INFLATIONISTS vs. DEFLATIONISTS -- a compendium in progress

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INFLATIONISTS vs. DEFLATIONISTS -- a compendium in progress

Postby ninakat » Mon Jan 19, 2009 10:45 pm

"Will the world economy sink into a Japan-like slump...or will the feds cause a Zimbabwe-like catastrophe? Every day, our head aches from trying to figure it out..."
-- Bill Bonner, The Daily Reckoning, January 9, 2009

* * *

a compendium in progress

Dear RI reader:

I'm not an economic analyst, but I'm very concerned about the future of our economy and how best to protect myself and my family. So, like most people, I turn to the experts. But when it comes to predicting the direction of the economy, many reputable experts don't agree -- so much so that their opinions often diverge spectacularly.

In the interest of trying to get a handle on what the prevailing opinions are, I've gone to the internet to sample and compile the opinions of a myriad of economists and analysts -- mostly outside the mainstream media (MSM), since the MSM tends to be biased by corporate interests. And of course there's bias from those I've selected here too, but I suspect it's far less.

The hope is that by seeing all of these perspectives in one compilation, we'll be better informed so that we can decide for ourselves which side of the argument makes the most sense. I'm trying my best to keep my own bias out of this listing -- just to fairly present the opinions from a variety of sources. In doing this research, I've concluded that there seem to be three major groups: (1) Inflationists who don't believe we are having or will have deflation; (2) Deflationists who believe we're now experiencing deflation, but will have inflation later; and (3) Deflationists who don't believe we will have significant inflation (or don't forecast that far ahead). So I've structured the list according to those three general camps. Of course, there are variations -- some subtle, some more obvious -- so keep in mind that I'm somewhat of a novice at this and am open to suggestions about how to better structure this list.

It's likely that I've left out some noteworthy commentators in my listing, but this is a work in progress, so please contribute any additional sources and opinions in the discussion thread, and I'll update this listing accordingly. Please limit your suggestions to people who publish articles, books, blogs, and/or videos to a readership/listenership -- people who have an established reputation and are active on a regular basis. In other words, I would prefer this listing not include anonymous bloggers.

One last point. I've tried to find links to the most up-to-date opinions from these people. If someone has more current information that changes or clarifies the positions of anyone on this list, please post it and I'll make the update.

-- ninakat

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Here's an article by John Rubino that illustrates the divisiveness on the inflation vs. deflation debate as of September 2006. While not current, the opinions have likely not changed that much, and it's insightful as an overview.

THE Question
by John Rubino,
September 28, 2006

"Choose the form of your destruction." -- Gozer the Traveler, Ghostbusters

By now, pretty much the whole sound-money community agrees that humanity in general and the U.S. in particular are headed for seriously hard times. But exactly how we get from today’s illusion of prosperity to tomorrow’s financial Armageddon is a tougher call. Will the global economy collapse under a mountain of debt as in the 1930s, or will central banks run the printing presses until hyperinflation vaporizes most fiat currencies? As Sprott Asset Management’s John Embry recently put it, inflation vs deflation "is THE question, really."

The answer matters for a lot of reasons. Hyperinflation and deflation favor very different investments, obviously, gold the former and cash the latter. But it also goes to the heart of our understanding of post-gold standard economics: Are today’s central banks in complete control of their fiat currencies’ value, or do the markets ultimately determine exchange rates and price levels? Is there a point of no return, when rising debt levels make one outcome or the other inevitable? How do you invest to make sure you’re covered either way?

I’ve been keeping a file of the best stuff written on the subject, some of which is pasted below: (article continues with the words of John Embry, Ben Bernanke, Jay Taylor, Steve Saville, Mike Shedlock, and Doug Noland).

* * *


Ben Bernanke
"The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."

Peter Schiff, Euro Pacific Capital
December 2008
"By borrowing more than it can ever pay back, the government will guarantee higher inflation for years to come, thereby diminishing the value of all that Americans have saved and acquired. For now the inflationary tide is being held back by the countervailing pressures of bursting asset bubbles in real estate and stocks, forced liquidations in commodities, and troubled retailers slashing prices to unload excess inventory. But when the dust settles, trillions of new dollars will remain, chasing a diminished supply of goods. We will be left with 1970s-style stagflation, only with a much sharper contraction and significantly higher inflation."

Ron Paul
January 2009, YouTube 4:13
"2009 will see inflation and a rapid deterioration of the dollar. We’re spending too much money, borrowing too much money, and printing too much money."

John Rubino,
September 2008
"Here we go. America's options have finally dwindled to just two: Accept a 1930s-style deflationary crash or embark on a Weimar Republic-style hyperinflation. There was never much doubt about which course our leaders would choose, but today they made it official. Treasury will assume essentially dictatorial powers to buy up pretty much the entire U.S. financial system, and the Fed will print the required trillions."

Jim Sinclair, JSMineset
January 2009
"The dollar cannot and will not remain strong, nor can a planetary Weimar [hyper-inflationary] experience now be avoided."

John Williams, Shadow Government Statistics
January 2009
"As inflationary pressures mount anew and the financial markets increasingly shun U.S. Treasuries, an inflationary depression can evolve quickly into a hyperinflationary great depression. Although hyperinflation became inevitable in the last decade, the onset of the process just recently was triggered by Fed and the Treasury actions in addressing the systemic solvency crisis. The process would be accelerated by unfettered and unfunded government spending that appears to loom in early 2009."

