You're not going to believe this: Inflation/deflation debate still alive?

[*T*]

Re: You're not going to believe this: Inflation/deflation debate still alive?

Some say the world will end in fire,
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To know that for destruction ice
Is also great
And would suffice.

Robert Frost

[Guest]

Re: You're not going to believe this: Inflation/deflation debate still alive?

Has anyone else noticed that 99% of the threads on iTulip die a quick death? Wonder why?

I suggest posters concentrate more on getting a central point accross, rather than on apparently attempting to wow us with their depth of knowledge, which I'm sure is extensive. We get it, you are bonafide.

I'm reading a lot of posts here that go on and on w/o really saying anything or bothering to sum up their point. That point can get lost in the details and long, complex, often run-on sentences being used. Some of us have jobs and other interests and can't devote 5 minutes of parsing your post to get to the point.

For example. My rubuttal to one post on Argentina would be relatively short and sweet.

"Prices rising for wages and goods don't cause inflation. Inflation causes prices to rise." W/O even reading much about it, I'm guessing Argentina's government printed too much money. Am I close?

Or

"The reason we masses had cash for $4 cups of coffee and $3,000 TV sets was that it was all borrowed or printed money. Those days are over. Get used to it. It was never real." Prices of stuff we don't really need (McMansions, fancy coffee, personal services, etc) will fall while prices of stuff we do need (food, energy) will rise.

I realize economics is complex. "makes Mongo's head hurt". But to expect any sizeable number of people to read what is basically a PhD thesis in every post is asking a lot.

I'm guilty also, I run on in my posts as well. But simply thinking of a simple way to say something instead of using the most words possible is a good start.

[jk]

Re: You're not going to believe this: Inflation/deflation debate still alive?

But when loans are written off through default, there is no deflation because the money that was borrowed into existence was already spent and remains in the economy.

but the note was near-money. when i own a tbill, e.g., i think i'm holding money, even though i'm just holding a note. when loans are written off through default, the holders of those formerly valuable loans feel much poorer.

[CanuckinTX]

Re: You're not going to believe this: Inflation/deflation debate still alive?

I'll second that Bruce.

Even though I have a degree in Economics and MBA in Finance I feel pretty stupid some days trying to figure out what the heck some people are trying to say.

[metalman]

Re: You're not going to believe this: Inflation/deflation debate still alive?

Has anyone else noticed that 99% of the threads on iTulip die a quick death? Wonder why?

I suggest posters concentrate more on getting a central point accross, rather than on apparently attempting to wow us with their depth of knowledge, which I'm sure is extensive. We get it, you are bonafide.

I'm reading a lot of posts here that go on and on w/o really saying anything or bothering to sum up their point. That point can get lost in the details and long, complex, often run-on sentences being used. Some of us have jobs and other interests and can't devote 5 minutes of parsing your post to get to the point.

For example. My rubuttal to one post on Argentina would be relatively short and sweet.

"Prices rising for wages and goods don't cause inflation. Inflation causes prices to rise." W/O even reading much about it, I'm guessing Argentina's government printed too much money. Am I close?

Or

"The reason we masses had cash for $4 cups of coffee and $3,000 TV sets was that it was all borrowed or printed money. Those days are over. Get used to it. It was never real." Prices of stuff we don't really need (McMansions, fancy coffee, personal services, etc) will fall while prices of stuff we do need (food, energy) will rise.

I realize economics is complex. "makes Mongo's head hurt". But to expect any sizeable number of people to read what is basically a PhD thesis in every post is asking a lot.

I'm guilty also, I run on in my posts as well. But simply thinking of a simple way to say something instead of using the most words possible is a good start.

what did the man say, 'sorry for the long letter, if i had more time i'd have written a shorter one".

i can live with anything here. the topics we tackle here are ambitious even for trained economists. some folks need a lot of words to say a little others can say it in a few... we all started from different places and we're all in different places. sometimes we don't have time to write a short post. that means the reader has to do more work. you get back what you put in, is your point, and it's a good one.

