Will Deflationary Forces Overwhelm Global Fiscal Stimulus? 40 comments
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While Uncle Sam and his international brethren are doing everything they can to reflate the global economy, will the deflationary forces deeply embedded in the deleveraging process carry the day and the future? In doing so, will these deflationary forces usher in an economic dynamic not seen since the 1930s?
The analysis and review by market savants, media mavens, and government pundits is ultimately mere noise relative to the denouement of the question proffered above. Jeff Gundlach, of Trust Company of the West, has spoken his mind and believes deflation will ultimately weigh upon our economy and markets. Today I share with you Deflation Rising: Making the Case for a Lasting Deflationary Environment recently produced by Black Swan Trading. High five to loyal Sense on Cents reader Ben for sharing this report.
The professionals at Black Swan produce a thoroughly superb and comprehensive review of this critically important topic. I strongly encourage you to put this post in your “Save” box for further review as we navigate the economic landscape. The report is launched as follows:
“If Americans ever allow banks to control the issue of their currency, first by inflation and then by deflation, the banks will deprive the people of all property until their children will wake up homeless”
Thomas JeffersonUncle Sam, whom we’ve dubbed the “stimulator of last resort”, is doing all it can to create some inflation. Inflation creation, through the debasement of money, is one thing governments have proven historically they do quite well.
Inflation bails out creditors because it allows them to repay debt more cheaply in the future, paying back the nominal value of debt with currency that loses a substantial amount of real value.
There is no bigger creditor than government.
But that said, at the moment it seems governments are losing the battle of inflation, to deflation, despite pumping money into the market around the clock.
This report makes the case for deflation. In it we examine the powerful deflationary headwinds that could lock the US and global economy into years of deflationary pressures that are reminiscent of the lost years in Japan when they became locked in a deflationary bear hug.
The report puts forth a wealth of compelling evidence for the deflationary case. The evidence covers the following topics, complete with numerous graphs and analytics:
- Relationship between gold and the U.S. Dollar
- Growth in money supply
- Review of decline in the Consumer Price Index
- Lack of Velocity of Money
- Increase in bank reserves
- Decline in outstanding consumer credit
- Decline in nonfinancial corporate business credit
- Discretionary spending reaches 50-year low >>>the writers posit that consumption will be much more dependent on income than credit
- Decline in personal income
- Structural headwinds in global economy including:
- U.S. economic policies
- likelihood of asset bubble in China
- dynamics in the oil and food markets
After an exhaustive, but not exhausting, 22-page review, the writers make a compelling case that the lessons of The Lost Decade in Japan will now very likely be played out here in the United States. What plagued Japan during that decade and to a great extent even today….deflation.
Additionally, the buildup of leverage within our economy took place over a 20 year time frame with a few significant hiccups. To think that our economy will be able to delever and recover within a year or two is beyond naive. I would project this delevering, adaptation, and recovery process will take at least five years if not longer.
Whether you place yourself in the deflationary camp, the hyperinflationary camp, or somewhere in between, do yourself the favor of reviewing this report. In the process, you will be more educated and qualified to navigate the global economic landscape.
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The issue is not whether the Fed can beat deflation - that's the easy part. Of course the Fed can beat deflation. Just like Volcker could beat inflation if he wanted it bad enough, Bernanke can beat deflation if he wants it bad enough. All he has to do is monetize enough spending and put the dollars directly in to the hands of eager consumers or tax payers. Game over.
The real issues are:
1) Do they have the commitment required? and
2) What damage will they cause?
My reading is that they certainly have the commitment. If you see Bernanke and co. as closet deflationists then good luck to you. They will need the cooperation of the government if they have to go the extra mile, but no government has ever preferred deflation to inflation. So commitment will not be a problem.
As for damage, make your own estimate. Me, I own gold.
Also, regarding gold, I agree with their view that "If deflation prevails, we think the dollar goes higher and gold falls." Many on SA, irrationally in my view, take the opposite position.
You hit the nail on the head. It's really that simple.
The ongoing deflationary discussions, and relentless comparisons of the present to the '30's, frankly, amazes me, since the two situations could not be more polarly opposite. In the '30's we had a money supply that fatally contracted (1929 levels were again reached in 1938), but today we have a worldwide flood of monetary infusion.
The results will not be similar, nor would it make any sense if they were.
On Sep 29 06:28 AM chap08 wrote:
> Thanks for the report. I agree with parts and disagree with others
> e.g. the optimistic view of oil supply. The main point though is
> that they, like every other deflationist argument that I have seen,
> fails to characterize the issue correctly.
