Follow The Bottom Violation
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Dec
1
Consumer-driven Deflation? Not Even Close
“Inflation is the senility of democracies”
– Sylvia Townsend Warner
If you ask the average person to define inflation, you get this response: “Rising prices.” Similarly, the same person would likely define deflation as falling prices. But both answers are incorrect — in fact, they’re gross misrepresentations of the words, and this simple, but popular misconception is the root of every single economic problem we face today.
Rising prices do not cause inflation, nor are they inflation. On the contrary, rising prices are the result of inflation. Specifically – speaking in terms of the entire economy (as differentiated from individual goods and services) — rising prices always result from an increase in (or inflation of) the money supply – through printing currency, and/or the manipulation of interest rates by any entity controlling the money supply (like the Fed, The ECB, or whatever).
Simply put, inflation is always monetary. Likewise, pulling currency out of circulation constitutes the deflation of the money supply. Falling prices are not, in and of themselves, deflationary. Indeed, if prices are falling, but the government is printing more money, then the economic environment is properly described as inflationary. Remember, inflation is defined as the printing of money, not as rising prices.
And so here we are.
You may be unaware of the fact that the authorities controlling the status quo – namely Ben Bernanke, Barack Obama, and all their little elves – actually want you to use the words inflation and deflation incorrectly. You might also make the claim that I’m merely splitting semantic hairs – that these definitions are insignificant in the grand scheme of things. But that’s not really a good argument, because if the majority of people believe we are in a deflationary period, despite the fact that the Fed is printing money at the fastest rate ever, well, then we’re not preparing for the inevitable. We are certainly not in a deflationary period – nor have we been for many, many decades. And the “inevitable” to which I am referring is an incalculably rapid rise in prices across the globe.
If you think about it, it makes sense: more dollars in the economy mean less valuable dollars. Money is just like everything else — it has value, and the laws of supply and demand are every bit as applicable to currencies as they are to everything else: the larger the supply of money, the lower its value.
In the midst of all this misapplied talk about deflation, one of the main arguments I keep hearing is that the main reason prices are dropping — on everything from real estate to electronics – is that consumers are waiting for bargains; as such, they won’t spend now.
In the last twelve months, I’ve heard and seen my share of specious arguments, fantastical predictions, moronic conclusions, and positively farcical objectives — from all measures of wannabe (and practicing) politicians and economists. But this idea that consumers aren’t spending because they are waiting for lower prices is just absurd. And the ensuing leap of logic, that consumers are responsible for a so-called “deflationary” environment is positively imbecilic — for at least two reasons.
First, it’s a misapplication of the word deflation — as I pointed out above. Second, while it is true that the average consumer isn’t (and won’t soon be) spending as much as he used to, it’s not because he’s waiting for bargains. No, it’s because he’s out of credit, he’s unemployed, his house, car, motorcycle, boat, and plasma television have all either been repossessed or foreclosed upon, and his wife just left him. He’s not exactly in the mood for shopping. He’s not waiting for bargains. He’s waiting for a miracle. And I don’t think they sell those at the mall.
You think consumers really stop spending in anticipation of lower prices later? Really? Ever heard of Moore’s Law? The one that says the price of technology will be halved every 18 months? Buy a computer today, it will be worth 50% of that value in a-year-and-a-half. So, in an industry like technology — where real prices consistently fall — do you really believe that most people put off buying products in anticipation of lower prices? I mean, it happens, but it’s not the exception, not the rule.
Consumers, for the most part, do not postpone purchases — even in an industry like technology. This is only borne out by the fact that the technology industry has been one of the fastest growing and profitable in our economy for decades. People will pay today – even in the face inevitable obsolescence.
So let the pundits talk about deflation all they want, but we know (or should know) the truth: the money supply is not shrinking. And even if the prices of most asset classes are still falling – which is arguable, at best, in real dollars — consumers do not postpone purchases in anticipation of lower prices. And they are not causing “deflation.”
Say it with me: we are in an inflationary environment. How do you think the government is going to pay for all of the trillions of dollars it has promised to spend over the next two (or more) years? I’ll tell you how: it’s printing dollars. Lots of them. The money supply has been increasing for decades — lately, at a faster clip than ever. In fact, the line just went vertical — as you may remember from a chart I posted in another article about inflation, earlier this month.