[ocelotl]

Re: You're not going to believe this: Inflation/deflation debate still alive?

I've been pondering points on actual situation worldwide, and referring it to late 70's and early 80's, and how it all worked down here in Mexico. What bugs me the most is the possibility of bank bailing by nationalization.

On September 1st, 1982, at the final Government yearly inform of López Portillo, he cried while he was pondering the critical situation that the administration of his predecessor, Luis Echeverría, and his own, put Mexico on. At the end of his speech, after trying to convince the public he was acting patriotically, he decreed to nationalize all private banks in Mexico.

What did the privatization of banks in Mexico brought to Mexican Economy?

First of all we have to remember that 1150 companies of all kinds of business were owned by Mexican Government by the year 1982.

As we have seen first hand, when a company is owned by a Government, there is no clear progress and development incentive due fundamentally, that as the owner, the government will keep supporting it no matter what their income is, and will use it on contracts since there is not the need to bid for them.

This lack of incentives makes any company to become ostracized, bureaucratic on both its internal management and work methods, and that bureaucratization is precisely what prevents innovation and modernization.

When a national government obtains monopoly not only in the money generation business, but also in the internal handling of it (Via the FIRE Economy) all kind of distortions regarding the growth of economy prevail. There is not a clear incentive to control money creation, since all of it is managed by the government, therefore, destroying confidence on the soundness of the policies under which money is managed. International investment flows away, and the government goes bankrupt. That is precisely what happened on Mexico between 1971 and 1982.

After the nationalization of Mexican banking system, no bank or country in the world lent any money for 26 months to Mexico. Most of the credit line opening as after those 26 months were not because of improvements on internal monetary policies, but due to the needs generated by the reconstruction of national infrastructure that had to be done after the September 19th 1985 8.1 Richter Earthquake.

How can US government support a nationalizing of the FIRE Economy? Could it stand for an extended period without external financing of deficit? If the internal monetary policies keep as they are, Would US bonar survive a loss of confidence from the rest of the World?

[phirang]

Re: You're not going to believe this: Inflation/deflation debate still alive?

I've been pondering points on actual situation worldwide, and referring it to late 70's and early 80's, and how it all worked down here in Mexico. What bugs me the most is the possibility of bank bailing by nationalization.

On September 1st, 1982, at the final Government yearly inform of López Portillo, he cried while he was pondering the critical situation that the administration of his predecessor, Luis Echeverría, and his own, put Mexico on. At the end of his speech, after trying to convince the public he was acting patriotically, he decreed to nationalize all private banks in Mexico.

What did the privatization of banks in Mexico brought to Mexican Economy?

First of all we have to remember that 1150 companies of all kinds of business were owned by Mexican Government by the year 1982.

As we have seen first hand, when a company is owned by a Government, there is no clear progress and development incentive due fundamentally, that as the owner, the government will keep supporting it no matter what their income is, and will use it on contracts since there is not the need to bid for them.

This lack of incentives makes any company to become ostracized, bureaucratic on both its internal management and work methods, and that bureaucratization is precisely what prevents innovation and modernization.

When a national government obtains monopoly not only in the money generation business, but also in the internal handling of it (Via the FIRE Economy) all kind of distortions regarding the growth of economy prevail. There is not a clear incentive to control money creation, since all of it is managed by the government, therefore, destroying confidence on the soundness of the policies under which money is managed. International investment flows away, and the government goes bankrupt. That is precisely what happened on Mexico between 1971 and 1982.

After the nationalization of Mexican banking system, no bank or country in the world lent any money for 26 months to Mexico. Most of the credit line opening as after those 26 months were not because of improvements on internal monetary policies, but due to the needs generated by the reconstruction of national infrastructure that had to be done after the September 19th 1985 8.1 Richter Earthquake.

How can US government support a nationalizing of the FIRE Economy? Could it stand for an extended period without external financing of deficit? If the internal monetary policies keep as they are, Would US bonar survive a loss of confidence from the rest of the World?