Henry C.K. Liu
January 2009
"Thus far in this financial crisis, the Bernanke Fed has sown the seeds not for a quick recovery but for a decade or more of stagflation for the US and the global economy." Note: Stagflation is high unemployment along with high inflation. (link)
July 2008
"The bursting of the latest dollar-denominated debt bubble created a global credit crisis in August 2007 that is beginning to cause globalized trade to contract. Exporting economies around the world are now forced to reconsider their dysfunctional strategy of seeking growth through exports for fiat dollars that are pushing the world economy towards hyperinflation, leading all other fiat currencies in a depreciation race to the bottom."

Robert Higgs, The Independent Institute
December 2008
"...does deflation actually loom at present? If it does, its occurrence will surprise me greatly, because the Fed has been creating base money as if there were no tomorrow, and if the bailouts continue, as seems likely, more of the same is virtually certain. ... In short, given the monetary conditions now prevailing, the greater threat by far is inflation, not deflation. And contrary to what the investment "experts," the politicians, and the mainstream economists believe, inflation is not a benign element in the economy's operation. It is, as it has always been, the most dangerous and destructive form of taxation."

Eric Janszen, iTulip
November 2008
"Over 100 books, papers, and original analysis went into developing and refining Ka-Poom Theory over the years, and model that explains how, following the collapse of the credit bubble, the US economy will experience a short (six month to one year) period of deflation that we call disinflation, such as we are experiencing today, followed by a major inflation induced by monetary and fiscal policy and the actions of US trade partners in response to that inflation."

Jim Willie, Golden Jackass
January 2009
"False Deflation Diagnosis and Gold Bullish Crossover Signal"
January 2009, Hat Trick Letter (subscription)
"No sign of deflation exists in monetary measures, when the financial sector data is incorporated."

Marc Faber (Dr. Doom), Marc Faber Limited
December 2008, YouTube 3:27
"... we'll essentially have a tail wind for inflation in the long run and for precious metals"
December 2008, YouTube 5:29
"... in the case of the U.S. today, it is likely that this money printing exercise by the Fed will lead to a weaker dollar, and of course the question comes up: weaker dollar against what? all the other currencies are not much better, so I think weaker dollar against hard assets, you know, such as precious metals, oil, and industrial commodities that have been absolutely hammered..."

Jim Puplava, Financial Sense Newshour
January 10, 2009 (listen from 16:00 - 18:00)
"... at some point, something is going to crash, running trillion if not multiple trillion dollar deficits, John [Loeffler], there's only one way that you're going to pay for that, and that is you're going to have to hyperinflate your way out of that..."

James Turk, GoldMoney
January 2009
"The outlook for the US dollar continues to worsen as the Federal Reserve balloons its balance sheet. What's more, the Fed's zero interest rate policy removes any incentive to hold dollars in an environment where counterparty risk remains an intractable problem and where rapid money growth portends a surge in inflation in the weeks and months ahead."

Martin Hutchinson, PrudentBear
January 2009
"The combination of reappearing inflationary trends and a soaring budget deficit will cause 'buyers’ strikes' at Treasury bond auctions, sending interest rates through the roof. ... The rise in long-term interest rates will choke off economic recovery while the resurgence of inflation caused by excessive monetary growth will force the Fed to reverse its policy and increase short-term rates to some margin above inflation."

Steve Saville, The Speculative Investor
November 2008
"By trying to counteract today's falling prices by increasing the supply of money, central banks are setting the stage for a major inflation problem in the future. Think of it like this: by the time the de-leveraging process has run its course a lot less money will be needed, but if central banks and governments get their way there will actually be a lot more money. We acknowledge that wealth destruction could lead to less money being borrowed into existence in the future, and, consequently, to deflation. After all, tens of trillions of dollars have been knocked off the market values of equities, houses and high-yield bonds, thus reducing the collective ability of the owners of these investments to borrow money. However, as long as the total supply of money continues to grow we can confidently conclude that the deflationary forces that stem from wealth destruction and credit contraction are being more than offset by the inflationary actions of the central bank and the government."

Mogambo Guru
December 2008
"Well, inflation "reasserting itself" is a given, as far as I am concerned! Hell, the money and credit necessary to finance all those higher prices is already being created, and if you don't believe me, then explain how there is already an estimated $8 trillion in new government spending and lending announced, in an economy whose GDP is a measly $13 trillion to start with! This means a budget deficit of over 50 percent of GDP! 50 percent! Yikes! Unheard of!"

Puru Saxena
January 2009
"The main reason why I do not foresee deflation (decrease in the supply of money) is due to the fact that the contraction in credit arising from deleveraging is being more than compensated by the money-pumping actions of the various governments. In the past year alone, the Federal Reserve has expanded its balance-sheet by a whopping US$1.2 trillion! Moreover, thanks to Mr. Bernanke’s cash injections (quantitative easing), reserve balances have sky-rocketed from roughly US$5 billion to almost US$600 billion in roughly 3 months... Now, you may be wondering why there is so much talk about deflation these days when inflation (expansion in the money-supply) is the real issue at hand. There are two reasons for this: First and foremost, you must remember that banks are in the business of lending and the central banks’ prime objective is to manage inflationary expectations. So, Mr. Bernanke and his comrades are paid to keep a lid on the public’s inflationary fears. Accordingly, a ‘deflation scare’ is engineered ever so often, so that they can continue with their long-term stealth inflation agenda without raising too many eyebrows. Secondly, the establishment needs to advertise a ‘deflation scare’ so that the central banks can slash interest rates. If inflation rather than deflation was perceived as the legitimate threat, then the Federal Reserve would not get away with near zero interest-rates."

Howard Ruff, The Ruff Times
December 2008 (see 2nd paragraph)
"It is axiomatic that deflation is the spawning ground for inflation, as the government doesn't know how to fix deflation, depression or recession other than to throw money at it. The creation of all the money floating through the economy will eventually meet all the conditions for inflation."

