Jim Bradley

Why Everyone Is Wrong About the Inflation/Deflation Debate

The wise investor will hedge their bets for direction, timing, and duration.

Whether the currency will end at "zero" doesn't tell us the critical issue of whether you or I will make it financially to that point. We could be wiped out by making investment mistakes long before that.

I think the lack of definitive direction and timing is the real crux of the issue here. For example, maybe it will be insane volatility, from one extreme to the other... that's essentially "none of the above".

All sorts of arguments can be made. Have you considered whether the authorities CAN inflate? Of course, in the abstract they can "do" anything, but creditors might hammer the bonds and force the government to either yield to deflation or go "all in" and hyperinflate. How anyone "knows" what the authorities will do and what the market will do is beyond me. It's a complex system that isn't predictable to that extent.

I have a suspicion, depending on the number and severity of the inflationist arguments, that we may be in for a period of the opposite. But I can be wrong like anyone else. We'll see...

BTW, oil at $72 isn't price inflation unless the trade weighted rise in oil is higher than the trade weighted declines in non-oil prices. Taking into effect all prices, we are closing in on the zero point, but we're not into the price inflation zone yet. And if we do go positive, the question is whether it accelerates, or rolls over in six months.

On Oct 15 08:48 AM Carlos Lam wrote:

> This statement by the author is incorrect:
>
> ---------
> 1 - No one really knows or can possibly know what the "endgame" will
> be ...
> ---------
>
> All fiat currencies eventually return to their true value: zero.
> Eventually, the dollar will fall. It probably will not occur for
> decades, but a wise person will position his assets to deal with
> such an eventuality. Indeed, the warning signs are evident:
>
> * gold surging to new nominal highs
> * oil at $72/barrel even though the economy is on its knees
> * the dollar falling against major foreign currencies
>
> Knowing that the signs of devaluation/depreciation are evident, the
> wise investor will try to move out of the dollar as much as possible.

Why Everyone Is Wrong About the Inflation/Deflation Debate

Chap08: Here's what I'm looking at: In August of 2007 the securitization market seized up (I traded many bonds in this market as it collapsed nearly overnight - fortunately I did not rely on traditional hedging) ... that was when gold took off. During this time, the S&P tried one more time to rally, then fell for 7 months before gold showed any downtrend. Gold and stocks lagged the events significantly.

Then, Gold bottomed and took off 4 months before the stock market and a year before the credit markets.

A casual look at the CPI (not the best stats) will demonstrate that gold, even after eliminating the "froth" in the market in the 80s, did not protect any investors against inflation as it persistently sold off for two decades.

Gold was also uncorrelated to the dollar for a long time, as gold fell and the dollar rose or fell ... that is until more recently.

Basically I think the argument that gold responds to "inflation" and "deflation" hasn't been well verified over time. In fact, we haven't had real deflation (contraction of spendable funds and declining prices) by any measure, until just recently.

Take care.

On Oct 15 08:17 AM chap08 wrote:

> If everyone is wrong, would that include you too Jim? I think this
> is a good article and you have a number of things right, but I disagree
> with you on gold. You note "the huge fall in the price as inflation
> continued for decades". What you are talking about is a period of
> declining inflation (from the start of Volcker's medicine and then
> thru the 90s). Inflation fears disappeared. That's why gold fell.
> It went from a period of inflation panic to one where inflation risks
> were forgotten. Gold turned upward again when commodity prices and
> inflation fears returned in this decade.
>
> In your theory, the gold price depends on a "solid foundation under
> dollar assets - and the foundation can be broken by either a higher
> risk of price inflation or price deflation". If that was the case,
> then gold would have raced up when doubts about the "solid foundation"
> and deflation fears came to the fore last year right?? Wrong, gold
> fell ~30% and bottomed at the peak of the panic. Equally, gold would
> have sold off as confidence in the "solid foundation" returned this
> year, right?? Wrong, gold has rallied ~45%.
>
> Gold is where it is because we have policies that lead to a weak
> dollar and inflation. If we turn back towards deflation and get a
> dollar rally, then gold will do what it did last time and sell off
> 30%.