And what did we just say about supply and demand? That’s right — the value of dollars is going down, not up. It may not feel like we’re in an inflationary environment, but I promise you we are, and even if you don’t feel it now, you will. You can rest assured, the very nanosecond Ben Bernanke suspects that the effects of this rapidly increasing money supply are causing upward pressure on prices in our economy, he and his gang of calculator-toting dandruff eaters are going to start jacking up interest rates every way they know how. Then they’re going to huddle in the middle of the room and start praying it works. Which it won’t.
Welcome back to the early 1980s, everyone. Only it’s going to be a lot worse this time. Do yourself a favor. Short Treasuries. Now. You can thank me later.
Still not convinced? Have you seen what precious metals, agriculture, and oil have been doing for the last twelve months? They’ve been going up. And it isn’t because consumers are expecting prices to fall. Commodities are the best predictors of future prices. I don’t care what the Dow 30 are doing; look at commodities. That’s where the story is.
The Fed – by way of John Maynard Keynes — is the main instigator of this preposterous idea that we must fight falling prices with everything at our disposal. Lately, they’ve even attacked the long end of the yield curve by buying long-term Treasuries in the open market. Some of you may not understand the implications of this behavior, so I’ll give you a little help: if the Fed thinks it can maintain lower long-term rates by buying Treasuries, it’s going to have to use dollars, and those dollars will have to come from somewhere. Can you hear the printing presses groaning?
So this brings us to four final questions (as well as their answers, which I am thrilled to provide at no extra charge):
1. If the Fed is going to (attempt to) hold down long-term rates by using printed money to buy Treasuries, isn’t that going to cause downward pressure on the value of the currency? (Yes!)
2. And as the dollar loses value, won’t U.S. creditors be reluctant to loan us more money – or even to hold existing American debt? (Yes!)
3. And won’t that necessarily mean rising interest rates? (Yes!)
4. So how, exactly, is that going to keep long-term Treasury rates lower? (It won’t!)
Look, if you ignore everything else I’ve said, try to remember this: the Fed is comprised of a decidedly small number of people, who make decisions that will affect you, your job, your family, and your life for years to come. They are not gods; they are human beings, and their perception of reality is just as subject to error as yours and mine. Your currency is more vulnerable than at any other time in history, and you should be scared. Actually, you should be terrified. I know I am.
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Disclosures: Paco is long TBT, UCO, and gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.
You can buy his novel Discipline wherever books are sold.
18 Comments so far
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While the content is nothing new (you've been maintaining this theme for a while now), I like the writing style of this last post! Keep up the good work. I may copy of your stuff in my next post.
Inflation is a mind blowing topic. If a person's home and stock portfolio are suddenly worth a lot less than formerly, doesn't that imply that dollars are suddenly worth more than formerly? Isn't that equivalent to cutting the money supply?
In other words, how is the amount of available credit properly evaluated in determining the money supply?
Rising prices are a symptom of inflation -> agree
Falling prices are a symptom of deflation -> agree
Putting money in circulation (aka economy) will causes inflation -> agree
I have a question: how do you put money in circulation? It looks like you assume printing by Bernanke (liquidity) means putting money in circulation (capital). These things are different; money is created by banks via credit and not by Bernanke. So it seems credit is the most important thing to have more money (hence inflation hence rising prices). But what causes credit to expand in our fractional based systems and credit based societies? Is the willingness of people to take that liquidity the FED created and exchange it for things; at that moment, liquidity becomes monet which starts inflation. Is that happening? I see reflation in paper assets as banks have more than enough liquidities, but I don't see businesses and consumers taking credit; there is still a credit expanding (hence the Dow rising): the debt margins on NYSE (aka speculators). I personally don't take credit, think twice about doing it and actually save some money each month; like me, there are millions.
Sorry for the consistency-of-theme… I'm a value investor at heart! I promise!
I never believed I would be pushing these ideas the way I have been. Stocks will come back eventually — they will again be undervalued. For now, however, I see opportunity in destruction, and no one is more disheartened by that statement than its author.
I hope we find better days soon…
Well, that's the theory, and Man-of-the-Year Bernanke is certainly hoping his manipulation will balance the forces looming over him.