Paul Craig Roberts
January 2009
"The third source of financing is for the Federal Reserve to monetize the debt. In other words, the Treasury prints bonds and the Fed purchases them by printing money. The supply of money thus expands dramatically in relation to goods and services, and high inflation, possibly hyperinflation, would engulf America."

Gerald Celente, Trends Research Institute
December 2008, YouTube 4:05
"... and also realize that their dollar might be worth dimes in the coming years because they're creating a situation for hyperinflation so we're looking at gold to go to probably $2000 an ounce."

Lew Rockwell
December 2008, YouTube 4:44
"What apparently we'll end up with is, at least in the industrial world, a global hyperinflationary depression."

John Embry, Sprott Asset Management
September 2008
"There is a good argument for a deflationary spiral like the Great Depression. On the other hand, this time paper money isn’t anchored. Everything’s fiat and the government can create it with the stroke of a pen or the touch of a computer key. If you really want to pin me down, I'd say we’re going to have a hyper inflationary depression. The value of money will be destroyed and economic activity will grind to a halt. It'll be the worst of all possible worlds--a South American meltdown."
November 2008
"For now (though we believe it a temporary state of affairs) the markets seem to believe that cash is king. They are still content to own paper in times of trouble, particularly US dollars and US Treasuries. But such confidence is misplaced, for many reasons. In the current environment, deflation à la the Great Depression is highly unlikely. Ben Bernanke, the head of the Federal Reserve, is already on record as saying deflation cannot happen, using the helicopter drop analogy to prove his point. Under a fiat currency system this is true enough, and made abundantly clear with the central banks assuming the role of buyer and guarantor of last resort."

Dan Denning, The Daily Reckoning Australia
November 2008
"If we're right here at The Daily Reckoning in Melbourne, Australia, however, and the bond bubble began bursting in late October, then the Treasury's line of credit with global savers is nearing its end. Global creditors will be reluctant to finance American deficits any further. Because isn't that how the world got into this mess in the first place? So in order to borrow, the Treasury is going to have pay much higher rates of interest to reflect the credit risk the US government has become. Trouble is, the US can't afford to borrow at higher interest rates right now. So that leaves the option Roubini thinks is least likely -- printing money. The fancy term for it would be "monetizing the debt". In practical terms, it would mean the Fed buying public debt issued by the US Treasury with freshly printed money. And THAT, we reckon, is super inflationary."
January 2009
"Perversely, the monetary authorities will destroy public confidence completely through massive inflation. It will also unleash a great deal of social and political disorder. But the authorities appear to prefer this chaotic result (which they can then police and manage with new rules) to another Great Depression characterized by too little money and price deflation. The excesses of the credit bubble will not be liquidated. Instead, they will be perpetuated and subsidized."

Jim Rogers, Rogers Holdings
October 2008
"The current rescue plans, which will force governments to issue more debt, print money and flood the markets with liquidity, will flare up inflation after the crisis is over and will create worse problems, Rogers warned. 'We're setting the stage for when we come out of this of a massive inflation holocaust,' he said."
October 2008
"I'm of the view that the world's going to recover some day, and with all the money that's being created, history shows it has always led to inflation."

Alf Field
November 2008
"The problems are manifold, but the most pressing one is to restore confidence in the banking systems of the world. Failure to do so will measurably increase the odds of a deflationary depression. The power of the modern electronic money creating machine suggests that the odds still favour an inflationary outcome."
November 2008
"In 'Crisis Cogitations' (essay by Alf Field), it is acknowledged that the current credit/debt deflation could get out of hand and result in a serious deflationary depression. There is debate as to how gold will react in a deflationary environment, but the fact is that in a serious depression bankruptcies will be rife and price levels will decline. This may result in cash and Government bonds performing better than gold, but this is not certain. Gold cannot go bankrupt and is thus an asset that people can hold with confidence in a deflationary depression. It is possible that demand for a "safe haven" investment may be large enough to cause the metal to perform better than cash or Government Bonds. The odds, however, strongly favour an inflationary outcome. Given a strong will and the ability to create any amount of new money via the electronic money machine, it seems a foregone conclusion that runaway inflation will be the end result. If Mugabe could do it in Zimbabwe, there seems little doubt that Ben Bernanke and his associates in other countries will have no trouble in doing it too. ... I feel very strongly that it is time to quietly hold onto one's gold insurance and not attempt to trade it."

Ambrose Evans-Pritchard,
January 2009
"So yes, printing money is not as easy as it looks, but to conclude that the Fed cannot bring about inflation is a leap too far. ... My tentative guess is that Bernanke's blitz will "work" -- perhaps later this year. Markets will start to look beyond deflation."

Bob Chapman, The International Forecaster
December 2008
"Zero interest rates can only make matters worse. In combination with massive money and inflation it will bring about the collapse of the dollar. Shortly due to these monetized infusions, inflation will rise strongly from current levels. America and the 20 leading nations have never seen such massive monetary aggregate creation being deliberately coordinated."

Rich Toscano and John Simon, Pacific Capital Associates
January 2009
"We believe that this state of affairs is simply incompatible with the existence of the type of protracted "deflationary spiral" about which it has become all the rage to worry. Deflation is a choice in the current monetary regime, and it is a choice that our government simply cannot make. ... We believe that the current monetary system, political climate, and prevailing analytical framework are incompatible with a prolonged period of either monetary or price deflation."

Dmitry Orlov, ClubOrlov
December 2006
"We should certainly expect shortages of fuel, food, medicine, and countless consumer items, outages of electricity, gas, and water, breakdowns in transportation systems and other infrastructure, hyperinflation, widespread shutdowns and mass layoffs, along with a lot of despair, confusion, violence, and lawlessness."
September 2008
"About the only thing the government currently seems it fit to do is extend further credit to those in trouble, by setting interest rates at far below inflation, by accepting worthless bits of paper as collateral and by pumping money into insolvent financial institutions. This has the effect of diluting the dollar, further undermining its value, and will, in due course, lead to hyperinflation, which is bad enough in any economy, but is especially serious for one dominated by imports."