SHort answer: no.

Long answer: the US has a lot of very desirable intellectual property and strategic assets that it can cannabilized to survive in the short-term, but the Empire is gone and, in the long-run, the USD.

[Charles Mackay]

Re: You're not going to believe this: Inflation/deflation debate still alive?

In keeping with the spirit of Bruce's msg, I'll keep mine pithy.

Monetary inflation occurring simultaneously with credit deflation will continue for some time... probably until some black swan event. Best investment stance is to build your own personal hedge fund to be long gold and natural resources and short the credit bubbles like real estate, finance, and maybe the bond market. ;)

[bart]

Re: You're not going to believe this: Inflation/deflation debate still alive?

I find it quite informative the graph that you post above, Bart. It reminded me to a table of data referring to the evolution of the minimum wage here in Mexico. As measured per Mexican CPI data, in real terms it was at the highest level in 1976, after a decree on the final period year by Luis Echeverría. We see that the bulk of the afterwards deterioration was during the rampant inflation period, namely between 1976 and 1988, and that later governments until 2000 maintained a loss in Minimum wage deterioration, being, numerically and in real terms, the Vicente Fox period the first one that ended with a minimal loss of minimum wage in real terms.

Table can be found, with related explanation in spanish from Manuel Aguirre Botello, the author of it, HERE

Why is the minimum wage so important in Mexican Economy?

Before the rampant inflation period, tariffs and fines were set on a base level, and corrected (if applicable) every now and then according to decrees. At the early 80's since it got too difficult to be legislating constantly the new tariffs, which were eaten alive by inflation before being implemented, the idea was to link them to a base price that anyway had to be modified as pertaining by mexican legislators. The most widespreadly used price tag that has always been subject to decreed increases is the daily minimum wage.

Other issue is that there are three numbers nationwide for the Minimum Wage in Mexico.

Just to set another example where inflation turned rampant with an inflation in wages that kept losing in real terms and has not "catched" price inflation until both were leveled to a single digit.

Very interesting parallels that you noted for Mexico, and especially that it also started in the '70s. Thanks... and for once I'll refrain from any tinfoil hat views about the parallels. ;)

[GRG55]

Re: You're not going to believe this: Inflation/deflation debate still alive?

a chat I had with an econ friend of mine who's at MIT:


" inflationary spiral .. that's the key thing to control here ... i mean all you need is sufficient consumption curtailings to induce that to not happen -- could include maintaining low wages among other things ... the oil shocks i think as they run their course will induce this anyway .. im not concerned about an inflationary spiral. .. this is cuz the oil shocks .. ppl tend to misread it as an increase in the price of a huge component of our consumption bundle. the better way to understand it is like an adverse productivity shock -- it makes us less cost effective in production in all industries because its like increasing the marginal cost everywhere. "

Presumably there wasn't sufficient "consumption curtailings" to contain the inflationary spiral that was ignited by the oil shock in 1973 then?

The food and fuel "shocks" we are seeing are the manifestation of an inflationary spiral that is now looks very much baked in the cake. The danger I sense is the belief that some sort of "consumption curtailment" is the modestly painful and politically manageable (as opposed to excruciatingly painful and politically unacceptable) exit solution from the box the Central Bankers and FIRE economy interests have put us in.

[ASH]

Re: You're not going to believe this: Inflation/deflation debate still alive?

But when loans are written off through default, there is no deflation because the money that was borrowed into existence was already spent and remains in the economy.

but the note was near-money. when i own a tbill, e.g., i think i'm holding money, even though i'm just holding a note. when loans are written off through default, the holders of those formerly valuable loans feel much poorer.

I recently got around to reading Galbraith's "Money: Whence it Came; Where it Went", and he says pretty clearly that both the credit and the loan function as money. It makes sense to me. The borrower can spend the credit, and the debt can be bundled and sold, or used as the capital base for futher lending. Therefore, the way I understand it, creating a loan for $X effectively increases the money supply by twice $X.

