Deflation’s the Real War
Chuck Ponzi March 11th, 2008
Despite all that you hear and see in the headlines about rising oil and gold prices, we are about to experience the worst deflation in the history of the United States, or at least the 2nd worst after the Great Depression.
I have to write this entry because of the amount of absolute rubbish that I see printed throughout the media and repeated ad nauseum in the blogosphere regarding the money supply and how the recent fed actions are inflationary.
Even with the dramatic action today in the stock market (the last time we saw a 400 point day in the dow was mid 2002, near the depth of the last bear market), the general trend is that the market is quickly siphoning off the dollars put out via the central bank the past 8 years.
Noone now doubts that Greenspan made 2 fatal mistakes that caused the largest bubble in history. First, he brought interest rates too low and held them too long, and secondly and more importantly oversaw the most complete and utter breakdown of lending standards in history. Put together, it pumped too much debt into the system.
This debt became non-servicable from income during a time when debt should have been waning, not peaking since the largest demographic baby boomer bulge is passing into its retirement age. The sad state of affairs of most baby boomers is only a testament to the incredibly poor management of their finances until this point. Several decades of declining interest rates and ever-increasing credit has created a new age of debt serfdom where most can only hope to ever service the debt and hope it never gets called, the serf ever sickens, or misfortune visits a single household.
Put succinctly, increasing the money supply is inflation, deflation is decreasing the money supply. The accomplished blogger Mike Shedlock has made this case quite well, and the facts speak for themselves.
In the deluded minds of those pumping housing, they are hoping that actions by the FED will rescue housing. It won’t. Housing was in a bubble that was reinforced by the increase in money supply, and as long as the money supply is contracting and remaining contracted, we not see a return to the insane days of lending we have seen the past 7 years. This is deflation. Assets going down in value. Housing, stocks… even commodities should be declining. Which brings us to the next bubble… commodities. It was only a matter of time; and frankly I haven’t a clue as to how long it will last. But it’s not ready to pop yet. We are just now getting the first whiff of a bubble; and there will be plenty of time for commodities apologists to scoff it off and disprove recent price action, but let’s not forget the fundamentals… commodities are priced between the cost of production plus normal profits and the cost of alternatives. Gold, corn, rice, sugar, even oil has alternatives, and let’s be honest… we have departed from these fundamentals. It costs approximately $400 to produce an ounce of gold. It costs approximately $4 to produce an ounce of silver. We have all gone mad in the search for the next place to put our dollars. We are living in an inflated world where stocks and housing are no longer considered safe havens after the last 2 bubbles have popped, yet commodities are just warming up.
But, let’s not forget that even with the bubble forming in commodities, it does not yet have a complicit Federal Reserve bank… borrowing for precious metals is much more difficult than leveraging equity in a house or margining stocks; and there are few takers to lend the money in that kind of speculation.
I predict this next commodities bubble will be much shorter than the last 2 and more violent to the participants.
Disagree below.
Agree completely. Gold and oil are in a bubble. I’ve been following the gold market since 1999 and now this reminds of housing in 2005. Home builders = minining companies. By the way, it only costs $300 an once to produce gold.
Thanks, news. I had heard $300 as well, but I was estimating some actual price inflation in there. Even factoring not going after the low-hanging fruit, the cost has got to be under $400/oz. I could maybe see $500/oz as a stable price, but once something enters a bubble, it’s nearly impossible to predict its trajectory. Perhaps that’s why most famous investors just stay out after it bubbles up.
Chuck Ponzi
Good post but you are late to the Deflationista party my friend…at least for a RE Bubble Blogger that is.
In reality though, most of the general has no clue what is really happening. They all literally think the FED went into the basement last week and printed out $200B extra dollars and handed it over the stock market yesterday. Of course they didn’t really do that. They just accepted a bunch crap loans as collateral for 28 days (supposedly). Last night was a perfect testament to the cluelessness of the general public. I was in my Operations Management class in Long Beach. The instructor began talking about how the Euro has climbed relative to the dollar since it’s inception and the class was pretty clueless about why. They all kept citing how the EU has become so much stronger than US and that it was bound to happen. I just laughed and said NO, that is not why. If you want to know who is responsible for the decline of the dollar in the past several years then ask Alan Greenspan what the hell he was doing with our Monetary Policy during that timeframe. Of course, they had no idea what I was talking about. Then, on the way home last night, I’m listening to Coast to Coast and George Noory has this idiot Sean David Morton on as a guest talking about Gold. Well, as soon as he gets on he goes off on a rant about Bernanke dropping money out of helicopters and printing money in the basement. No one challenges him on it. Then lots of calls about inflation…or more precisely rising prices in goods. Then, he really screws up and starts citing M3 as the monetary base and that is a measure of the money printed. Freaking Idiot. This is why Ron Paul could not get traction unfortunately. The American public is completely and utterly clueless about economics.