George Ure, Peoplenomics
January 12, 2009
"Since the US (and the West) seems by my reckoning to be working its way through an echo of conditions of the Great Depression, it's interesting that the hyperinflation groundwork has been laid with all the bailouts and now a wider war comes into view."

Kevin Depew, Minyanville
November 2008
"The argument against deflation and inflation is both academic and political. Present economic elites benefit from inflation and suffer terribly in deflation. Therefore, there is great incentive for the small minority -- the 2-3% of wealthy who control the vast majority of assets in this country -- to continue to press government and the Fed to maintain the present course of inflation over deflation."

* * *


Larry Edelson, Money & Markets
January 2009
"Now mind you, all that fiat money being printed will not work its way into the system overnight. And it pales in comparison to the wealth destruction that’s already occurred. So short term, deflation still has the upper hand. But, and this is very important, when the wheels of commerce and business begin to turn again ... when banks begin to lend again ... and when investors start to pull their money out from underneath their mattresses -- you are going to see a tidal wave of worthless money get thrown into the markets. And when that happens, it will re-inflate almost all tangible assets. And the chief beneficiary? Gold!"

Stoneleigh, The Automatic Earth
January 11, 2009
"When we eventually do see inflation, it will not come from the initial havoc in the bond market, but from the aftermath of its destruction. Once deleveraging is over and countries must function in financial isolation, there will be nothing to prevent them from printing actual cash, as opposed to desperately trying to expand credit in a double-or-nothing gamble as they are currently doing. Down that road lies a currency hyperinflation on a Zimbabwean scale, but we are nowhere near that point now. You must survive deflation in order to have to worry about hyperinflation."

John Mauldin
January 2009
"For a very long time, I have been adamant that deflation is in our future. In the next few pages I outline how inflation might come back, but I doubt it will be this year [2009]. For now, deflation is the economic factor that the Fed and central banks will be battling. And believe me, it will be a very large and controversial battle."

Rick Ackerman, Rick's Picks
December 2008
"Inflation Coming, But Not in Time. We expect that to change, but not in time to rescue debtors with a flood of cheapened money. We have told you for years to tune out the inflationists because they do not know their butt from a hole in the ground. That is still true. ... Deflation will run its course no matter what the puny central banks attempt to throw at it next. It will take years to play out, and the price declines we have seen so far in the housing market are not even halfway to their bottom."

Chris Martenson
October 2008
"I hold gold because of the possibility that the Fed might inadvertently veer off into the hyperinflationary ditch. Historically, this has a very high chance of occurring. Either way, inflation or deflation, I can make the case for gold. But right now? The data says that you need to begin preparing for a nasty deflationary crunch."

Mike Whitney
December 2008
"That's why Bernanke is planning to force-feed credit into the system via untested methods that, many believe, will engender Weimer-like hyperinflation when the recession winds down. If the economy kicks in faster than Bernanke figures, he'll have to mop up $8.3 trillion of liquidity or watch while the dollar gets torn to shreds. For now, the problem is deflation; steadily falling asset prices which are shrinking profits, increasing layoffs and forcing fire sales of distressed assets. As unemployment soars, aggregate demand falls even more, causing a vicious downward cycle. Once deflation becomes entrenched--as Japan discovered during its "lost decade" in the 1990s---it becomes more difficult to eradicate. Between 1994 to 1999, Japan initiated 7 stimulus packages which amounted to hundreds of billions of dollars. All of them failed to restart the flagging economy. According to the Wall Street Journal: 'Only in this decade, with a monetary reflation and prime minister Junichiro Koizumi's decision to privatize state assets and force banks to acknowledge their bad debts, did the economy recover.'"

* * *


Mike Shedlock, Mish's Global Economic Trend Analysis
September 2006
"It seems that everyone feels the Fed is all-powerful, and that the Fed can defeat the business cycle by forever printing money. That is the fallacy of the inflationist arguments. It cannot be done. The root cause of the great depression was an overexpansion of money and credit. "Helicopter Drop Bernanke" could no more cure that by printing more money than I could take on Michael Jordan in one on one basketball at his prime."
January 2009
"2008 is the year the impossible happened, the impossible being deflation. Deflation was called on this blog and a few other places but the idea was essentially mocked as impossible by the masses."

Karl Denninger, The Market Ticker
January 2009
"'Hyperinflation', or even 'Serious Inflation' (similar to what we had in the 1970s) is impossible without a means to transmit the rise in prices into wages."
December 2008
"Deflation, not inflation, will become evident well beyond housing. Other capital goods beyond housing will see real price declines for the first time since the 1930s. Debt is inherently deflationary; the 'hyperinflationists' will once again be shown to be wrong (how many years running will it be now?)"

Nouriel Roubini
November 2008
"You'd think evidence of even bigger deficits in the United States is clearly inflationary. But not everyone agrees. The new prophet of doom, Professor Nouriel Roubini -- a tutor in economics & international business at NYU's Stern School of Business -- says at least four factors are setting up what he calls 'Stag Deflation.' As opposed to the stagflation of the 1970s, where you had no growth and rising prices, he foresees no growth and falling prices -- a depression by any other name."
October 2008
"So should we worry that this financial crisis and its fiscal costs will eventually lead to higher inflation? The answer to this complex question: likely not."

Robert Prechter, Elliot Wave International
December 2008
"Protecting your liquid wealth against a deflationary crash and depression is pretty easy once you know what to do. Protecting your other assets and ensuring your livelihood can be serious challenges. Knowing how to proceed used to be the most difficult part of your task because almost no one writes about the issue. My book remedies that situation."