It seems to me that if the loan is defaulted upon, then instead of twice $X running around in the economy, we are left with $X -- so the money supply has decreased. That said, the money supply is still larger than it was before the loan was made, since $X is still out there.

Is this perhaps the distinction between dis-inflation and deflation? It seems that default does destroy money, but only the half that was created by the original loan.

Complications occur to me. Even if the money supply doesn't shrink relative to its size before the loan was made, it still shrinks relative to what it was before the default. Further, it could shrink relative to the supply of goods and labor. You could see prices decline, I suppose. There's also the impact upon money creation to consider -- loan defaults lead to weak balance sheets and reduced credit creation. Banks could choose to collect payment on outstanding loans but not re-lend the money. If the capital base contracts as the result of some defaults, then you would expect a period of money destruction as loans that aren't in default get paid off, but banks fail to re-loan the money. There is also a leverage effect, since banks loan a multiple of their reserves. Default on a small number of loans could result in destruction of a much larger sum of money in the form of paid-off loans that aren't re-issued.

By the way -- I am not a deflationist. I drink the iTulip koolaid (plus I tend to believe my own eyes.) I just wanted to point out that it isn't the change in the supply of money which matters, but rather that change relative to the change in the supply of things you can buy with money that matters. One should also think about the capital base from which banks make loans.

[phirang]

Re: You're not going to believe this: Inflation/deflation debate still alive?

gaaaah ash, you're slaying the deflationary demons!!!

[FRED]

Re: You're not going to believe this: Inflation/deflation debate still alive?

Rick and EJ continue the discussion, below.

Rick: Better you should ask how the yen performed relative to all other classes of yen assets. Answer: Just fine. Gold in fact has always done relatively well as an investable (sic) during deflationary times. Still, as a hard-core deflationist, I have my doubts that the POG will get to Sinclair’s promised land above $5000 oz.

The yen performed well because the yen is not a reserve currency, the Japanese experienced a hyperinflation after the war, and so protecting the yen was more important than preventing deflation. In contrast, the Fed is throwing the dollar under the bus to prevent deflation. It works – too well.

Please take another look at the Argentina example. The relationship between the dollar and gold now for the US is similar to the relationship between the peso and the dollar for Argentina in the late 1980s. Deflation in domestic peso terms, yes, inflation in dollar terms, yes also. Asset prices are falling in dollar terms but crashing in euro terms.

Not only US stocks but US real estate is cheap if you are a European.

Wage rates increased in Argentina during their 1988 - 1991 inflation but an American company could buy labor in Argentina for pennies on the dollar. Today US wage rates are 50% lower in euro terms than a few years ago -- great if you are a European company paying employees in the US. US wages are deflating against commodities priced in dollars, and domestic commodity prices, to the extent that these are determined by imports, are continuing to inflate.

Oil not gold is the ultimate money as it is the critical input to everything else. As Peak Cheap Oil arrives, everything is deflating against oil, which we experience as commodity price inflation. This event is widely misunderstood as a demand shock. Oil demand in OECD nations has declined to 2% annual growth rates since 2004 as oil prices doubled then doubled again. As China and oil producers are starting to reduce subsidies, demand may fall some more, but we'll see how long the oil kelptocracies and Chinese state continues with that program -- government give-aways are all they have to maintain political legitimacy. Meanwhile, oil producers have demonstrated that they intend to keep more of the oil they have left in the ground, so in spite of politically motivated assertions to the contrary they are not increasing supply but cutting it faster than demand is falling.

Rick: But I have no qualms about assuring my subscribers that gold is all but certain to hold its purchasing power – not only relative to all other classes of assets, but relative to anything that you would care to call money.

Gold is an international currency. As governments print to reflate economies, the value of national currencies deflate against gold.

My theory since 2001 is that this process will eventually take gold to $2500. Needless to say, that was contrarian back when gold was trading at $270. At $900 we have new entrants with very deep pockets to take us to the next stage of the market:

"Gold prices may rise to $5,000 an ounce as investors seek to protect themselves against accelerating inflation, said Schroder Investment Management Ltd., which oversees $277 billion of assets globally."

