Five Things You Need to Know: Stagflation

[FRED]

Five Things You Need to Know: Stagflation
June 21, 2006 (Minyanville)

What we see as stagflation looming on the horizon in our side-view mirror today, may be full-blown deflation up close as dollars are hoarded to pay down excessive debt and reduce, reduce, reduce. Warning: object in mirror may be closer than it appears.

AntiSpin: How can you have deflation when your currency has declined 50%? Given that U.S. inflation today is only as low as it is because foreign lenders are supporting the dollar via purchased of dollar denominated financial assets, if they slow, inflation will rise. Still, Minyville makes an articulate case for deflation over our case for deflation versus our long standing case for inflation as an outcome of debt repudiation.

[jk]

deflation

the risk of deflation lies in debt revulsion: daisy chain defaults and bankruptcies, failures of derivative counterparties to live up their otc contracts, etc. sure, the fed will drop rates way down, but the worry is that they'll be pushing on a string. as in japan, no one will want to borrow, however low the rates. this scenario was the subject of bernanke's famous "helicopter" speech: if there is debt revulsion the fed can buy non-traditional assets- it can buy equities, bonds and porcelein figurines - to pump money into the economy and push prices up. in a pinch, they can drop money from helicopters. but in a bad enough liquidity crisis, i think deflation remains a possibility.

[metalman]

Ben promised

to buy all across the yield curve, 10 year bonds, 30 year, whatever. no deflation! impossible. Japan was a creditor when their bubble popped. US lenders will worry about getting repaid. if ben does this, currency markets may go haywire, dollar down, rapid inflation, POOM!

[zmas28]

Japanese experience with defaltion

I've read that inflation and deflation are monetary phenomena, i.e. the value of money, in relation to all other goods and services, is altered by increasing the money in circulation (inflation) or decreasing the money in circulation (deflation). How does this square with Japan's recent experience with deflation? According to this article, the BOJ increased the money supply dramatically during the deflationary period.
http://www.safehaven.com/showarticle.cfm?id=4111&pv=1
What am I missing?

[blazespinnaker]

I bet anything that Ben is very weak at the fed. I suspect the vice chairman (kohn?) is running the show, mostly.

But, regardless, the fed will protect the dollar. The chairman may be appointed every four years, but I believe the various govenors are in there for a lot longer and do not have to answer to the president du jour.

My bet is that they understand that if they do not protect the dollar it will just settle into an inflationary spiral. Basically, the long term rates will skyrocket because they do not trust the fed, and it all becomes a self fulfilling prophecy.

What does this mean? Rough times ahead, I think, unless

- alternative energy sources come on board quick and solve the energy tax problem
- India can come on board and re-energize globalisation and solve inflation problems

Interestingly enough, in both cases, I think this will push equity / land prices through the roof. That would really suck for me at 90% cash, but I do see it as a possiblity.

[bart]

I've read that inflation and deflation are monetary phenomena, i.e. the value of money, in relation to all other goods and services, is altered by increasing the money in circulation (inflation) or decreasing the money in circulation (deflation). How does this square with Japan's recent experience with deflation? According to this article, the BOJ increased the money supply dramatically during the deflationary period.
http://www.safehaven.com/showarticle.cfm?id=4111&pv=1
What am I missing?

The charts are deceptive at best. Here's one from the Fed's IETF publication - the rates of changes and growth were *much* lower in the '90s than generally known.

[WDCRob]

Disclaimer: I'm a Layperson

If I've followed the general gist of iTulip and of several of the recent daily/weekly postings by EJ, this site is arguing that we're heading towards some bad times and has predicted that they'll eventually be highly inflationary as the Fed surrenders its fight against inflation before killing it off entirely. Or, alternately, that the causes of inflation are non-responsive to higher rates (right?)? Either way...POOM

But can someone flesh out a bit further what will ultimately decide if we in fact see the 'POOM' or whether we see deflation? Is it simply a matter of political will on the part of Bernake and the Fed?

If so, why would the Fed capitulate? Because other central banks do (EJ: France?)? Because, unlike Japan, we're in debt up to our eyeballs and not well positioned to ride out an extended deflationary period?

And if those are right, could someone someone explain in a bit more detail why France (for eg.) would elect to break ranks and drop rates? And if you're feeling really generous...flesh out a bit further why household savings and a current account surplus helped Japan ride out the last 15 years (if it did)?

Finally...could 'protecting the dollar' (above), or 'deflation' possibly lead to a full blown 'depression'?

Cheers and thanks to anyone willing to do a bit of remedial education.

[bart]

Disclaimer: I'm a Layperson

If I've followed the general gist of iTulip and of several of the recent daily/weekly postings by EJ, this site is arguing that we're heading towards some bad times and has predicted that they'll eventually be highly inflationary as the Fed surrenders its fight against inflation before killing it off entirely. Or, alternately, that the causes of inflation are non-responsive to higher rates (right?)? Either way...POOM

But can someone flesh out a bit further what will ultimately decide if we in fact see the 'POOM' or whether we see deflation? Is it simply a matter of political will on the part of Bernake and the Fed?