Inflation or Deflation? How to Tell

JeffDB - Perhaps you are right, and while I can agree it's wise to hedge both sides, I don't see you pointing to a mechanism with reliable data that money is being put (or about to be put) in great volume into the economy that isn't kept by or returned to the banking system to stay. What's left is curtailment of supply on essential goods, and I certainly agree with 'non-housing essential goods inflation' but not with 'overall inflation'.

In my view, your case is best supported by monetized government deficits, which would appear to be a one-shot: in other words, it quickly hits banking system where it stays as banks have a rough time finding enough good borrowers to really make a money expansion. Over time, deleveraging is offset by money printing, but so far that's not inflationary.

If you've got a mechanism that you can point to, I might agree ...

On Sep 09 04:28 PM JeffDB wrote:

> On Sep 09 03:30 PM Jim Bradley wrote:

Inflation or Deflation? How to Tell

Jeff - The increases of transactions money (M1) is not flowing through the system to generate new deposits (which are show by the graphs above), so there's an effect in M1 which isn't being fully transmitted. While the rate of M2 growth has been high, it is slowing, not increasing. See M1 at research.stlouisfed.or... and M2 at research.stlouisfed.or...

The bottom line effects are mixed, but I believe the recent monetary changes will show a pop in inflation, then it will settle down later. If recent data holds, it already is.

On Sep 09 12:55 PM JeffDB wrote:

> "First question is then, is money (cash plus deposits) rising or
> falling?
>
> Answer: it is rising slowly."
> ------
>
> But according to the Fed's numbers, M1 (Cash in circulation + Current
> Deposits Held by Money Holders at the commercial banks) www.federalreserve.gov...
> has gone up 19.9% year over year, which I would consider rising a
> bit more than "slowly".
>
> M1 (billions of $) research.stlouisfed.or...
>
> 1383.3 8-16-08
> 1658.2 8-17-09
>
> Graph: www.scribd.com/doc/193...
>
> If you add in (All types of Deposits Held by Money Holders at commercial
> banks) - ie money market funds, etc. we would have M2 which as risen
> a little in excess of 8% year over year, which I would also consider
> a little above "rising slowly".
>
> 8312.4 8-17-09
> 7691.4 8-18-08
> 621 / 7691.4= .0807 increase year over year
>
> research.stlouisfed.or...
> Graph: www.scribd.com/doc/193...

Inflation or Deflation? How to Tell

Jeff - Is it your feeling that the distribution of the funds matters? I just don't see the dispersal (yet) to make that case. I think your best argument has to do with the destruction of supply via government increasing the impediments to production while running a loose monetary policy as was done in the late 70s. But is that occurring faster than the effects of the restructuring? I don't think over the next few years that it will.

While looking at health care, oil, food, etc. I do believe those items will continue to show strength. However for your analysis to be correct, those items would have to rise (on a trade-weighted average) more than other items will drop. In my view, households are more and more on a tight budget, so increased expenditures on item X will mean decreased expenditures on item Y unless there is an 'expansive' financing mechanism (such as new debt creation).

Since my expectation is for prolonged restructuring and continued distress, perhaps your view is different.


On Sep 09 02:22 PM JeffDB wrote:

>
> On Sep 09 01:50 PM Jim Bradley wrote:

Inflation or Deflation? How to Tell

Tony - you don't consider the drop in housing costs by near 50% a significant factor? Basically the CPI didn't measure the housing cost inflation on the way up, nor did it reflect the drop on the way down. While it's hard to separate the price changes from relative pricing adjustments from monetary effects, there still is a strong argument to be made that the run up and down wasn't properly reflected.