I don't think he has a chance. But that's just me…
The money is out there — pressing against the dam. Eventually it will hit the economy, and when it does, it will be catastrophic. We've never printed this much before. We've never eased credit to this extent. And certainly we've never done it on a global scale.
This isn't Japan… this is the world. I'd like to think Bernanke is capable of pulling the trigger at the precise moment he'll need to. And I'd like to believe he really would… but he is, when all is said and done, a political creature.
No. The dollar is done.
Sorry for the consistency-of-theme… I'm a value investor at heart! I promise!
I never believed I would be pushing these ideas the way I have been. Stocks will come back eventually — they will again be undervalued. For now, however, I see opportunity in destruction, and no one is more disheartened by that statement than its author.
I hope we find better days soon…
Well, that's the theory, and Man-of-the-Year Bernanke is certainly hoping his manipulation will balance the forces looming over him.
I don't think he has a chance. But that's just me…
The money is out there — pressing against the dam. Eventually it will hit the economy, and when it does, it will be catastrophic. We've never printed this much before. We've never eased credit to this extent. And certainly we've never done it on a global scale.
This isn't Japan… this is the world. I'd like to think Bernanke is capable of pulling the trigger at the precise moment he'll need to. And I'd like to believe he really would… but he is, when all is said and done, a political creature.
No. The dollar is done.
[...] been reading my articles, doesn’t make a lot of sense — at least not on the surface. The Fed (and every other major central bank) is printing money and easing credit more than ever in history, and that, by definition, is inflationary. Remember what I’ve said so [...]
[...] I wrote an article not long ago about the true definition of inflation. I also mentioned it above, and I want to expound upon it again here: most people believe inflation [...]
[...] So the debate rages. Are we in an inflationary or deflationary environment? Are asset-classes rising in price, or falling in price? Over the last couple of years, so many of you have taken the time to remind me that the collapse in housing prices alone mandate that we are experiencing massive global deflationary price pressure. [...]
[...] and easing as fast as their little engines will perform. But they still haven’t got the message: nobody wants to borrow. And more importantly: nobody wants to lend. Still, that tidal wave of cash has more potential [...]
Um, Paco, private banks create far, far more dollars than government so your supply and demand argument is at best incomplete.
Moreover, what say we look at dollars not as the commodity-equivalents they aren'y but as the loans they are. (Deposits are loans, remember?)
If we look at it that way, the situation makes a lot more sense. In their lust to create profits through selling fake AAA securities, America's banks destroyed credit quality. When this bank-run counterfeiting was finally discovered, the value of every dollar deposit went down very suddenly. Worse, as loans went bad, the actual supply of dollars fell even more, leading to the massive spike in the dollar off the '08 low.
Naturally, as the credit markets fell apart, investors started demanding not only Treasuries and Japanese yen. but asset-backed credits – outside of the real estate market. Because the "flight to quality" was so huge and the real estate market is so immense, naturally the next-largest asset-backed credit market – traded commodities – has seen a reprieve from the kind of massive collapse we saw in virtually all traded commodity markets off the '08 highs. The question is to what extent the dynamic which produced the '08 commodity collapse is still out there.
What's different is the supply of money from government, obviously. Seeking to keep the supply of dollars up, the government flooded the market with massive amounts of high-grade credits. Naturally, this flood of Treasuries has been of lower quality – for a few, simultaneous reasons. The government's hope is that they can ride out the storm and their bonds will survive – damaged but viable. Yes, "everybody" knows rates are going up but as bond strategists will tell you, Treasuries are still selling well, at good spreads, because there's just no significant amount of non-government fixed-income credits on the market these days.
What "everybody" does not know is how bad the credit quality situation is or whether it will get worse. Clearly sovereign credit quality has suffered badly, but that's nothing compared to mortgages, where the entire portfolio of U.S. mortgages is arguably so far underwater as to be unmarketable. You can obsess about government bonds all you like, the more-immediate danger is still the truly massive amounts of deposits loaned to bad mortgages.
As for commodities, the more people park their money in unproductive assets, the more they are banking deposits against wasting assets rather than productive ones. "Capital preservation" is a myth. Economies move forward or die. People who think they are safe in commodities may learn an important lesson about markets – the hard way.