Nassim Nicholas Taleb
December 2008
"I think it is worse than Roubini thinks. No, I - I had the same story, haven’t changed my story since - and what convinced me of this is that we switched from an environment of inflation, hyperinflation, where people are afraid of commodity prices rising, to a total deflation in no time. Look at inflation bonds... I know that we are going [to] have massive deflation. The overhang of debt, massive deflation. Debt needs to be reduced. And I think Paulson seems to be doing a good job, particularly that they were part of the cause of what happened, you know, it is quite commendable."

Gary Shilling, A. Gary Shilling & Co., Inc.
December 2008
"For years, we've been forecasting that chronic deflation of 1% to 2% per year would start with the next major global recession. Well, it's here! ... Inflation? Many, of course, worry not about deflation but inflation, due to all the money being pumped out by central banks and governments globally. They, no doubt, are biased since most have lived only in an era of inflation and don't agree with us that inflation is the result of excess government spending in wars, both hot and cold. In peacetime, deflation reigns."
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Postby JackRiddler » Wed Feb 18, 2009 7:12 pm


Very hard work, ninakat - thank you!

Here's the head of iTulip going nuts on the inflation side - day before election 2008:

Does the New York Times confirm deflation spiral theory or signal end of disinflation?


As readers know, I have been unable over the years to resist my deflation obsessed friend Rick Ackerman's taunts. For years and years he's argued that when the credit bubble collapses, the US economy will devolve into a 1930s style deflation spiral with prices falling for years, 25% unemployment, soup lines, and perhaps a return of the Jazz Age. His latest is a response to heat he's getting from his readers to the completely unprovoked attack we launched against the deflationist camp last week with Deflationista takes on iTulip to prove deflation is here! and The truth about deflation.

Over the weekend Rick shot me a note to point out the Sunday New York Times article on deflation: "Even the New York friggin’ Times is onto the story now – on the front page, no less."

This was followed by Rick's latest on deflation that says in part:
"In any event, we’d suggest that readers imbibe articles about the economy in USA Today, the Times, the Wall Street Journal et al, with a grain of salt. The mainstream media did not see this disaster coming and even now seem incapable of imagining how much worse it could get. Conventional news outlets are barely paying lip service to those whose forecasts have been ahead of the curve for years. The truth is, deflationists were regarded as fringe lunatics until relatively recently. Writing for Barron’s and the San Francisco Examiner, we had the subject all to ourselves until around 1998, when the collapse of the Thai baht and its spillover effect on Asia brought a few more like-minded “lunatics” out of the woodwork.

I’ve promised to don a grass skirt and dance a hula in Times Square in mid-February if I am wrong. I wonder what Wall Street will look like with Goldman at $24.
Here's my response.


I always enjoy receiving your notes, but you’ve got to be kidding. Is it possible that you and I both live in the same country, the United States of Goldman Sachs? We both know that our Minister of Finance Henry Paulson’s company recently turned–presto!–into a commercial bank so that it could absorb the assets of failed banks at a fire sale prices. The perks won’t stop there. Yet you say that our Minister’s firm can suffer an ignominious a decline in share price?

Think Gosbank, man!

The disinflationary period we’ve been warning about years before the housing bubble popped, producing asset price deflation and spilling over–if only briefly–into commodity prices and wages, is here. Now all you have to do to see it is look out the window. Your mistake is that you can’t see past it to what is on the other side.

Government, and lots of it!

I sent you the picture of capital flows years ago when you were saying that the Fed can't print to save the soon to be crashed banks. Take another look. It shows what I figured was due to happen when the endogenous credit markets blew up and recession hit households and businesses during the asset price deflation. In a phrase, fiscal stimulus.

Ever go to Japan? I’ve been there several times over the past 20 years. Japan may be famous among economists for its “deflation” but if you go I recommend you bring lots of money because everything is very, very expensive there for us hapless Americans whose currency has been devalued.

Not so bad for the Japanese, though. From 1999 to 2007, Japanese wages climbed 8% while the CPI (theirs isn’t as phony as ours, by the way) fell 2.3%. Stuff got slightly cheaper relative to wages, but not exactly the USA’s 1930s Great Depression. Unemployment never exceeded 5.4% there either–not even close to the 9% unemployment we got here in the US in 1983. Here, after our first bubble in tech stocks popped, it was the other way around: our government's reflation policy after the last “deflation” in 2002 caused consumer prices to increase more than wages, up 24% and 23% respectively since then.

(Hat tip to member Bill for locating the research)


This chart shows what Japan did when its asset bubble popped and its “balance sheet recession”–a euphemism for debt deflation–followed. New Deal, pal, 1990s style. Note government spending produced more than half the total demand for credit in some years.

We’ll do “better” than that. In fact, we already have. How much has the Fed expanded its balance sheet already? How much of the housing bubble is already on the US government’s balance sheet? And that was the last bubble, the first fiscal stimulus ever done in reverse–first the jobs then the government spending rather than the more traditional order of stimulus then jobs.

Whether Obama or McCain wins tomorrow, you can bet that public money will flow like water over Niagara Falls, but to different places. The question isn’t money or not, deflation or not, it’s where to? Orange Country for the military industrial complex or Massachusetts for biotech? Coal or nuclear? Fox News or Frontline?

Where will the money come from? Why, from all of us, my friend! The future savings of the current and next generation are already spent. For the next ten years at least we’re all just cash flow to pay down debt while government spending generates the demand that creates the jobs that generates the income we use to pay down the debt.