If so, why would the Fed capitulate? Because other central banks do (EJ: France?)? Because, unlike Japan, we're in debt up to our eyeballs and not well positioned to ride out an extended deflationary period?

And if those are right, could someone someone explain in a bit more detail why France (for eg.) would elect to break ranks and drop rates? And if you're feeling really generous...flesh out a bit further why household savings and a current account surplus helped Japan ride out the last 15 years (if it did)?

Finally...could 'protecting the dollar' (above), or 'deflation' possibly lead to a full blown 'depression'?

Cheers and thanks to anyone willing to do a bit of remedial education.

Great questions, and I'll take a shot... with the obvious warning that trying to address all those areas will inevitably fall short. The questions are the subject of grad work and then some.

The simplest answer on POOM vs. a deflationary depression is that it depends on not only the Fed but also other key central banks like Japan, the ECB, England etc. and it wouldn't surprise me at all if the IMF/BIS were involved too.

Politics is of course a major factor, but the bottom line in my book is watching for indications that the "money presses" have been turned back on and to what degree after the CBs have recognized that inflationary expectations are under better control (or if there's something like a derivatives "accident"). There are no indications at all yet - it takes many months to affect the inflationary expectations that have been built up, and they've only been slowing for a few months so far.

Its unlikely at best from where I stand that rates will go up high enough in the US to kill the secular gold and commodity bull. Its not only political pressure that will prevent it but also and more importantly the almost absolute requirement of central banks in a fiat currency environment to continue expanding money supply and credit. Basically, both Bernanke isn't Volcker and Bush doesn't currently have the Reagan like political will and control to take pain now (way too simplified but hopefully my point is clear).
The Fed will capitulate eventually just because they have no other choice and that is their history. There are only two periods in its entire history where true and significant deflation occured and they inflated their way out of both.
Do note that I'm not taking into account any factors like the Amero or IMF/BIS actions - those could alter the scenario but not the intermediate and longer term inflation picture.

As far as some CB breaking ranks, *someone* will have to do it is the simplest answer. Game theory will come into play too as far as who breaks first - France is a definite possibility. But in my opinion, its not the details that are the issue - its the basic characteristic of central banking and the fractional reserve system. Its almost literally "inflate or die".

Do note too that although Japanese citizens are in much better shape than US citizens, the government is in much worse debt shape and Japanese banks are still in worse shape too - their capital ratios would make a US banker almost have a cardiac.
Here's a chart that will hopefully add some clarity:




As far as Japan and riding out the last 15+ years, I'm not sure precisely what you're driving it. But the deflation situation in Japan in my opinion has been severely overblown. Yes, real estate and stocks took huge hits but the actual deflation as measured by their CPI was minor - averaging only -1% to -2% per year. In the Great Depression in the US, it ran around over 3x that rate:




Compare that to the red line here on a previously private chart of mine covering the BoJ money, GDP, CPI, etc. All numbers are in annual percentage rates of change.




Of course household savings and the trade surplus gave the BoJ some additional leeway, but again its what the BoJ did and did not do with money supply and credit that is much more important.



One last thought - the definitions of the terms like inflation (I prefer "more money than goods") can be a real mess and major source of confusion when discussing these areas.
I'd call what happened in Argentina in 2001-3 a hyperinflationary depression for example... and that at least partially addresses your protect-the-dollar and deflation issues.

[jk]

france's central bank

have you guys heard of the euro? and the ecb? wtlw

[bart]

have you guys heard of the euro? and the ecb? wtlw

Go ahead... are you saying that France no longer has one or any autonomy?

What is "wtlw"?

[jk]

wtlw

welcome to last week

[bart]

welcome to last week

Thanks... and I'm still not sure that you know that France still has a central bank and its alive and well and pretty autonomous.

Consider possible effects they could create if, for example, they bought a few tons of gold instead of selling.

[jk]

france's cb

[no offence intended by my "wtlw."]

frankly, i didn't know that france still had a central bank, and i agree that a decision to purchase large amounts of gold would be significant.

but the mentions of france in the discussion above refer to a putative decision to drop interest interest rates. m. trichet works at the ecb, and france's bank doesn't control rates.

[bart]

[no offence intended by my "wtlw."]

frankly, i didn't know that france still had a central bank, and i agree that a decision to purchase large amounts of gold would be significant.

but the mentions of france in the discussion above refer to a putative decision to drop interest interest rates. m. trichet works at the ecb, and france's bank doesn't control rates.

No offense taken at all jk... and hopefully I'll get a credit to apply in the future when I'm misinformed? ;) -- Hopeful attempted humor there - there is literally so much false and/or misleading information on the web that it was one of the primary reasons I started maintaining my own data and charts.

You're of course right about the rates and the ECB and Trichet... and the plot continues to thicken about what all the various world central banks will do. I'm reminded yet again of the old Chinese curse - "May you live in interesting times". *sigh* and ;)

[jk]

france's cb

[no offense intended with my wtlw]

i did NOT know france still had a cb, and if it bought a lot of gold that would indeed matter. but the mentions in the discussion above was about setting interest rates, and m. trichet works at the ecb.