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From Seeking Alpha.
Late 2008’s stock panic has certainly had a complex and multifaceted impact on popular psychology. Mindsets and outlooks that were scoffed at as recently as 6 months ago have suddenly become fashionable. One of the more intriguing is the meteoric rise to prominence of the deflation thesis.
The growing legions of deflationists see an unstoppable depression-like deflationary spiral approaching like a freight train. They cite some convincing data. The stock markets have been cut in half in just a year. In the past 6 months, some key commodities prices fell farther and faster than they did in the entire Great Depression. House prices are down by double digits across the nation, with no bottom in sight. And credit is a lot harder to come by today than in any other time in modern memory.
In light of these universal falling prices, how could we not be entering a sustained deflationary period? The case may seem airtight, but I’d like to offer a contrarian view in this essay. Believe it or not, despite 2008’s price collapse there is plenty of overlooked evidence suggesting big inflation is coming. You won’t hear much about this on CNBC, but it could have a big impact on your investments in the years ahead.
Inflation and deflation are purely monetary phenomena. Inflation is not just a rise in prices, lots of things can drive prices higher. Inflation is the very specific case of a rise in general price levels driven by an increasing money supply. If the money in an economy grows at a faster rate than the pool of goods and services on which to spend it, general prices are bid higher as a result. Only money creates inflation.
Consider this example. You live in a small town in rural Texas with 10k people and 3k houses. A small local explorer discovers a gigantic new oilfield, an elephant. Within months your town’s population swells to 20k as a major oil company partners with the explorer to start developing the find. House prices skyrocket as 20k people compete for only 3k houses. Is this inflation? No, it is pure supply and demand. Its driver was not monetary in nature.
Similarly deflation is not just falling prices, but falling prices driven by a contraction in the money supply. It is true that most modern economists would add contracting credit to this definition as well, but money is very different from credit. Would you rather receive a gift of $100k cash or a new $100k credit line? While you can spend both, money is very different from credit, which is short-term debt.
Carrying the Texas town illustration farther, imagine oil prices fall by 90% in the years after the big discovery. The oilfield work dries up and there is a mass exodus of people. House prices collapse. Is this deflation? Of course not, it is pure supply and demand as well. Lower local demand for houses drove down prices, not a contraction in the greater money supply. This distinction is very important to keep in mind.
We witnessed a stock panic in late 2008, an exceedingly rare event. The dictionary definition of this is “a sudden widespread fear concerning financial affairs leading to credit contraction and widespread sale of securities at depressed prices in an effort to acquire cash.” Panics are bubbles in fear which drive investors to liquidate everything they can at any price. They get so scared they only want to hold cash.
When all investment assets are sold heavily in a short period of time, prices naturally collapse. But this is not deflation if it is not driven by a contraction in the money supply. For stocks, commodities, and houses, prices fell sharply in the second half of 2008 because there was a sudden huge oversupply relative to demand. Many more investors wanted out than wanted in, so prices plunged. They had to fall until a new equilibrium was reached, low enough to retard supply (investors too disgusted to sell anymore) and raise demand (from other bargain-hunting investors).
Now the deflation argument is strongest for houses because most buyers borrow to buy houses. So the stock panic’s impact on credit availability definitely hurt the housing market. But the degree of impact is debatable. Sure, borrowers needed to be more creditworthy and put more cash down in late 2008 than in 2006. But the stock panic scared people so much that they may have slowed house purchases anyway even if banks were begging to give them easy loans like in 2006. Panics breed extreme economic fear, and extreme economic fear greatly slows big purchases no matter how easily they could be made.
Acknowledging that debt-financed house prices are a special case that may indeed be deflationary (contraction of credit), I am focusing on stocks and commodities in this essay. From October 2007 to November 2008, the flagship S&P 500 stock index plunged 51.9%. About 4/7ths of these losses snowballed in just 9 weeks during the stock panic. From July 2008 to December 2008, the flagship Continuous Commodity Index plummeted 46.7%. Almost half of this mushroomed during the stock panic.
Deflationists argue these price drops are proof of deflation, and most people today believe this. But they are only deflationary if they were driven by a contraction in the money supply. Stocks and commodities are generally cash markets. Credit such as stock margin can be used, but it is trivial relative to the market sizes. And real commodities purchased for industrial uses are paid for in cash or near-cash (short-term trade loans), not multi-decade loans like houses. So the money supply during 2008’s slides is the key.
If available money to spend indeed contracted, then the deflationists are right about seeing deflation in 2008. But if the money supply fell by less than stocks and commodities plunged, was flat, or even grew, then deflationists are wrong. When prices fall simply because demand declines (too much fear to buy anything immediately), this is merely supply and demand. If money didn’t drive it, then it isn’t deflation.