>
> The issue is not whether the Fed can beat deflation - that's the
> easy part. Of course the Fed can beat deflation. Just like Volcker
> could beat inflation if he wanted it bad enough, Bernanke can beat
> deflation if he wants it bad enough. All he has to do is monetize
> enough spending and put the dollars directly in to the hands of eager
> consumers or tax payers. Game over.
>
> The real issues are:
> 1) Do they have the commitment required? and
> 2) What damage will they cause?
>
> My reading is that they certainly have the commitment. If you see
> Bernanke and co. as closet deflationists then good luck to you. They
> will need the cooperation of the government if they have to go the
> extra mile, but no government has ever preferred deflation to inflation.
> So commitment will not be a problem.
>
> As for damage, make your own estimate. Me, I own gold.
>
> Also, regarding gold, I agree with their view that "If deflation
> prevails, we think the dollar goes higher and gold falls." Many on
> SA, irrationally in my view, take the opposite position.
Will deflation save the US Dollar? Not necessarily. We'd expect deflation to spur TBond buying as higher yields kick in. But deflation will not support the US Dollar if the threat of government default on its bonds becomes an issue. Then TBonds will become junk-bonds, with high yields but with only speculative purchases. The US is taking on a huge debt burden -- and, at the same time, government tax revenues are diminishing. Will we be able to service this growing debt? And with foreign buyers of TBonds leaving the scene, who will buy these bonds when the Fed runs out of will to keep interest rates low? Then rates will rise swiftly, and if there are no buyers they will rise very high, becoming essentially junk bonds. Will investors rush in to the high-yield bonds? Only if they are convinced that America is solvent.
Historically, gold does well in deflation periods because it is NOT a commodity, it is a currency substitute. If you look at an historical chart of gold prices, you'll see gold does well during deflationary periods also. Gold is a hedge against inflation; it is also a hedge against stocks.
What will be interesting is if history repeats itself despite the expansion in money supply. It will torpedo every economic model ever created.
I think sustained deflation is unlikely, the fed will simply flood the economy with money.
It is in the interests of the USA to create inflation in the medium term.
What work during the expansion cycle (bubble inflation cycle) don't work during the contraction cycle (bubble deflation cycle). Today's spending is NOT WORKING either.
Full quote:
“We have tried spending money… We are spending more than we have ever spent before and it does not work… After eight years of this Administration we have just as much unemployment as when we started.” - Henry Morgenthau, Jr., FDR’s Treasury Secretary, 1939
I also agree that bond yields may rise. Personally I can't see the mercantilists or the oil exporters stopping the buying, although they may reduce some. This will just add to the pressure on the dollar and so inflation. You also have to wonder what would happen if we couldn't sell enough bonds. Would the govt cut back on spending? Unlikely, certainly in the short term. Much more likely that the Fed would monetize the difference. So again, inflationary.
As for gold in deflation, where are you looking, the 30s? As you will know, we had a gold standard then. Gold only went up in dollar terms in the 30s because of a deliberately inflationary act - shifting the gold standard from $20.67 to $35. That's the kind of dollar devaluation that even Bernanke would be proud of! They did that to introduce inflationary forces - and it worked. CPI went from double digit negative, to positive. If they'd wanted more deflation they would have revalued the dollar form $20 to $10. People who say that "we had deflation in the 30s and gold went up" are misreading what happened.
Now we have fiat - the complete opposite.
On Sep 29 06:58 AM Michael Clark wrote:
> In a word, 'yes'. Deflation will overwhelm the global stimulus spending.
>
>
> Will deflation save the US Dollar? Not necessarily. We'd expect
> deflation to spur TBond buying as higher yields kick in. But deflation
> will not support the US Dollar if the threat of government default
> on its bonds becomes an issue. Then TBonds will become junk-bonds,
> with high yields but with only speculative purchases. The US is
> taking on a huge debt burden -- and, at the same time, government
> tax revenues are diminishing. Will we be able to service this growing
> debt? And with foreign buyers of TBonds leaving the scene, who will
> buy these bonds when the Fed runs out of will to keep interest rates
> low? Then rates will rise swiftly, and if there are no buyers they
> will rise very high, becoming essentially junk bonds. Will investors
> rush in to the high-yield bonds? Only if they are convinced that
> America is solvent.
>
> Historically, gold does well in deflation periods because it is NOT
> a commodity, it is a currency substitute. If you look at an historical
> chart of gold prices, you'll see gold does well during deflationary
> periods also. Gold is a hedge against inflation; it is also a hedge
> against stocks.
The idea that we're going to suffer some kind of sustained deflation in the current monetary flood borders on ridiculous. For deflation to occur dollars have to be worth more, not less. Any signs of that? The huge increase in money supply would be similar to farmers all coming to market one year with twice as many apples and expecting a price increase. Not happening.