I think the treasury is working the Fed over by keeping M0 going negative. Figure they do that for a while.
When/if Obama/Hillary gets elected I expect the new secretary of the treasury to pump up M0. I believe looking at Mish’s graphs on this, that Rubin was pumping in currency for a while. Still its a small drop in the bucket compared to M3.
However, I think in this enviroment the slightly negative M0 is really driving the banks.
Its interesting to see the momentum in these things. Once it turns wow!
Not sure if I am way off base about this Chuck.
Ok, I think I’m a pretty smart guy, but someone needs to clue me in on how the Fed printing money and giving it to banks, people who don’t pay taxes, and anyone else they can dump in on can lead to deflation. Deflation, as I understand it, is when the dollar buys more goods and services (stuff becomes less expensive in dollars).
That would happen under two circumstances: dollars became less plentiful, or goods and services became cheaper. Dollars are becoming more plentiful, currently at the rate of ~+15% annually. This causes trade-adjusted currency value to decline relative to other currencies, which increases import costs, which causes those goods to increase in price. Meanwhile, workers demand more money because their basic need items (which are imported) are increasing in cost, raising costs for domestic business, and hence domestic products. Prices go up… hence inflation.
What am I missing?
You have have the definitions wrong that is what you are missing. Inflation is expansion of monetary supply and Deflation is the contraction of money and credit (M3). The attendants effects will manifest in the prices of goods and services as well as capital assets. Anything bought with debt gets cheaper and anything consumed gets more expensive. Bernanke is trying to delay deflation as long as he can (burst of credit bubble and housing bubble) by providing liquidity into the market. The net effect is still deflationary in nature which is why you DO NOT WANT TO BE HOLDING A LOT DEBT IN THE NEAR FUTURE.
Go look a graph of M3 and correlate visually to the housing market in SoCal for the past several years and you will see that it is nearly perfect correlation. In other words, the inflation you all are looking for has already happened in the form of a credit/housing bubble and now start a deflationary cycle.
This is what the general public does not understand and the MSM will not explain it to you. Dont look for them to use D word until it is already too late for J6P to react to it. Get ahead of the curve now.
Good stuff. So, the relatively few people out there with zero debt and plenty of cash will finally have their day? Then I guess I could go for a nice bout of deflation.
Sounds like if I can capitalize on this rare event, then I could set myself up for a comfortable life.
What you’re missing is that the “price increases” of today are due to inflation from years ago. Inflation does not get felt in real-time… it takes years to creep into consumer prices.
Right now, the problem is recession and with recessions comes deflation.
It’s like driving a car at 60MPH and only looking 6 inches down the road. If there’s an obstacle in the road, you need to be looking 1000 feet ahead so you can adjust your speed and lane.
Bernanke is doing the right thing right now with lower rates. We won’t feel the effects of that until 2009 at the earliest. Meanwhile, all other assets are quickly deflating. We need to make sure pretty quickly that we don’t enter a depression. It doesn’t help when a buch of idiots start talking inflation when that’s clearly not the problem.
Exactly.
This is just the final melt up before we deflate a la Japan.
Parabolic Commodities: The End is in Sight
I think you are way off base with your deflation hypothesis. We experienced deflation in the late 90s when oil was under $10 a barrel, gold sold for $264 an once and you could not give copper away. The tech market crash soon followed.
Commodities prices will continue to rise as long as the Fed pumps dollars into the economy — think $800 gold in 1980. Once John Maynard Bernanke realizes his error, the Fed will drain liquidity and commodities prices will fall, just as they did when Reagan/Volker imposed tight money in the 1980s. The world did not end when the price of gold fell.
The Fed is using liquidity as a salve for the wrong illness. All the dollars in the world will not the change the fact that there are billions in MBS/CDO of dubious value. Their owners must be required to bear the cost, we can’t inflate it away.