Rest Here.
http://seekingalpha.com/article/1162...pular_articles
Late 2008’s stock panic has certainly had a complex and multifaceted impact on popular psychology. Mindsets and outlooks that were scoffed at as recently as 6 months ago have suddenly become fashionable. One of the more intriguing is the meteoric rise to prominence of the deflation thesis.
The growing legions of deflationists see an unstoppable depression-like deflationary spiral approaching like a freight train. They cite some convincing data. The stock markets have been cut in half in just a year. In the past 6 months, some key commodities prices fell farther and faster than they did in the entire Great Depression. House prices are down by double digits across the nation, with no bottom in sight. And credit is a lot harder to come by today than in any other time in modern memory.
In light of these universal falling prices, how could we not be entering a sustained deflationary period? The case may seem airtight, but I’d like to offer a contrarian view in this essay. Believe it or not, despite 2008’s price collapse there is plenty of overlooked evidence suggesting big inflation is coming. You won’t hear much about this on CNBC, but it could have a big impact on your investments in the years ahead.
Inflation and deflation are purely monetary phenomena. Inflation is not just a rise in prices, lots of things can drive prices higher. Inflation is the very specific case of a rise in general price levels driven by an increasing money supply. If the money in an economy grows at a faster rate than the pool of goods and services on which to spend it, general prices are bid higher as a result. Only money creates inflation.
Consider this example. You live in a small town in rural Texas with 10k people and 3k houses. A small local explorer discovers a gigantic new oilfield, an elephant. Within months your town’s population swells to 20k as a major oil company partners with the explorer to start developing the find. House prices skyrocket as 20k people compete for only 3k houses. Is this inflation? No, it is pure supply and demand. Its driver was not monetary in nature.
Similarly deflation is not just falling prices, but falling prices driven by a contraction in the money supply. It is true that most modern economists would add contracting credit to this definition as well, but money is very different from credit. Would you rather receive a gift of $100k cash or a new $100k credit line? While you can spend both, money is very different from credit, which is short-term debt.
Carrying the Texas town illustration farther, imagine oil prices fall by 90% in the years after the big discovery. The oilfield work dries up and there is a mass exodus of people. House prices collapse. Is this deflation? Of course not, it is pure supply and demand as well. Lower local demand for houses drove down prices, not a contraction in the greater money supply. This distinction is very important to keep in mind.
We witnessed a stock panic in late 2008, an exceedingly rare event. The dictionary definition of this is “a sudden widespread fear concerning financial affairs leading to credit contraction and widespread sale of securities at depressed prices in an effort to acquire cash.” Panics are bubbles in fear which drive investors to liquidate everything they can at any price. They get so scared they only want to hold cash.
When all investment assets are sold heavily in a short period of time, prices naturally collapse. But this is not deflation if it is not driven by a contraction in the money supply. For stocks, commodities, and houses, prices fell sharply in the second half of 2008 because there was a sudden huge oversupply relative to demand. Many more investors wanted out than wanted in, so prices plunged. They had to fall until a new equilibrium was reached, low enough to retard supply (investors too disgusted to sell anymore) and raise demand (from other bargain-hunting investors).
Now the deflation argument is strongest for houses because most buyers borrow to buy houses. So the stock panic’s impact on credit availability definitely hurt the housing market. But the degree of impact is debatable. Sure, borrowers needed to be more creditworthy and put more cash down in late 2008 than in 2006. But the stock panic scared people so much that they may have slowed house purchases anyway even if banks were begging to give them easy loans like in 2006. Panics breed extreme economic fear, and extreme economic fear greatly slows big purchases no matter how easily they could be made.
Acknowledging that debt-financed house prices are a special case that may indeed be deflationary (contraction of credit), I am focusing on stocks and commodities in this essay. From October 2007 to November 2008, the flagship S&P 500 stock index plunged 51.9%. About 4/7ths of these losses snowballed in just 9 weeks during the stock panic. From July 2008 to December 2008, the flagship Continuous Commodity Index plummeted 46.7%. Almost half of this mushroomed during the stock panic.
Deflationists argue these price drops are proof of deflation, and most people today believe this. But they are only deflationary if they were driven by a contraction in the money supply. Stocks and commodities are generally cash markets. Credit such as stock margin can be used, but it is trivial relative to the market sizes. And real commodities purchased for industrial uses are paid for in cash or near-cash (short-term trade loans), not multi-decade loans like houses. So the money supply during 2008’s slides is the key.
If available money to spend indeed contracted, then the deflationists are right about seeing deflation in 2008. But if the money supply fell by less than stocks and commodities plunged, was flat, or even grew, then deflationists are wrong. When prices fall simply because demand declines (too much fear to buy anything immediately), this is merely supply and demand. If money didn’t drive it, then it isn’t deflation.
Rest Here.
http://seekingalpha.com/article/1162...pular_articles
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