On Sep 09 02:26 PM Tony Daltorio wrote:

> Japan - a very small, closed society is NOT a valid example to compare
> to the US. The actions the Japanese took is nothing like the actions
> the Fed has already taken and WILL take in the future.
>
> Also please tell me where the much-vaunted deflation is except in
> the price of assets (housing, US stocks) that had reached bubble-like
> valuation levels?? It's not in the cost of living - utilities, energy,
> fuel, healthcare or elsewhere like wages,etc.
>
> Deflation is nothing more than a fairy tale invented by Wall Street
> and Washington to get more government spending and to get dumb investors
> to buy Treasuries at near zero percent.
>
> Even back in 2002, Ben Bernanke was spinning myths about the dangers
> of non-existent deflation.

The Fed Has Made the Entire U.S. a Hedge Fund - Get Your Portfolio Ready

otbricki, constructe, simple accountant, others - The plan is not a gold standard, but a dual monetary standard giving people the choice of their asset to use as money. Monetary competition is what keeps the government honest. That is the proposal. In effect, it simply codifies what now exists because people want an indestructible *asset* as money not someone else's debt as an "asset". Debt can disappear, while gold is near indestructible. If the demand for dollar transactions rises, the gold price will fall, and the Fed will need to increase settlement money to keep the gold price steady. That's it. It's simple and effective.

Pulling out money is good advice to people that stand to take losses from being exposed and it also cures the system. The bottom line is the "finance" industry is way too big and has to shrink. That can only happen if a number of weaker players fail. I reject the idea when it's time to shrink, the weaker players in finance get to drain the rest of the economy to keep going. that's the "Japan" solution which is many times worse than a correction. Even worse, if the government backstops this, it may run into making itself financially insolvent and then the mother-of-all-depressi... will occur.

We can survive a 1 year correction. But losing 15 years of your life like happened in Japan? How do you get that back? Let's make the tough choices now and have a brighter future...

What is Countrywide's Lending Operation Worth?

sunburned - Depends if a buyer can separate their operations from their obligations. That's why the analysis focused mostly on the operations. With their obligations, you'd have to come up with a loss severity estimate (i.e. how bad is housing going to get) before a final figure emerges. I've given a few ballpark estimates of severity.

Why The Inflation - Deflation Debate Doesn't Matter

L. Bow - Split the bet by buying a consistent dollar amount of different assets over time (monthly, bi-monthly, or quarterly). When a particular asset goes up, you automatically buy less of it relative to the other assets in your portfolio. You should rebalance your asset allocation periodically (usually each year) to move gains in rising assets into cheaper assets.

Example: save $250 per month and buy a commodities fund. At $20 per share you're going to buy more than if the fund share price is at $40. Hopefully your savings will increase over time (more income), but it should remain consistently upward as much as possible. The strategy works best when emotion is taken out, and varying the amount of savings means the investor is exposed to the emotions of the market and will usually tend to do worse.

If an investor had done this since 1980, by 2000 they would have owned a substantial amount of gold and non-dollar assets by taking their stock gains and buying gold and commodities. Although the investor would have lost the compound stock gains from 1980 to 2000 in the short run because of portfolio rebalancing, the risk profile is far different as the gains are not subject to catastrophic losses and periodic buying means the average asset isn't bought "at the peak". The protection of gains becomes more and more important the closer to retirement a person gets. This is a long run savings plan which tends to do very well.

The only environment in which the plan fails (as all plans would) is under a severe deflation when the investor is forced to sell at the worst time to survive. In reality, an investor can time the market to some degree by changing the rebalancing frequency of the portfolio. As a particular market goes asymptotic which the investor owns, rebalance the portfolio more frequently to reduce the risk.

Why The Inflation - Deflation Debate Doesn't Matter

flow5 -- MZM is growing because no one wants to "go long risk" ... if an investor sells mortgages and buys money market fund assets, that's not "soaring inflation" but a restructuring of debt ownership. The context makes all the difference.

Reserves haven't been binding for a decade, true ... and all that time credit has expanded, which means leverage is higher, not lower. That means if there's any financial accident, leaving reserves roughly the same is a policy of deflation.

A collapsing dollar is from past inflation .... We'll see if the Fed inflates by expanding money, or if the market decides to revalue existing credit (which would be inflationary).

