[Ben Simonton:]

Well said, Gary. Unfortunately, everything you have said is true.

I would add that we have become anti-business and anti-investor, much more so of late, and are causing a slow but sure exodus of business and investment. The latest spending frenzy by our federal government based on the false premise that we can afford anything we desire, as promised to us by the pied piper, is a major step down the road to reduced prosperity. We have been by far the most prosperous nation in the world, but are now rapidly moving away from prosperity while blaming our demise on the cause of our prosperity. Our country has been turned upside down.

We are going to get what we deserve. Sadly, my wife remarked the other day that she is glad we only have one grand-child. She is right. But the process is reversible although history would not support a reversal.

Apr 27 06:57 AM

[Allan Frain:]

No fiat money has ever stood the test of time.

That Americans have seen the system functional for a timeframe in excess of lifespan is deluding.

The money supply must continuously increase, else there is deflation. At the end each fiat experiment the money supply grows exponentially. The referenced phenomenon...

"But as Prof. Fekete says, when it takes more credit dollars to produce one dollar of GDP, an economy is devouring itself."

...is proof that the exponential endgame phase has begun.

Apr 27 07:05 AM

[pragmattist:]

It seems to me that the USD is already hyper-inflated given that the $700 trillion derivatives market and another $360 trillion in credit markets are mostly dollar denominated. Wouldn't the deleveraging process underway in these markets only deflate the USD, as the Fed can never print enough money (which by the way does not require a buyer) to offset the hundreds of trillions of USD deleveraging versus the tens of trillions of EUR deleveraging?

No central bank can allow high inflation. $500 trillion notional value in interest rate swaps would cause a crisis that would make the 2008 CDS crisis look like child's play.

Apr 27 10:42 AM

[pragmattist:]

Isn’t the USD already hyper-inflated relative to other currencies given that the notional $700 trillion derivatives market and another $360 trillion in credit markets are mostly dollar denominated?

Wouldn't the deleveraging process underway in these markets only deflate the USD, as the Fed can never print enough money (which by the way does not require a buyer) to offset the hundreds of trillions of USD deleveraging? Though the Fed is surely trying.

Wouldn't there be a strong USD vs EUR simply because there is more demand for the USD to deleverage USD denominated debt than demand for EUR to deleverage EUR denominated debt?

Doesn't the Fed have more flexibility than the ECB (endogenous QE only) to increase or decrease its balance sheet? Couldn't the EUR get stuck in inflation (if they are able to contain deflation first) a lot easier than the USD from quantitative easing due to that lack of flexibility?

How can any central bank allow high inflation or stagflation? Wouldn't the notional $500 trillion in interest rate swaps cause a crisis that would make the 2008 notional $60 trillion CDS crisis look like child's play? Wouldn't central bankers sell their gold before they let that happen?

It seems to me that central bankers are indeed walking a tight rope between 0 and 2% inflation, but the USD can only gain in relation to other currencies as the deleveraging process brings us back to 1998 levels of GDP. 1998 being the year before Clinton and Congress repealed the Glass-Steagall Act.

May 01 03:30 PM