If funds keep throwing billions at the gold market, and CBs become net buyers as Schroder expects, who knows – maybe we'll get to $5000. The paradox is that the guys who created this mess are the same guys who are now struggling to maintain the purchasing power of all the money they made on it. The rest of us are collateral damage.

Rick: Even more certain is that, on a day in the not-too-distant future, Americans will realize that the hundred dollar bills they carry in their wallets are fundamentally and intrinsically worth no more or less than the $1 bills. I can’t tell from your writing whether you understand this, but if you do, it should disabuse you of the notion that the economy is somehow going to continue to muddle along. Muddling is one thing we deflationists all strongly agree cannot continue for much longer.

I have no allusions that the US economy can muddle along. For a quick summary of my positions, I recommend:

USA, Inc. Common Shares: Long or Short?

A Financial Market Crash is a Process, Not an Event

The Myth of the Slow Crash

Rick: Concerning deflation and its symptoms, there is little I would care to add to the story I linked from the Chicago Tribune (which you have yet to acknowledge and presumably did not bother to read). When middle-class America cuts out lattes and starts refilling soda-pop containers, that is not inflation, or stagflation, or hyperinflation; it is a small step toward Depression, when almost nothing pleasurable, or that we currently take for granted, will be affordable.

I did read it. Substitution always occurs during inflations. See:

Inflation in America - Part I: Five signs of inflation

This will go on and on for years and years as living standards decline. Inflation is easier for people to adjust to than you'd think, certainly easier than 25% unemployment and no money around to buy anything, as was the policy choice in the 1930s as wealth holders pressured the State to stick to the gold standard which tied the Fed's hands to create inflation. As soon as the US went off the gold standard in 1933 and gold was re-priced, an instantaneous spike in inflation from -10% (deflation) to +15% (inflation) resulted.

This inflation occurred after thousands of banks failed and the banking system had basically cratered. Those who hold fast to the theory that we are going to see commodity and wage price deflation as an outcome of this credit bubble don't seem to understand this part of the history of the last US credit bubble.

By the way, the gasoline sign using to illustrate the Five Signs of Inflation piece was created using a web tool atom.smasher.org. Actual gas prices at the time in April were around $3.50 for regular and few believed that regular gas was going to rise of over $4. Now the sign looks like what you see everywhere. Soon those prices will look quaint.

Rick: Like Mish, I’m not looking for an argument -- I simply don’t have the time.

If I'd been forecasting deflation for years on end and a google news search produced 136 times as many results for a search on "inflation" versus "deflation" (142,539 search results vs 1,043 search results), I'd be looking to make some adjustments in my model.

The only major adjustment that I've had to make is my forecast is on long term interest rates. I expected they'd have turned up by now, given the high levels of inflation. A friend who is a hedge fund manager running $1B told me in March he was finally taking huge short positions in long treasuries. He moved into the 10 yr at 3.34% and now it's at 4:16%. Good move. Will yields continue up and prices down?

Here's a surprising voice added to the inflation chorus:

When asked about the potential for stagflation, a combination of weak growth and high inflation, Greenspan said, "Oh certainly."

Greenspan also said, contrary to the opinion of many, that there isn't a commodities bubble building. "Once you get inflation pressure starting to emerge, you don't get bubbles." he said. (Forbes, May 2008)

I'm sure Bernanke wasn't too happy about that pronouncement.

But I would be grateful if you would provide me with a bullet-point synopsis of the major economic events that you expect to occur over the next 7-10 years. That will be the easiest way for me to determine whether I may have misunderestood you. Do we perhaps envision the same endgame -- an economy in smouldering ruins, credit markets wrecked for at least a generation, widespread poverty and unemployment to match or exceed the Great Depression, and the U.S. having to rebuild its manufacturing capacity almost from scratch in order to make an honest living in the global marketplace? If that’s “stagflation,” or hyperinflation, then you needn’t bother to respond.