Finally, rising prices isn't inflation. If I buy Xs and Ys, and Ys go up by $100 and I buy $100 less Xs, that's not inflation. It's when Ys go up by more than Xs go down (price x volume) that we can be assured inflation is occuring. When house prices went up ... and nothing went down, that was inflation.

The Fed is Deflating: 10 Reasons Why

pater - the most interesting thing is that your argument validates the reverse position. If it is true that the banking system net settles and can do with near zero liquidity, then it is true that leverage is off the chart. That makes liquidity more powerful, not less powerful -- and the analysis here more relevant. Good luck to you.

It's Either Inflation or Deflation - Not Much in Between

Lucia - For most financial institutions, it would not take much (as a percentage of assets) to wipe out the equity. Unfortunately, for a number of financial firms, the quality of the assets is not transparent, meaning there is unknown, but potentially fatal, risk.

It's Either Inflation or Deflation - Not Much in Between

BlueSky&Sunshine - In my view the inflation / deflation debate is too aggregative, but it does help to present the basic issues.

If you work in a "long maturity" industry (takes a long time to come to market with a viable product, especially one which is financed on credit) you will likely be hit hard, while consumption goods will zoom upward. Even if there's no net inflation, imagine losing everything being in the wrong industry, while your expenses still rise!

What matters is which prices do what.

User 167683 - You're right. It sure makes sense, if possible, to have assets in a variety of places, even out of the country (like quite a few congresspeople do).

The Fed is Deflating: 10 Reasons Why

special1person - It's important to distinguish between credit (M3 or L) and money. Money hasn't expanded at all to keep up with leverage. In fact, leverage is vaulting higher because equity is shrinking (asset losses) while investment houses have been forced to hold paper they don't normally.

While I can't say what the Fed or the international dollar market will do, I can definitively say (if the Fed's balance sheet is to be believed) what the Fed has done in the last 2 years.

Now that the Fed has opened up their discount window to Investment banking houses, failures may slow down, and that can be inflationary if liquidity expansion increases substantially while supply constraints still exist ... but the effects now will be felt down the road, not immediately. Past policy is having effects now (witness the sudden collapse of Bear Stearns and failure of 240 mortgage banking companies).

Even with significant expansion of liquidity and price-volume effects, continued losses will likely pressure and may still take down more major players. That can, by the way, still happen in inflation. We'll see.

The Fed is Deflating: 10 Reasons Why

Damienh - M3 is a broad credit measure with very little consistent connection to long term price inflation.

ItsJustMe - CIA stats put Chinese GDP at more than 7 Trillion on a PPP basis. I suspect the actual figures of Chinese vs. U.S. are closer than the official stats, especially since the U.S. has been fudging the CPI numbers for some time.

StateofConfusion - Keep a portion of assets in physical cash and physical gold. The point is whether we have inflation or deflation depends on a number of factors. The underlying secular trend is inflationary, while periodic cycles speed up and slow down that trend. It can switch violently if the Fed is unsuccessful.

Big Jim Slade - I concur with your sentiment. However, its very unlikely the losses will be monetized except over a long period of time. If the markets thought the losses would be quickly monetized, it would immediately bring on hyperinflation (dumping the dollar) and the only way the Fed would "remain in business" would be to vigorously deflate credit and money so substantially that a good portion of the banking system would go down. Only the most well capitalized companies would survive and they would then be a buy. The market can ask for and get deflation if the market overcomes the central banks attempted support of the dollar.

The whipsaw would be unbelievable (inflation to deflation and vice versa). I don't think anyone really can reliably make out on that volatility except to hold both sides of the fence: cash and gold.

Stanley - The Fed is actively deflating at the same time trying to prevent the settlement system from going under.

MarkInSF - Commodity prices are price inflation from prior credit and money inflation, not present credit and money inflation. The Fed will likely reverse course and begin inflating at some point in the future, but it is not doing so yet.

Thank you for the opportunity, everyone. Good luck in this investment climate.