On Sep 29 07:44 AM Michael Clark wrote:
> I'm reminded of the quote of FDR's Treasury Secretary in 1939 after
> 7 years of governmental flooding the markets with money: "We've spent
> money...AND IT DOES NOT WORK!"
>
> What work during the expansion cycle (bubble inflation cycle) don't
> work during the contraction cycle (bubble deflation cycle). Today's
> spending is NOT WORKING either.
>
> Full quote:
> “We have tried spending money… We are spending more than we have
> ever spent before and it does not work… After eight years of this
> Administration we have just as much unemployment as when we started.”
> - Henry Morgenthau, Jr., FDR’s Treasury Secretary, 1939
Countries that suffer banking crises endure steep drops in output that do not rebound for at least seven years, the International Monetary Fund said on Tuesday in a study it called “sobering” for the long-term productivity prospects of many economies.
As hopes strengthen that the global economy is recovering, the IMF pointed out that banking crises usually leave “long-lasting scars” on countries, knocking an average 10 per cent from output per capita.
Propping up over leveraged asset prices will not end well. I agree with using the financial tools for softing the landing but prices were out of control, houses, energy, food. Some deflation is good after the debt fueled inflation that peaked last year.
Bernanke has the tools to beat deflation overnight. He is simply juggling chainsaws hoping that he can manage the process to avert a crisis. Good luck to him.
"It will take a center right government to rein in entitlements and control spending"
They are equally incompetent as they proved the last 8 years. They left a system without any redundancy in case of a mishap. A politician who can potentially fix the problems is simply unelectable.
On Sep 29 10:39 AM Formyx wrote:
> @Geoffster
>
> "It will take a center right government to rein in entitlements and
> control spending"
>
> They are equally incompetent as they proved the last 8 years. They
> left a system without any redundancy in case of a mishap. A politician
> who can potentially fix the problems is simply unelectable.
Quoting Jim Jubak, this meant that:
"In 1937, the Roosevelt administration and the Federal Reserve moved to reverse many of the extraordinary measures they'd taken to fight the Depression. In 1937, the federal deficit was cut to $2.5 billion from the previous year's $5.5 billion as Roosevelt and Congress slashed spending by 18%...... The Federal Reserve moved in the same direction. After pursuing policies that had resulted in an average 11% annual increase in the money supply in the previous four years, the Fed reversed course at the beginning of 1937 and began to contract the money supply"
which resulted in:
"Unemployment, which had marched down from its Depression high of 25% to a low of 14.3% in 1937, climbed again, hitting 19% in 1938. Personal income dropped 15% from its 1937 peak. And manufacturing output fell 40% from its 1937 peak, all the way back to the levels of 1934."
I will place a large bet on Bernanke and Obama not repeating the mistakes of Morgenthau. They will make other ones instead.
On Sep 29 07:44 AM Michael Clark wrote:
> I'm reminded of the quote of FDR's Treasury Secretary in 1939 after
> 7 years of governmental flooding the markets with money: "We've
> spent money...AND IT DOES NOT WORK!"
>
> What work during the expansion cycle (bubble inflation cycle) don't
> work during the contraction cycle (bubble deflation cycle). Today's
> spending is NOT WORKING either.
>
> Full quote:
> “We have tried spending money… We are spending more than we have
> ever spent before and it does not work… After eight years of this
> Administration we have just as much unemployment as when we started.”
> - Henry Morgenthau, Jr., FDR’s Treasury Secretary, 1939
Oil is having a hard time staying above $70. Gold? Well, hard to say how much of the valuation is speculation and flight to safety not tied to the dollar. Gold should fall as the dollar strengthens in deflation, though, all other forces being equal. They are not equal with all the volatility in currencies and the markets (threat of double dip.)
I understand the problem to be the fed's limited ability to affect global liquidity. The Fed only controls (guessing) around 10% (8% a year ago, haven't seen figures since.) It's the falling liquidity. I argue the de-leveraging (credit destruction, as mentioned above) that is the source of global deflation and the Fed just cannot keep up. Indeed, the world's central banks cannot...or will not. I argue inducing inflation is not the easy part, it's actually proving quite hard to do. All money is contracting: dollars, euros, yen...and velocity is way down.
Wanna see inflation? Get the banks lending, again. Let loose the derivative market. Balance trade. Oh, yea, baby...coupled with the unprecedented easing, that's inflationary. Lending and borrowing are down, the derivative market will be regulated, and China said, "no."
The government will not default, to do so would be political suicide ending with the destruction of American dominance (which could end for other reasons, so...) We've had heavy debt before and paid it down. I see no reason why it can't be done, again.