Good news! No deflation spiral in Japan or here. The bad news: more government and less private markets. Definitely less consumption. The only way to avoid a slow, grinding decline in our standard of living is a new productivity miracle. Tell the Silicon Valley guys and gals to crank it up! We need another invention like the Internet, but this time let’s not give it away. Wonder how much export income we lost by not licensing the Internet to China? Not that they'd actually pay–they'd rather buy Treasury Bonds than shell out license fees for the hundred million Microsoft software licenses they've pirated.

Look, you got the current crisis driven dollar rally part right years ago. Good work. Now look beyond it. A dollar rally ain’t deflation. It’s a panic out of stupid investments in securities not denominated in dollars. What’s the trade? When it ends so does some of the source of disinflation. Not to say it won't go on longer, but markets appear to already be pricing in what comes next.

Ask yourself this: In the face of crashing global markets and a developing world-wide depression, why does oil hang stubbornly above $60, a “bubble” price just two years ago?* Do commodity markets smell a global orgy of government spending on the way? Also, last we checked, governments aren't all that good at finding commodities, only at taxing them once someone has gone to the trouble and expense of finding and producing them. That's why Mexico and Russia seem to have suddenly run out of oil, coincident with taxation creating disincentives to invest in exploration and kleptocrats chasing off anyone with know-how out the country. (That's not an ad for either McCain or Obama, by the way. It's just a cold, hard fact.)

Add it all up and it's disinflation then inflation, just as we’ve been saying for years. Disinflation first–it's here–followed by inflation–it's coming.

The mainstream press, as you know, fulfills an important function in the execution of monetary policy. When the stories on inflation reached fever pitch last year it was time to get out of commodity positions, just as when deflation made the front page in 2002 it was time to back up the truck and buy gold. In this disinflation/deflation cycle–and it's a big one!–maybe we shouldn't wait for the next Deflation: Making Sure "It" Doesn't Happen Here speech from Bernanke like the one he gave November 22, 2002 when gold was trading at $316.

We may have to wait a while for the shots of you hula dancing in Times Square, but we're patient. We promise to post them here on the front page of

Your pal,


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Last edited by FRED; 11-03-08 at 04:13 PM.


* meanwhile dropping to $35 with demand for everything plunging globally and crisis continuing. I expect this to change. Yes, the related debate: peak oil or pure speculation?
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Postby JackRiddler » Wed Feb 18, 2009 7:33 pm


To make up for the above, here is a deflationist, Yves Smith of Naked Capitalist. ... ation.html

Sunday, January 20, 2008
Inflation or Deflation?

Mere mortal investors and their professional colleagues are (at least if they are honest and have a modicum of sense) a bit confounded as to what to do at this juncture. By all measures, inflationary pressures are gaining strength, and yet recessions lower aggregate demand and with it, price pressures. Ah, but what about the Chinese? Even if things get bad here, they aren't fully in lock-step with the US economy and have plenty of firepower. And what happens when Helicopter Ben throws cash at the problem? Won't lots of money creation debase the currency and by definition produce inflation?

It's very easy to get a headache from this sort of thinking.

Michael Panzner offers a useful post, "The Wrong 'Flation" on this topic, arguing for the deflationary outlook. The most powerful evidence for this view comes from the fact that the monetary authorities have lost control of credit generation (broader money, the old M3) as observers ranging from market mavens like Michael Shedlock to Serious Economists like Mohamed El-Erian have pointed out. The credit crisis means credit contraction, a process the Fed will likely be unable to staunch. That in turns points to deflation.

However, "unlikely" does not necessarily mean "unable". Bernanke is a well known expert on the Great Depression, and well schooled in the dangers of letting contractionary processes feed on themselves. So he and his colleagues will be doing everything in their power from keeping a vicious circle from setting in. The Term Auction Facility was a creative measure that managed to stave off a crisis in the money markets. Perhaps he will be able to use a combination of novel measures, liquidity injections, and smoke and mirrors to keep confidence at a reasonable level (confidence and willingness to extend credit are what really is at risk here).

The problem, ultimately, is that credit extension (witness no-doc loans, mezzanine CDOs, speculative real estate lending, and "cov lite" LBO deals) went well beyond sustainable or sensible levels. There will need to be a reduction in credit, which will inevitably lead to a contraction. But what shape will that take? How far down is down? While I think a financial meltdown is a real possibility, I guesstimate the odds at 30%. That is dangerously high by any standards, but also says the greater likelihood is that a crisis will be averted.

While I am still generally pessimistic about the near-term prospects, the powers that be may be able to forestall a crisis (and by that I mean a credit crunch a la 1990-1991, not a real calamity) and instead engineer a fairly ugly recession (I'd prefer a short and very nasty one, but given the housing crisis, we are more likely to get a prolonged sluggish period). Not pretty, particularly for middle and lower middle income consumers, who will take the brunt of it, but the alternative (most likely a Japan-style deflation due to refusal to realize losses on inflated asset values) would be even worse.

From Panzner:
Those of us in the very small group that has correctly anticipated that past excesses would eventually come home to roost generally fall into two camps: the deflationists, who believe that another Great Depression is on the cards -- at least initially -- and the inflationists, who argue that hyperinflation -- where prices spiral rapidly higher -- is the most likely near-term outcome.

While there are more than a few reasons for the contrasting perspectives, in my view it largely comes down to a difference of opinion about how the U.S. reached the "tipping point" to begin with. That is, was it "printing presses" that fueled the housing and other bubbles, the malinvestment and imbalances, and the widespread belief in "something for nothing," or was it excessive credit creation?

If the answer is the former, then the dollars that were and continue to be created remain in circulation, stoking inflationary expectations and exerting a relentless upward push on prices. As economists put it, there is too much money chasing too few goods.