I know you’re wrong. The FED is not pumping dollars into the economy. They are trying to staunch the rapid suctioning sound coming from the free market of dollars vanishing into thin air. Face it, right now, we are deflating. The war against today’s gold and oil prices should have been fought 4 years ago. Because Greenspan capitulated, we now have high commodities prices. Right now, we are going to lose the battle of 2011 and 2012 if we don’t lower rates something quick.
Liquidity is not solvency. We have a crisis of solvency, not liquidity. That insolvency feeds a future crisis of lower future income and slower economic growth, if not negative economic growth.
The problem is that you should borrow in lean times and pay off in fat times.
Insanely, we borrowed right through the fat times. Nevertheless, if we don’t borrow through this lean time, we will have another Great Depression.
Chuck Ponzi
My guess is you missed the *headlines* about the Fed dumping, er, pumping $200,000,000,000 into the economy.
And you keep changing the subject. First it was deflation, then solvency. Solvency is caused by many things — like the boneheads *you* write about buying homes they can’t afford.
And lower economic growth/income ain’t deflation either, nor does its presence indicate deflation. We had lower economics growth in the 1970s with inflation.
I only recently discovered your blog and I enjoy it. But your economic analysis leaves much to be desired.
You are not correct.
The 200B is a drop in the bucket compared to the amount of lending that is going to be choked off.
Deflation is looking farther down the road. You can choose to ignore it and live in the today, but don’t come crying for help when you’ve been bloodied by the market. Either you see what’s going on and prepare for it now or you believe the headlines.
The FED is pushing on a string, and they’re working overtime to prevent all-out deflation. This is straight out of Bernanke’s playbook.
Chuck Ponzi
No, you are incorrect actually. Go look up the Austrian definition of Inflation and Deflation.
Ah, but the owners will not be required to bear the cost - that is, unless you understand that the U.S. taxpayer is destined to become the owner.
You know what I find interesting though? The banks obtain cash from the Fed using loans as collateral which are not worth their face value - but no transfer has occurred here, the banks still have to report those loans on their own books unless some accounting shenanigans allow otherwise.
As those loans default, the banks will still become insolvent unless the Fed is willing to allow them to default without consequence.
“The Fed is using liquidity as a salve for the wrong illness. All the dollars in the world will not the change the fact that there are billions in MBS/CDO of dubious value. Their owners must be required to bear the cost, we can’t inflate it away.”
Agreed. Now what is it about Deflation that you don’t understand??? Net effect will be deflation unless you think that the Fed will actually go Weimar in order to offset the destruction of credit that is happening right now??? And don’t give me the bullshit about stagflation that he MSM is touting.
The contraction is happening quicker than I thought it would happen. Resorts in Maui have specials at 50% of last year’s prices; airline tickets to get there are 30% off last year’s prices. If you have nerves of steel, shorting commodities in the next year will be a huge play.
So if I understand the deflation hypothesis correctly, because there is less credit available, businesses will have to decrease their prices to remain competitive, even as their own costs are likely increasing due to rising commodity, import, and labor costs. In addition, asset values will decrease as they continue to correct to market (without bubble speculation).
But… the government / Fed will undoubtedly continue to print money and give it to people and businesses to try to “stimulate” economic activity, which will increase the overall “money” supply (as defined by total currency in government obligations). In the extreme case, the government could, say, give out 10 trillion US dollars to the American people if they wanted to arbitrarily decrease the purchasing power of the dollar, which would cause inflation, right?
I still can’t imagine the scenario where US dollars would have more purchasing power (deflation), and the government couldn’t reverse it immediately if they wanted to. It seems like the Fed is not trying to do anything related to deflation, but rather trying to keep the deficit-spending economy going by creating large-scale inflation. Could someone lay out the economic cause->effect steps which would get us from here to deflation?
Personally, I think it would be great if deflation was happening, and my dollar assets were increasing in purchasing power; I’d love that. I just don’t see how it happens yet.
Thinking more about this…
Is the difference just one of terminology? I can see how asset prices will decrease in US dollars, as the inflated values caused by the credit extensions correct themselves. I always assumed deflation was more of an increasing of purchasing power of the US dollar, though (like relative to other currencies or consumables). When the non-consumable assets decrease in value to correct for the debt-fueled bubble values, they will decrease relative to all currencies, which won’t increase the purchasing power of the dollar except with respect to those specific assets.
