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Re: You're not going to believe this: Inflation/deflation debate still alive?
EJ writes in:
Originally posted by jk
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As aways, you make good points. Thank you for noting Gross' recent article.
When I first started to look into the inflation versus deflation issue ten years ago, within a short time it became clear to me that the US was deflation prone due to over-indebtedness but also inflation prone because its currency was vulnerable to depreciation for all of the classical reasons, not least massive fiscal and trade imbalances, and foreign indebtedness.
I developed Ka-Poom Theory after concluding that in the event the US government by following post Great Depression anti-deflation monetary orthodoxy was setting the US up for a future inflation spiral kicked off by currency depreciation to defend against debt deflation. Later, as the government eventually found ways to compensate for dysfunction in the endogenous credit markets to prevent a self reinforcing cycle of credit contraction at some point after the inevitable debt crisis appeared, every effort to close the "break in the chain of payments" was to result in further dollar depreciation; all this even before foreign capital flows reverse. If and when that happens the greater inflationary process I've put forward in Ka-Poom Theory remains in the realm of possibility.
Next week I will dissect a strong inflation versus deflation analysis by Lehman economist Aaron Gurwitz published last week. It is not only thought provoking but lays out a compelling contradictory theory, that the US risks a deflation spiral long term. It's worth noting that the debate has reached the point that investment bank economists feel compelled to provide analysis of the question for their clients who are demanding that investment decisions be made with these factors in mind.
The error that most analysts make who are not familiar with the theory and the history is that the processes involved need to be conceptualized not in terms of levels of debt, or money, or credit, although levels are indicative, but rather relative money flows, changes in flows as measured in rates of change in levels, and interactions among processes that affect flows, such that processes that we have long experienced as homeostatic and stable can suddenly become unstable and chaotic. Inflation and deflation have to be understood as processes that can become suddenly unstable and self-reinforcing after a breaking point is reached, with monetary intervention either only marginally mitigating or even accelerating the process.
Of all the many articles and books I have read on the topic none is better than Irving Fisher's 1933 "Debt-Deflation Theory of Great Depressions" and I strongly recommend it to anyone with an interest in the subject.
Four conclusions of his which have stood the test of time that I believe are indisputable: 1) major depressions, whether inflationary or deflationary, follow from the malady of over-indebtedness and that all other factors, such as mal-investment, are secondary or result from the condition of over-indebtedness; 2) there is no such thing as a business cycle. There are processes that repeat, but not on their own, leading to; 3) markets do not heal themselves as they do not tend toward equilibrium. The myth of the self-healing market is pervasive, even among many of our esteemed members, despite fact that there exists not one shred of historical evidence to support it; and 4) deflations are always preventable, although the cure may be worse than the disease for many members of society, while inflations are not always preventable.
In spite of clear and ancient wisdom so well verified by 75 years of history, I frequently encounter all manner of confused analysis of the issue. I read about "inflation scares" and "deflation scares" and other creative and often tautological inventions to explain the impact of intervention by governments in the debt deflation process, as if the inflation expectations of market participants were a product of their own expectations.
The Fed has succeeded in preventing deflation and will continue to do so at considerable cost to the purchasing power of the US dollar. The Bernanke Fed is so keenly aware of the risks of a deflation spiral, given the degree of over-indebtedness of the US household, financial, and business sectors, that I imagine a white knuckle ride up the yield curve, Ka-Poomwise, with the Fed funds rate closely following inflation by no less than two points but never exceeding it for fear of tipping the system into a deflationary spiral before debt levels have been sufficiently reduced by the inflation process.
When I first started to look into the inflation versus deflation issue ten years ago, within a short time it became clear to me that the US was deflation prone due to over-indebtedness but also inflation prone because its currency was vulnerable to depreciation for all of the classical reasons, not least massive fiscal and trade imbalances, and foreign indebtedness.
I developed Ka-Poom Theory after concluding that in the event the US government by following post Great Depression anti-deflation monetary orthodoxy was setting the US up for a future inflation spiral kicked off by currency depreciation to defend against debt deflation. Later, as the government eventually found ways to compensate for dysfunction in the endogenous credit markets to prevent a self reinforcing cycle of credit contraction at some point after the inevitable debt crisis appeared, every effort to close the "break in the chain of payments" was to result in further dollar depreciation; all this even before foreign capital flows reverse. If and when that happens the greater inflationary process I've put forward in Ka-Poom Theory remains in the realm of possibility.
Next week I will dissect a strong inflation versus deflation analysis by Lehman economist Aaron Gurwitz published last week. It is not only thought provoking but lays out a compelling contradictory theory, that the US risks a deflation spiral long term. It's worth noting that the debate has reached the point that investment bank economists feel compelled to provide analysis of the question for their clients who are demanding that investment decisions be made with these factors in mind.
The error that most analysts make who are not familiar with the theory and the history is that the processes involved need to be conceptualized not in terms of levels of debt, or money, or credit, although levels are indicative, but rather relative money flows, changes in flows as measured in rates of change in levels, and interactions among processes that affect flows, such that processes that we have long experienced as homeostatic and stable can suddenly become unstable and chaotic. Inflation and deflation have to be understood as processes that can become suddenly unstable and self-reinforcing after a breaking point is reached, with monetary intervention either only marginally mitigating or even accelerating the process.
Of all the many articles and books I have read on the topic none is better than Irving Fisher's 1933 "Debt-Deflation Theory of Great Depressions" and I strongly recommend it to anyone with an interest in the subject.
Four conclusions of his which have stood the test of time that I believe are indisputable: 1) major depressions, whether inflationary or deflationary, follow from the malady of over-indebtedness and that all other factors, such as mal-investment, are secondary or result from the condition of over-indebtedness; 2) there is no such thing as a business cycle. There are processes that repeat, but not on their own, leading to; 3) markets do not heal themselves as they do not tend toward equilibrium. The myth of the self-healing market is pervasive, even among many of our esteemed members, despite fact that there exists not one shred of historical evidence to support it; and 4) deflations are always preventable, although the cure may be worse than the disease for many members of society, while inflations are not always preventable.
In spite of clear and ancient wisdom so well verified by 75 years of history, I frequently encounter all manner of confused analysis of the issue. I read about "inflation scares" and "deflation scares" and other creative and often tautological inventions to explain the impact of intervention by governments in the debt deflation process, as if the inflation expectations of market participants were a product of their own expectations.
The Fed has succeeded in preventing deflation and will continue to do so at considerable cost to the purchasing power of the US dollar. The Bernanke Fed is so keenly aware of the risks of a deflation spiral, given the degree of over-indebtedness of the US household, financial, and business sectors, that I imagine a white knuckle ride up the yield curve, Ka-Poomwise, with the Fed funds rate closely following inflation by no less than two points but never exceeding it for fear of tipping the system into a deflationary spiral before debt levels have been sufficiently reduced by the inflation process.
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