The hope is that the new government money – whether deficit-financed tax cuts or spending – will be invested in assets which create economic growth. Wall Street is at best dubious about that proposition, which doesn't help. Some want to invest in growth. Some want to grab as much as they can and "get out".
If things go bad, they'll find to their shock that there's no place for them to get to.
I'm an avid reader of and student of this discussion. I spend a lot of time doing so, not only because I find it so intriguing, but because I have a couple of daughters and a family to protect. The inflation vs. deflation debate is an interesting one. Given your comments, where do you come down on this issue?
The government is simply lying to us about "inflation." First, the way I (and all Austrians) define inflation is not the rising or prices, but rather the printing of currency and easing of credit that leads to rising prices. Every major economic power on the globe is employing such so-called "quantitative easing," and it is going to end in catastrophe. Yes, there are asset classes that are falling in price, but the most basic goods and commodities have been rising steadily for years. That's what policy makers don't want you to know…
hyper-inflationary price increases are just around the corner…
Paco
http://www.BottomViolation.com
The government is simply lying to us about "inflation." First, the way I (and all Austrians) define inflation is not the rising or prices, but rather the printing of currency and easing of credit that leads to rising prices. Every major economic power on the globe is employing such so-called "quantitative easing," and it is going to end in catastrophe. Yes, there are asset classes that are falling in price, but the most basic goods and commodities have been rising steadily for years. That's what policy makers don't want you to know…
hyper-inflationary price increases are just around the corner…
Paco
http://www.BottomViolation.com
Paco, the problem with the Austrian School definition of "inflation" is not that it begs the entire question of inflation, replacing it with a definition of money supply, but that it fails to define the money supply. By and large, private banks create money. The proof of that statement is in the spending. You, I and we all have spent money that was deposited by a depositor who borrowed it from a bank who borrowed it from a depositor who borrowed it from a bank who borrowed it from a depositor and so on and so on. You may think that's unjust or wrong or intellectually dishonest or whatever and I may disagree but it doesn't matter in this regard. The important thing is that it happens. Certainly it's true that the great majority of debt is created by private entities.
Keynesianism – whether the more common form of Keynesianism for the rich and powerful or the developed-nation standard of Keynesianism with some level of income-transfer downwards – undermines credit quality in the near term. Everybody knows that. It's nothing new. It's called "borrowing". "Quantitative Easing" is just another form of borrowing – extending liability, replacing inconvenient debt with more debt. You may think that's wrong and I may think it's not but, again, that doesn't matter. The question is the credit quality of world borrowing – default risk in the world's debt markets. We know some institutions are going to default. It was ever thus. The question is what the other institutions are going to do about that default risk, how big the risk is and how much they're going to do.
You think the governments are going to do too much, presumably based on the Austrian School tendency to believe that anything governments do is too much. Thus you're looking for inflation. I think the default risk is the important factor and I don't see default risk being addressed properly. Thus my worry is deflation (to answer your question, snirdley)
As for your observation about basic goods and commodities, it reminds me too much of what people said about real estate. It reminds me that "everybody" knew that there was too little oil in the world and prices would skyrocket when oil was $150 a barrel. "Everybody" knows gold is going up because there are too many dollars. I'm more concerned with what "everybody" does NOT know: default risk among private entities, particularly financial firms.
If you look at the Goldman Sachs Greek currency swap story, I'm sure we see opposite sides of the same coin but I'm also sure that what we should agree on is that what amounts to financial fraud has been perpetrated by financial institutions on a massive scale. Whether govenrments failed to regulate, condoned, encouraged or even (in the Greek case) seem to have solicited this fraud is outragous, but it's still clear to me that economic danger is how much bad debt the creators of the great majority of debt – private firms – have created
I don't disagree that bad sovereign debt is bad, but the history of bad sovereign debt is that it's most often manageable. I accept that in the case of hyperinflation it's not, but hyperinflation has been most common among nations where people had easy currency alternatives.
With the Dollar, Euro and Yen all in the same boat, I don't see the credit alternatives available. Gold just seems to me a non-starter. Holding wealth as numbers has zero opportunity cost. Holding wealth as gold has a huge opportunity cost. I though we learned that in the 1300's when book-entry credit (aka, fiat money on a private basis) was created.