To put another way, the deceasing value of non-consumable assets is unlikely to cause the CPI to decrease, since the CPI tracks consumables, which are closely tied to production cost. The average person will continue to see every day consumable prices increase as the government continues to print money, even though “investment” assets will be decreasing in value and businesses will be struggling. Do I have that right?
This is one of the problems with comparing CPI with inflation. Inflation is a monetary phenomenon. It only reflects itself in the price index after the money has had a chance to circulate. With housing write-offs taking 200B off the table and average reserves being 10%, you’ll be decreasing the overall money supply by 2T sometime in the next 12 months. The FED is doing all it can to slow that bleed. As it rightly should. Inflation happened in 2002, and there’s nothing you can do now to change that. Gold is $1000, Oil is $110, and that’s based on an expectation created from 2001 to 2007. Inflation expectations only reverse themselves when they are compelled to. A deep recession ought to do that nicely.
Of course, if we have deflation, you won’t feel that in prices until 2009-2011.
Chuck
You almost have it, except that the Govt or the Fed rather, is not really printing money in a literal sense.
Sorry Chuck, can’t agree with you on the deflation argument…
Gold = Money. It’s the same thing. It has nothing to do with the price to produce an ounce of gold. Gold is always gold and it’s the equivalent of a certain amount of money.
As long as the Fed keeps printing money and the government keeps spending money it doesn’t have (via deficits, stimulus plans, etc.) and most importantly, as long as we keep running a massive trade deficit, then we are debasing our currency. And in that case, holding an ounce of gold will buy you more and more and more and more US dollars (as the dollar becomes less valuable by the day).
Those dollars aren’t disappearing. They are going overseas to China and other countries who are building the products we buy. The dollars are still out there. They just aren’t in housing, the stock market, etc. I wish it was deflation. But it’s not. It’s simply the transfer of funds to another location…
Wilson,
It’s possible that just like housing did in 2005, gold will get to even crazier prices like $1200-$1500. What makes me even more sure that it will go down to $500-600 by the time this is all done are arguments like yours. They are based on your fear of your purchasing power disappearing, when it’s actually been increasing for quite a few assets and services rapidly in the last six months. If you only have $25000 sitting in the bank, it seems like inflation is high. When you have $2,500,000, we are in deflation.
To all:
From Today’s Wall Street Journal:
“…Creating a lot of liquidity does not resolve an issue of solvency, which is now the driver of credit contraction. All the Fed will achieve is a dollar that will be further debased and inflation that will be higher. It cannot stop the process of deleveraging and asset price decline…”
Inflation, not deflation.
“higher. It cannot stop the process of deleveraging and asset price decline…””
That is the effect of a net Deflation. Again, before you go spouting off about this, do some real reading about Austrian school of Economics.
Wall street journal is not very good at accessing of what’s actually going to happen in six months. Just go back and read what they said six months ago, twelve months ago. I became a housing bear and gold bull in 2003. I am still a housing bear, but also a commonidities bear now. The main reason is that a lot of economic growth in emerging markets has been credit driven. As the credit contracts, their economies will slow substanically in the next year; thus reduced demand for commondies. I don’t know what will happen in tens year, but the next few years are going to be deflationary for everyone.
Please email me at the email listed. I am attempting to coordinate housing bubble bloggers in a concerted effort to take action against the mortgage bailout.
Thank you.
add us.
I, too, am in the camp that oil, gold, etc, are in speculative bubbles.
Don’t get me wrong. I think gold is real money. Years ago I steadily acquired some to have and to hold (not to trade), but I stopped buying back in 2002.
Oil, too, has value due to its uses. But that is subject to ups and downs depending on what industry is doing.
I even heard comments on Bloomberg last week stating that oil has “decoupled” from its fundamentals and has become a place to park cash out of the dollar.
I know Bernanke is trying to reinflate out us out of our problems. And it certainly feels like an inflationary squeeze, with rents, food, and fuel all creeping up.
But I have my doubts all the Fed’s helicopters and all the Fed’s printing presses can stop a deflation tsunami that appears to have been seeded by this housing mess, which has been many many years in the making, in spite of the proliferation of housing bubble blogs only within the last few years.