I agree with one poster above, we're in this for a long haul...with significant scarring. A market rally does not a V shaped recovery make.
In the chart below, the first column is the CPI, 2nd column % price of gold increase, third column % price of silver increase.
Trend 1. Commodities price index (% change) 2. Silver's purchasing power (% change) 3. Gold's purchasing power (% change)
1623-1658 Inflation +51 -34 -34
1658-1669 Deflation -21 +27 +42
1675-1695 Inflation +27 -13 -21
1702-1723 Inflation +25 -18 -22
1752-1776 Inflation +27 -22 -21
1792-1813 Inflation +92 -33 -27
1818-1851 Deflation -58 +69 +70
1873-1896 Deflation -45 -6 +82
1897-1920 Inflation +305 -61 -67
1920-1933 Deflation -69 +32 +251
1934-1979 Inflation +2,149% +241 +27
Source: Silver: The Restless Metal, Roy Jastram (Wiley, 1981)
On Sep 29 08:55 AM chap08 wrote:
> Michael, I agree that the dollar is likely to have problems. But
> if this happens, it will be inflationary not deflationary. A falling
> dollar will push up the cost of oil, imports, CPI and any other inflation
> measure you choose.
>
> I also agree that bond yields may rise. Personally I can't see the
> mercantilists or the oil exporters stopping the buying, although
> they may reduce some. This will just add to the pressure on the dollar
> and so inflation. You also have to wonder what would happen if we
> couldn't sell enough bonds. Would the govt cut back on spending?
> Unlikely, certainly in the short term. Much more likely that the
> Fed would monetize the difference. So again, inflationary.
>
> As for gold in deflation, where are you looking, the 30s? As you
> will know, we had a gold standard then. Gold only went up in dollar
> terms in the 30s because of a deliberately inflationary act - shifting
> the gold standard from $20.67 to $35. That's the kind of dollar devaluation
> that even Bernanke would be proud of! They did that to introduce
> inflationary forces - and it worked. CPI went from double digit negative,
> to positive. If they'd wanted more deflation they would have revalued
> the dollar form $20 to $10. People who say that "we had deflation
> in the 30s and gold went up" are misreading what happened.
>
> Now we have fiat - the complete opposite.
> On Sep 29 06:58 AM Michael Clark wrote:
On Sep 29 10:01 AM Formyx wrote:
> I agree with Chap08. Fed can use the presses and distribute $100k
> to each household. Voila! Deflation is over.
>
> Bernanke has the tools to beat deflation overnight. He is simply
> juggling chainsaws hoping that he can manage the process to avert
> a crisis. Good luck to him.
I also wanted to show you a chart of the Dow/Gold ratio I put together in an instablog.
I'm working with regular 18 years cycles of Inflation (bubble inflation, credit and debt expansion) which I call Day-Cycles and 18 year cycles of debt deflation (bubble deflation) which I call Night-Cycles.
The chart in the instablog highlights Night-Cycles -- 1929-1947, 1965-1983; 2001-2019 etc. -- in terms of stocks/gold prices. In the stock chart, a high price is a triumph of stocks over gold, a low price indicate a triumph of gold over stocks. Note the general correlation between Night Cycles and surges in the price of gold.
seekingalpha.com/insta...
On Sep 29 08:55 AM chap08 wrote:
> Michael, I agree that the dollar is likely to have problems. But
> if this happens, it will be inflationary not deflationary. A falling
> dollar will push up the cost of oil, imports, CPI and any other inflation
> measure you choose.
>
> I also agree that bond yields may rise. Personally I can't see the
> mercantilists or the oil exporters stopping the buying, although
> they may reduce some. This will just add to the pressure on the dollar
> and so inflation. You also have to wonder what would happen if we
> couldn't sell enough bonds. Would the govt cut back on spending?
> Unlikely, certainly in the short term. Much more likely that the
> Fed would monetize the difference. So again, inflationary.
>
> As for gold in deflation, where are you looking, the 30s? As you
> will know, we had a gold standard then. Gold only went up in dollar
> terms in the 30s because of a deliberately inflationary act - shifting
> the gold standard from $20.67 to $35. That's the kind of dollar devaluation
> that even Bernanke would be proud of! They did that to introduce
> inflationary forces - and it worked. CPI went from double digit negative,
> to positive. If they'd wanted more deflation they would have revalued
> the dollar form $20 to $10. People who say that "we had deflation
> in the 30s and gold went up" are misreading what happened.
>
> Now we have fiat - the complete opposite.
> On Sep 29 06:58 AM Michael Clark wrote: