Speculative Thoughts on Possible Future Trends

by: Katy Delay

In reading the daily commentary of the American Institute for Economic Research for April 29, 2009, my speculative little crystal ball began to light up. AIER is the only serious business cycle analyst group that points out reality, and that reality is that contraction is everywhere in the stats, in spite of the recent "good news" in the stock market. (Desperate exuberance, anyone?)

So let's think it over.

We all agree that the government and the Federal Reserve are doing their best to prevent a deflationary spiral, to un-freeze credit, and to save major industry players from precipitating us all into a deep depression. Money supply creation is high, and we can see that the Fed's balance sheet has never been in a more inflated state.

According to some signs, these policies seem on the surface to be taking effect. Sales of existing homes are turning around, and the stock market is maintaining its rally. Meanwhile, the money supply is expanding by an annual 8.1 percent, while at the same time the CPI is stable or falling.

If past experience is any indication, it would seem logical that we are headed for an arrest--and perhaps even a reversal--of price deflation; and if the money creation continues unabated, as would seem inevitable given current Fed policy and the expansionary will of the administration, inflation should be the outcome. Some are even talking about hyperinflation.

But I have a slightly different crystal-ball image (which could of course change tomorrow). Keeping in mind that this is just a game, and that no one's fortune telling is better than anyone else's, just for fun I thought I'd throw this out.

Hyperinflation is not in my crystal image. This is not post-WWI Germany or Zimbabwe, in spite of the way things look. What is the reason? It's not because there is no monetary excess going on; it's because, unlike the world of speculative finance, a good part of American industry is too savvy to get caught up in the exuberance.

In fact, American industry has been savvy for a long time, at least one century or more. In pre-1929, over-issued money supply did not all pour into consumers' hands, where it must be before it can create hyperinflation. In the decade leading up to 1929, prices were relatively stable, yet money supply grew. Where did it all go? What did inflate was the stock market, which experienced a huge run-up that burst and started a cyclical downturn.

Why didn't the country experience general price inflation? Economists speak of nominal inflation versus real inflation. Nominal inflation can remain low or non-existent, even as real inflation grows. Prices are stable, whereas they should be falling. This is what happened in the 1920s. And American industry knew this, while the Fed governors pretended not to (or were too inexperienced to realize it).

Later, during the long inflationary run of the second half of the 20th century, industrial market players and their public adjusted to chronic price increases. It's similar to what we do as we grow older and wiser: We get used to living with low-grade arthritis pain. This chronic inflating, however, culminated in another stock run-up and the acute crisis of the 1970s, which some say was deeper than that of the 1930s in real terms.

But we got over it and it didn't take too long to get back to our arthritic monetary ways during the 1990s, helped by urgencies in the savings bank industry and in the commercial banking industry's politically motivated foreign investments. This time, the inflationary run popped in 2000 and 2001, having inspired another stock market bubble. By now, we were so good at putting up with pain that we returned immediately to our bad habits, creating the real estate and credit-speculation bubbles that have dropped us to where we are today.

Instead of taking our medicine once and for all, we're off to the races again. Today's crystal ball tells me that we will get a renewed stock market mini-hyperbubble, along with a government stimulus maxi-bubble targeted to specific groups of rent-seekers (special interest groups like financiers, government workers and programs, construction conglomerates, unions, and the like). While this is going on, general prices will remain fairly stable, and banks and investment houses will go right back to their speculative games. Gold and commodities may go through a mini-hyperbubble as well.

But the business cycle really wants to contract. This time, the arthritic pain is too acute. Look at the stats at AIER. It's possible that real industrial GDP may not progress, even though government stimulus money may creep in, pushing up the digits for a while. But keep in mind that government stimulus must be paid back by future capital, depriving us in the coming years of investment in real industrial GDP. The figures will mislead us all. But American industry knows this.

So to conclude, we could get some short-lived hyperbubbles in the stock market and commodities, but they might deflate and run out of exuberance for a while. The maxi-stimulus fake bubble will run out of public support for sure. GDP will eventually dive again and will become chronic stagflation as the increasingly impotent government and Fed blow stimuli through the system like air bubbles in a fish tank. Most of the new air will dissipate through short-lived financial speculation. (Japan, anyone?)

Keep in mind that, having exposed my insights to you today, I'll probably rethink this whole crystal vision by my next blog. But if the deflationary business cycle fights back and ultimately wins this contest between it and our desperate government and Fed efforts, expect bubbly stagnation for a good while, until industry decides it's time to make a come-back. Then we'll probably get the inflation we've been fearing.