If the answer is the latter -- which is what I believe has been and is the case -- then logic and history suggest that when the jig is finally up, it leads to relentless, liquidation-driven downward pressure on asset and other prices. As opposed to paper currency (or even digitally-created "money" that did not come about as a result of central bank buying and selling of government and other securities), much of the credit-money that was created out of thin air ends up "disappearing" (e.g., through default), diminishing overall demand.

In "Worried about Inflation? Just Wait," Reuters columnist James Saft lends further weight to the deflationist perspective and puts paid to growing worries over rising commodity and consumer prices.
Never mind inflation, the powerful and long-lasting effects of the credit crisis will rein it in soon enough.

With oil, gold and other commodities at very high levels and U.S. producer prices up 6.3 percent last year -- the most since 1981 -- fears have risen that an aggressive round of rate cuts by the Federal Reserve will embed inflation.

Consumer price inflation for December was up 0.3 percent and has risen 4.1 percent since a year earlier.

But these are likely to prove lagging indicators, even if demand from emerging markets remains strong for raw materials.

If credit is being strictly rationed and asset prices falling -- as they are in housing and in stocks -- investment, consumption and just about anything else that can be put off will be put off.

"The strong probability is that we will get at least disinflation in 2008," said George Magnus, senior economic advisor to UBS.

"I'm not aware of any banking crisis in history, almost without exception, that was not accompanied by falling inflation.

"When balance sheets are shrinking and credit restriction is being applied, the whole effect is to cause people either to not be able to make spending decisions or to defer them. It puts a downer on aggregate demand," Magnus said.

A round of poor data, notably unexpectedly weak retail sales, prompted rumors of a highly unusual inter-meeting rate cut by the Federal Reserve, whose next scheduled meeting is January 29-30.

The Fed declined to comment. Traders were roughly evenly split on Wednesday in betting on a 50 basis point or a 75 basis point cut this month in the Fed benchmark, currently 4.25 percent.

But even aggressive cuts in interest rates will have a limited and painfully slow impact on demand under these circumstances, according to Magnus. He contrasts the current crisis, which is fundamentally about the solvency of borrowers and the banks that lent to them, with other crises, such as 9/11 or the stock market crash of 1987.

"When solvency is involved and asset prices are declining, monetary policy can help but can't solve the problem."

Yen carry trade and credit cards next?

Ominously for the economy, the Baltic Dry Index BADI of shipping capacity suffered its biggest one day drop since records began on Wednesday, down 5.74 percent and following similar heavy falls on Friday and Tuesday. The index is down almost 20 percent since January 1.

Because trade travels on ships, the Baltic index is often a good indicator of forward demand, both for natural resources and finished goods. Interestingly, the Baltic index continued to climb as the credit crisis unfolded through the summer, supported by strong economic growth in emerging markets.

Tim Lee of pi Economics in Greenwich, Connecticut, thinks prices of many assets and commodities will fall strongly in what he calls an "incipient deflation".

"Ignore gold, ignore oil: they are lagging indicators of the excessively loose central bank policies we had in the past," Lee said.

"The leading edge that is really telling us what is going on is the government bond market and property prices."

Yields on 10-year U.S. treasuries have fallen as low at 3.69 percent, down almost a half a percent since late December.

The credit crunch is breeding new areas of concern, such as credit cards and commercial loans. Another round of losses in a new area would further dampen credit.

Citibank has more than doubled its loan loss reserve ratio on U.S. consumer debt since the end of the second quarter, with the sharpest move in the past three months.

Then there is the risk that cuts in U.S. interest rates will unravel what is perhaps the world's biggest leveraged bet, the use of carry trades, according to Lee of pi Economics.

Estimated at as much as $1 trillion, carry trades involve borrowing cheaply in yen or other currencies such as Swiss franc that have low interest rates in order to invest in higher yielding currencies, or indeed in anything else the borrower hopes will go up.

Both the yen and the Swiss franc have rallied sharply against the dollar in recent days driven by expectations of much lower rates in the U.S.

If funding currencies like the yen and franc continue to rise, borrowers could sustain big losses. For example, many Hungarians have taken out mortgages in Swiss francs and many Korean corporations have funded in yen. Strong moves upward in the currency they borrowed may leave them unable to carry the debt.

"As the carry trade unwinds, liquidations and asset sales will push prices (down) further," Lee said.

It seems clear that, as with the credit-fuelled boom that preceded it, the bust has taken on a life of its own.

Okay, here is what I do not get - am I dense, or is he wrong?

As opposed to paper currency (or even digitally-created "money" that did not come about as a result of central bank buying and selling of government and other securities), much of the credit-money that was created out of thin air ends up "disappearing" (e.g., through default), diminishing overall demand.

But default means the money extended in the process of credit is not paid down (and thus eliminated from the economy) - it stays in circulation. Perhaps squirreled away by whomever received it from the borrower, but not gone. So defaults raise the money supply and devalue the currency (also by spreading a bad rap on the economy as a whole). Am I wrong here?

What do ruling class superrich really want? The conventional wisdom on each side is that the nasty elite desires whatever the doomsayer is predicting. I differ.

I think those who have accumulated the most money want deflation, so they come in later and buy everything up, but they will get inflation or at any rate devaluation, because the govt's going to keep pumping in cash to make up the incredible shortfalls. The question is where that cash goes. I'm cynical, I think: they're taking the TARP and TAF and other goodies and not paying down debt, but looking to disappear the kaboodle offshore and default later. But if all the cash goes into paying off debt then the net effect will be deflation.

As clueless as ever - but clearly at least 50% of the blather economists are also.

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Postby JackRiddler » Wed Feb 18, 2009 7:38 pm

Interesting comments at the naked capitalist story:

Anonymous said...