I know that I sound naive, but the many people that saved and saved will soon be able to buy a house. It’s a shame so many will lose theirs at the same time.
By the way I really like your blog!
Chuck,
you are talking about deflation. What it means for value of the dollar? Do you predict buying power of the dollar will come back with the result of deflation?
OK, keep a couple things in mind. I don’t guarantee deflation, only that there are some enormous deflationary forces at work in the economy. I don’t know if the FED will be successful against deflation or not.
Secondly, if purchasing power of the dollar increases, it will likely be in the midst of a very substantial recession, or depression.
Finally, if you still have money after that, yes, you will be able to buy more crap.
Chuck Ponzi
M1 = Cash and checking deposits
M2 = M1 + Savings Deposits and smaller MM
M3 = M2 + Repos and Institutional Level MM
OK.
M1 is falling
M2 is rising at 6-7%
M3 is rising at 17%
How do you buy goods with Repos or Institutional Sized MM accounts. You cant.
M2 is generally gauged as the best proxy for inflatoinary pressure. 6-7% is bad, but not the end of the world.
That M3 is growing faster is indicative of velocity of money dropping, and money lent into the system not being re-lent, which means it is doing nothing to stimulate the economy.
The FED is pushing on a string. This is not long term inflationary.
The falling dollar is simply a result of interest rate differential, and loss of worldwide confidence in the dollar.
The winner in the battle of the flations (in vs de) is not even close to determined yet.
Seems like the deflation monster is loose.
Looking at that Krugman series of articles on deflation in Japan. All the monetary tricks did nothing to stop deflation.
I think that is what we are looking at. Except we have a lot of frivolus things compared to Japan.
God, will this ever get ugly.
Deflation monster on the loose? Hmmm. A very dramatic statement indeed. Yes, we’re seeing deflation in some places. In home prices, though not all that much really. Some in car prices. Maybe even on DVD players and flat screen TVs. And in wages.
But not at the gas pump. Not rents. Not health insurance. Not grocery prices. Not airline fairs. Not virtually every other goll-darned thing I buy with my God-forsaken dollars.
I guess whether we are in an inflationary or deflationary environment depends on the fundamental bias of the government making the decision as to which economic policy to endorse. Let’s look at some salient examples from history in this century.
Depression-era America demonstrated fiscal responsibility and a commitment to preservation of the currency; ergo, the depression was DEFLATIONARY in nature. This deflation turned to inflation during WWII.
Same thing with Japan. They went from their real estate bubble into their recession with money in the bank, a strong currency and massive savings by their populace, enough to effectively weather a 15 year recession without people rioting in the streets.
This is where their situation differs from ours, and why the Japan comparison is not applicable when looking at the current situation. See, when you have money in the bank, you prefer to have it keep its value. When you have massive debt, you don’t.
And that’s all you need to know to guide your thinking through the current crisis.
At the other end of the spectrum, you have the Weimar Republic in the aftermath of WWI. They hyper-inflated their currency and turned it into toilet paper. The main reason this happened is because they had massive DEBT over their heads (war reparations), with no economic means to repay it. They destroyed the currency by running the printing presses and giving all of it to debt holders (France and Great Britain mostly), who then dumped it into the German economy and crushed it dead.
Sound familiar?
And look at Zimbabwe today. 10,000% annual inflation thanks to a thoroughly corrupt, dictatorial government with a massively irresponsible monetary policy.
Remember this simple lesson darlings: inflation is easier than deflation. Deflation is usually the responsible thing to do. Let prices correct to their inherent value with the bursting of the speculative bubble. Let people and institutions suffer the consequences of their excess. Let banks fail. Let companies go bankrupt. Let unemployment rise. Let stocks crash. Let there be widespread pain, and wade through the mess with the expectation that you will come out the other side okay.
But given the political environment in this country, our leaders will likely choose expediency over responsibility.
Inflation is the product of wage growth. Increasing prices of goods is not inflation. We are and have been deflating for 10 years. Real wages have been dropping like a rock for the past 6 years.
The only thing that has kept this ponzi scheme we call free-trade going for the past 10 years is easy credit in the U.S. and the Chinese pegging their currency to the dollar. This has allowed China not to experience inflation.
That time is over.
I know things look bad for the U.S. at the moment, but just be glad we are not looking down the barrel of the Chinese/Indian economies. They are heading for real trouble when the prices of commodities go up with their overpopulation and poverty levels.
They will be experiencing the full effect inflation in the next 3 -6 years as the U.S. dollar continues to fall.
The only thing that can stop the dollar decline is for it to get low enough for a company to decide that it is economically in their best interest to employ Americans. No more bubbles up the FED’s sleeve now. They will have to actually drive the creation of real jobs in the U.S. to pull us out of this mess. Wages won’t be the primary factors in them doing this. The stagflation to hit China/India will cause political and economic turmoil which will drive companies to chose the stability of the U.S. over third world countries.
There are good byproducts to the falling dollar other than the U.S. being more competitive.
1. Higher Oil has hit the sweet spot to allow for investment in renewable energy sources.
2. Baby Boomer’s will have to put off retirement due to the loss of most of their invested wealth
Whats going on is really good for the U.S. in the long run.
The inflation regular people need to be worried about is not wage inflation, which is the definition that Hank Jestor is discussing. This is confusing things. This form of inflation should always be referred to as WAGE INFLATION, and it is a generally insignificant force in the flow of history.
If people were making more money in wages, that would be wage inflation. Wage inflation might in turn lead to price inflation, i.e. the price of food, rent, fuel, products, increasing. But not necessarily. If wage increases were accompanied by genuine productivity increases, then you would not expect price inflation.
Businesses and mega-corporations hate wage inflation; the rest of the serfs should usually welcome it. As Hank says, wages in the US have been stagnant (I would say for 2 decades). Cheap labor from across the globe has effectively anchored wages in the US, but more profoundly after the passage of NAFTA.
There is a lot of confusion and FUD as to what’s happening right now. There are some problems with people’s definitions that need clarification. Moreover, people are not grasping the complexity of the forces at work.
There can be no dispute that housing prices INFLATED massively over the last decade. That was caused by a credit bubble - easy money given to reckless people caught up in an ever-rising market driven by speculation, greed, blind-stupidity and corruption. Classic bubble action, and the bubble finally burst.
But will housing prices completely deflate? Here’s where it gets tricky. IMO, not necessarily. In fact, prices have been surprisingly resilient. They finally started to move down in recent months, and such movement could accelerate to a complete crash in real estate. But….here comes Congress to the rescue with a homeowner bailout plan! In addition to the hundreds of billions in bailouts to Wall Street. This action will effectively buoy housing and equity prices, prevent them from falling too much. The decline in housing prices will be gradual and long-term, and it will be accompanied, offset by currency inflation.
The Fed has a bias to not allow housing equity prices to fall too much. They SHOULD fall, and in terms of real dollars (or let’s say Yen, or Euros), they will. But if housing prices deflate too much, homeowners will get crushed by the debt and will just walk away from their mortgages. People will default en masse on their negative-equity loans, and banks holding toxic mortgage debt will fail by the hundreds. Across the globe. Massive panic, at which point, all bets are off as to what happens next.
If we were to witness CURRENCY DEFLATION, i.e. disciplined fiscal policy at every level of government and society, the value of the dollar increases, strengthens, then the mountain of US Dollar denominated debt hanging over mortgage owners, Municipal, State, and the Federal Government will completely stall the economy. You, me, your 4 year old child, will be paying 90% of our income to taxes, credit card companies, and mortgages for the rest of our lives. And forget about retiring - you will work until the day they put you in the ground.
The government will avoid this scenario as much as possible. There really is only have one way to do this: INFLATE THE CURRENCY, BABY! Run those printing presses 24 hours a day, 7 days a week. Bernanke will get on his hands and knees at the Federal Mint to sign all those fresh new $1,000 USD bills himself. $100 will be the new $20. Think about it - pennies are already finished, a complete waste of time. People don’t even bother to pick them up anymore. Dollar coins are already seeing circulation. These are the warning signs - ignore at your own peril.
But what about this commodity bubble we’re in? Is this really a bubble?
Commodity prices have increased in the last 7 years, but this is not a textbook case of inflation. This is in large part caused by supply and demand economics. Supply has been massively outstripped by demand for oil, corn, wheat, steel, nickel, copper, precious metals, etc. Part of that is speculation by investors (futures, derivatives, options), but a huge part of that equation is SCARCITY. Oil has gone up to $100, but it’s not because of speculation! And the oil price increases are causing price increases in the substitutes as well. So now instead of feeding our corn to our livestock, we’re using it for biofuel. So corn prices have skyrocketed. And wheat production is down globally - a combination of drought, rust infections, and declining bee populations. Is this inflation? Are we witnessing a wheat bubble? An oil bubble? A corn bubble? What if the shortages are real and lasting? What if the reports of peak oil and global warming are true?