I'm writing a book for Penguin that explains a tough transition period. We took a wrong turn in the 1970s. Now we have to go back and fix it.

The thesis of the book may help you understand where I'm coming from:

Working title: The New New Deal, Re-industrialization of Post Depression America

The recession that the US is entering in the early part of 2008 is not a typical business cycle recession or even a post bubble recession as occurred in 2001. The collapse of the housing bubble and the energy price shock are the triggers that started a process of major structural change in the US and World economy. When the transition is over in a decade, the US economy will hardly resemble its current form:

• Dependence on foreign borrowing to finance consumption and operate the government will end and reverse
• Dominance of the Finance, Insurance and Real Estate (FIRE) sectors of the economy for economic growth will give way to new productive industries in transportation, energy, and communications
• Trade deficits that started in the early 1980s will reverse and the US will begin to run a trade surplus
• Burden of economic rent extraction in the form of interest on public and Private sector debt will be lifted via a combination of inflation, restructuring, and debt cancellation
• Low national and household savings rates will rise to 1960s levels
• Consumption will decline by half, from 70% of GDP today to 50% of GDP
• Energy intensity, the amount of energy needed to produce a dollar of GDP growth will decline by half, led by conservation initiatives

The US will experience the transition as a series of recessions which,
cumulatively, may be as severe as in The Great Depression, but inflationary versus deflationary. We are seeing the first of these now.

The New New Deal asks and answers:

How did we get into this mess?

• Why have US financial markets been in turmoil for over a year?
• Why has the dollar weakened over 40% since 2002?
• Why is inflation rising?
• Why is unemployment rising?
• Why are asset prices falling?

How are we going to get resolve our crises?

My publisher doesn't want me sharing the solutions part of the book, but basically the idea is that unlike the old New Deal, this time we unleash markets on the problem, with equity versus debt based financing.

[grapejelly]

Re: You're not going to believe this: Inflation/deflation debate still alive?

but the note was near-money. when i own a tbill, e.g., i think i'm holding money, even though i'm just holding a note. when loans are written off through default, the holders of those formerly valuable loans feel much poorer.

Yes, but a default affects the ability of the holder (like a bank) to extend credit in the future but is not deflationary itself.

This is a key point and I don't know why people miss it. We can have widespread defaults on loans and no deflation. Deflation will happen if the money supply shrinks through people paying down their debts.

Think of it in central bank terms.

When they want to shrink the money supply (hahahaha they never do), the central banks sell debt to the banks, and take back dollars. This is the same as borrowing from the banks. When they want to increase the money supply, they buy debt from the banks...same as lending money to the banks.

Borrowing is inflationary.

Paying back is deflationary.

Debt default is not deflationary.

And, further, inflation is a big problem when there are widespread debt defaults because new money is borrowed into existence and this new money WON'T go into more investment. It will be borrowed in order to be invested in tangibles and therefore result in higher commodity prices.

(Not higher real estate prices due to the fact that real estate prices are credit-dependent.)

Mish and Rick don't get this. And they don't get the fact that consumers and businesses don't need to borrow...the borrowing can be done by other actors.

[ASH]

Re: You're not going to believe this: Inflation/deflation debate still alive?

gaaaah ash, you're slaying the deflationary demons!!!

Just like the preposterous recruiting commercial!

But seriously... there are people whom I think know more about economics than I, who seem to take the deflationary scenario seriously. I am under the impression that the debate really boils down to what the government (and Fed) will do -- and how American consumers of credit will respond. I think EJ and the iTulip crowd have it right, but fundamentally this argument is more about handicapping government strategy and consumer response than it is about objective economics. I mean -- it isn't as though deflation is technically impossible. Rather, it is a question of how alert the Fed is to deflationary threats versus inflation (cue snide reference to helicopters), whether they have the ability to successfully halt a collapsing credit bubble and re-inflate (cue snide references to printing presses), and whether over-extended American consumers will borrow if even more credit is extended to them under easier terms (cue snide reference to deranged weasels).