There's no essential difference in the mechanics or outcome of "printing presses", and excessive credit creation. Every cycle of easy money ends with some sort of banking credit deflation to some degree. Commercial banking credit "printing presses" create money just as easily as central banks.
January 20, 2008 4:54 AM

Anonymous said...

I think it could be argued that a combination of inflation and deflation could occur simultaneously, with the deflationary presures in sectors heavily reliant on credit (and largely discretionary) while sectors traditionally funded out of present income (and largely subject to only modest restriction) will be subject to inflation. The weakened consumer, whose equity withdrawal has averaged 500B per annum over the past 4 years, now meets the newly found financial discipline of his old lender. At the same time, competition for scarce commodity inputs, from foods to fuels, all of which interlink at some level, are being driven up by higher growth rates in poplations much larger than our own. The BRICs are nearly 3B people.
The Fed can surely create massive credit capacity, but that capacity becomes inflationary only when it is used. The sound consumers never relied on it, and the weak cannot now access it or afford it. Only the corporate sector will potentially benefit, if it is optimistic about prospects for growth.
January 20, 2008 8:25 AM

Anonymous said...

Why was the Japanese experience so bad? We seam to be making the real/nominal mistake in reverse when looking at Japan (no doubt the confusion is made worse by Japanese cultural differences).

1)Deflation in Japan during the period was understated. While the US & many Europeans used trick suck as chain weighting and hedonics to understate inflation the Japanese used an antiquated basket to overstate inflation/understate deflation. Allowing for this Real GDP growth was not bad over the period and combined with demographic trends Real GDP per head was actually pretty good. Evidence for this can be found in the consumption of luxury good which remained strong & even grew over time, hardly the shopping behaviour of the terminally depressed.
2)A strong preference for social cohesion led the Japanese away from mass redundancies towards a social safety net of paying people for non-jobs.
3)People moving into cities, unlike say Brits (an urban people who aspire to be country squires), Japanese dream of living in the heart of the action, the deflationary period allowed many people to move into areas they could only previously aspire to as their (considerable) savings went further.
4)Japanese companies were highly competitive in many sectors, in mobile technology & internet connection speeds they have powered ahead.

Lets hope the bursting of our bubble is dealt with so smoothly!
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Postby ninakat » Thu Feb 19, 2009 2:18 am

JackRiddler wrote:As clueless as ever - but clearly at least 50% of the blather economists are also.

See, that's my problem as well. And since many of these guys are reputable and yet diametrically opposed to one another, it's even that more difficult to get a handle on all this. That was actually the impetus behind the research I did. Am I any wiser now? Hell no. :(

Case in point, I posted the following article in the same thread over at LATOC, and then got this response from Stoneleigh (one of the guys from The Automatic Earth):

    Puncturing Deflation Myths, Part 1
    Inflation During The Great Depression
    by Daniel R. Amerman, CFA | February 12, 2009


    As the financial crisis continues to deepen, many people are deeply concerned that collapsing credit availability will lead to powerful monetary deflation, much like it did during the US Great Depression of the 1930s. As compelling as these arguments seem to be – are they backed up by the actual historical evidence?

    In this article we will:

    1) Ask a crucial real world question about deflation theories;

    2) Revisit the US Great Depression with a focus on 1933 rather than 1929;

    3) Show that the central monetary lesson of the US Depression is not the unstoppable power of deflation, but rather, the historical proof of how a sufficiently determined government can smash monetary deflation and replace it with inflation – at will and almost instantly, even in the midst of a depression;

    4) Examine two historical and logical fallacies that lead to the mistaken (albeit widespread) belief that the Depression proves the modern deflationary case, when it in fact proves the opposite; and

    5) Briefly discuss the third logical fallacy that threatens many investors’ standards of living over the years to come, particularly those who are retired or investing for retirement.


Response from Stoneleigh:

    This is a crock. The Great Depression clearly demonstrates the power of credit deflation and the powerlessness of government to do anything about it until deleveraging has run its course. Government stimulus has no effect until the point where the remaining debt is acceptably collateralized to the remaining creditors, at which point trust can begin to rebuild. This is because stimulus packages, as large as they may be, are dwarfed by on-going credit destruction, therefore the supply of money and credit is still decreasing in comparison with available goods and services, which is the definition of deflation. Deflation is NOT falling prices. Falling prices are a lagging symptom of deflation as rising prices are a lagging symptom of inflation. Inflation and deflation are always and everywhere monetary phenomena.

    If government stimulus attempts continue beyond the end of deleveraging, then the result would be inflationary, and perhaps hyperinflationary. 1929-1933 was a deleveraging phase, after which followed a recovery period from 1933-1937 and then another decline which led directly into WWII. There was no marked inflation then, but this time is likely to be different, albeit not for quite a long time. Inflation is not lurking just around the corner, even if we see a substantial fall in the dollar once the current flight to safety is over.

    That rally has lasted nearly a year already and has quite a bit further to go IMO, as cashing out creates a significant demand for dollars. Even when it is eventually over, the supposedly inflationary effect of a fall in the currency will still be outweighed by the deflationary effect of the credit bonfire. The dislocation that is likely to happen in the bond market at the same time, will precipitate a wave of default, thanks to very sharply higher interest rates, that will greatly increase deflationary pressure. For now however, investors are turning to the state as a safe haven, which means low yields and high prices for government bonds while investors turn their backs on private sector stocks and bonds. Politically, this is leading to a substantial increase in central power and resulting loss of freedom. IMO we will find out what police state really means in the years to come.


So Jack, since you understand all this so well ;-) please decipher the above and tell me which is it going to be? Deflation, inflation, or some bizarre combo deal? If you're sure of the answer, my advice would be to start a financial newsletter that costs $720 per subscriber. You could be the next Reinhardt! :lol: :shock: :lol:
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