Unless we move to a hydrogen economy, or experience a complete collapse of the global economy, oil will never see $20 a barrel ever again. More likely that we are in a global struggle for the earth’s remaining resources.
Unless we see a dramatic reduction in the earth’s population, or a global economic collapse, commodity demand will only continue to increase.
One of the reasons why the demand for precious metals has increased is that there is a possibility that the Fed’s actions could lead to a dollar confidence crisis, and a subsequent currency rout. I.e. that China loses faith that the US will pay back its debts and will dump their T-Bills on the open market at a steep discount. That will crush the US dollar and cause a surge in commodity prices ever further.
Gentlemen, in 1930 there was no lack of money whatsoever.The problem was the lower economic classes went completely bust.I suggest to you that the deflation of the 30’s was the result of the lack of spendable cash within the economically lower but numerically much greater population.When people can’t buy prices go down.
Frustrating reading this board as everyone is pretty much in agreement and do not even realize it. As I see it, there is just confusion over definitions and some misguided assumptions.
Definition of Inflation/Deflation
Is it a function of prices levels or money supply? Answer: Makes no difference.
Misguided assumption #1
Prices of ALL assets are always positively correlated. They are not. Some asset prices will rise while others will fall. Case in point, housing prices and commodities prices going in opposite directions.
Misguided assumption #2
The Fed infusions had an impact on money supply. It depends on what you look at. The Fed infusions actually increased the money supply (if you look at M2/3). But if you looks at M1, the Fed infusions did nothing to increase money supply. The motivation behind the Fed infusions were to prevent the drastic destruction of money supply which would have occured by massive bank/broker failures. You see this in M1 and M2/3 going in opposite directions. In effect, the Street financed much of its assets (much of which were crappy assets) through short-term financing. As firms got nervous about each other’s credit, short-term financing dried up. As a result these crappy assets could not be financed and firms would go bankrupt. Bear was the straw that broke the camels back and the Fed was forced to accept these crappy assets as collateral for financing. Basically, the Fed is providing the financing that other banks won’t to prevent the system from collapsing.
Conclusion
We are in a holding pattern, balanced on the edge of a knife. Commodity prices are/will go up. Other assets (housing/credit/anything leveraged) are/will go down. We are in a deleveraging environment which is also characterized by inflation in some places and deflation in some places. Its just depends on what you care about. But deleveraging is occuring at the same time so is inflation and deflation.
So those who measure inflation as a function of asset prices must realize there is not necessarily a positive correlation among all asset prices.
For those who measure inflation as a function of money supply, you are getting conflicting information from M1 vs M2/3.
The Fed infusions prevented a financial meltdown for now, but the question is will it be able to avert it in the future. Banks desperately need to rebuild their capital bases (which will take years). In the mean time, the Fed will provide the banks all the cash they need to remain solvent. But to generate actual new economic growth, we need the debt flow among consumers to go positive (which seems a long, long way off).
There are lots of structural problems in the system that are very difficult to resolve and for which monetary policy has less impact that it otherwise would.
My bet is we see commodity prices rise for a while as people seek to diversify from other asset classes and the dollar to continue to get weaker long term. If you are going into equities, certain stocks do seem cheap on a valuation basis.
It looks like you think that inflation is when something rises in price and deflation is when something drops in price.
More accurately, inflation is when goods & services (in general) rise steadily, continually in price. It’s caused by an increase in money supply as you have noted. But you say that real estate crashing would be evidence of deflation. There simply cannot be deflation without a contraction of the money supply. Right now, the Fed is increasing the money supply by 16% per year. In this environment, all real estate has to do to crash is stay steady in price.
Anything that stays steady in price while our money supply increases is crashing. The stock market has crashed over the past 10 years by simply not keeping up with the 8 to 12% annual increase in cost of living.
So, yes, there are bubbles in fragmented areas of assets, but their expansion and contraction don’t determine whether we are in inflationary or deflationary times; the money supply does.