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All that Spending and Still Deflation



February 21, 2010 – Comments (10)

I have intended to visit deflation again after core CPI showed deflation for the first time since 1982.  Mish summaries it nicely.

I went back and looked at some of my previous musings on deflation and it is a topic that I have discussed fairly often:

Battle of Economists - Inflation or Deflation

 This one really summarizes why I left the market and why asset protection became much more important to me then trying to chase yields.  This was the period that I got out of a bubbled home and bubbled stocks.  It enabled me to buy another home mortgage-free with a mortgage helper, aka, a rentable suite.  My rental income covers my share of utilities, insurance, and maintenance, so basically I live rent and utility-free right now.  What I am saving in expenses I guess works out to about 5-6% on the money that is no longer in the bank, but is now in a house.  

Inflation or deflation?

Deflation seemed apparent to me fairly early because leverage massively increased the money supply, far more then any printing program can keep up with.  Something that I have said before, but I am not referencing here, I think the banking system would have collapsed with out the bailout money.  Losses simply completely wiped out all reserves.  It seems the bailout moved the losses off the bank balance sheets and kept the banks capitalized so we can all still go to the bank and take money out.  Essentially when the banks lose all that money it is our deposits they have lost and the losses were so big there was no way that insurance would have covered them.

Betting on Japan Style Deflation

 This post from over two years ago I went with the premise that mortgage garbage would continue to cause problems for banks into 2010.  The mortgage modifications have actually delayed some of the problems so whereas two years ago I was thinking the banks would have had to deal with all this mortgage stuff by this year sometime, well, I think the accountability has been moved out at least another 2-3 years.  And the commercial real estate is also going to hit hard over the next few years.  Banks have gone back to prudent lending standards and their are few borrowers that actually meet reasonable lending standards so credit is contacting and it will continue to contract for some time I imagine.

Deflation Conveyor Belt

 This one explains why I thought deflation even if money is printed.  I really do not write about financial issues like I did two years ago.  I also touched on the issue of priviledge of the US dollar and how that ties up cash, so the cost of goods have not increased to what the money supply has become.  You'd think massive inflation right away if that money all of a sudden returned to economy rather then sitting in safes and bank accounts from around the world.  But, the credit expansion was so massive, even this would be absorbed.


 More on the contraction of credit.

Inflation - deflation and debt

This one I touch on responsible lending standards and in a way I show how low increase rates cause massive increases in monetary supply.  I also explain how big of bs it is that low interest rates are good for the consumer.  They are only good for the consumer if costs remain constant and reasonable lending standards are applied.  

It also shows how low interest rates suck the economy dry for decades.  If you borrow to 30% of your income with high rates even a small increase in payments results in huge savings.  Consumers are powerless to reduce their debt burden at low rates and with 30 year mortgages and low inflation, well that is 30 years of struggling.  Income never rises enough to have the mortgage burden become manageable and 30% of income going to shelter is actually challenging for a household budget.  With higher inflation that wages keep up with the percent of household income going to mortgage declines and families can adjust to the increasing costs of raising a family.  That so isn't going to happen going forward.

Deflation of Wages

With such high unemployment, wages are going down.  This is one example.

Credit Contration = Deflation

More on how credit contraction causes deflation.


Hmmmm.... I was going to get Prechter's book...  I never did..  I need to add more of this guy's stuff to my reading list.  I was reading something awesome of his last week.

Still in Deflation Camp

Well, I still think the market rally was not because of good fundamental analysis, but people go on past experience without really looking at how things are different.  There have been a few that have lost their shirts being early with the correct analysis.  I do not see fundamentals to support the market and I do not think my analysis is wrong it is just early in terms of understanding what is happening ahead of the crowd...

10 Comments – Post Your Own

#1) On February 22, 2010 at 10:58 AM, JakilaTheHun (99.92) wrote:

Great compilation post.

At this point, I definitely agree on the issue of deflation still looming.  While many are accusing the Fed of creating "hyperinflation", I think it's just the opposite.  They are not being aggressive enough by targeting 1% inflation and we will end up back in deflation.  M2 money supply only increased 1.9% for 2009, which seems dangerously low to me.  Notably, Wal-Mart's earnings are increasing, while revenues are decreasing, which might be another indicator of deflation.

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#2) On February 22, 2010 at 1:58 PM, outoffocus (22.86) wrote:

I'm in the stagflation camp.  High US debt will keep the dollar week and commodities high causing commodity based inflation. High private and public debt and all the crap that still needs to hit the fan in that area will deflate asset prices and cause deflation.  Then we can't forget stagnant wages in a slow growth economy will keep a lid on consumer good prices for a while.  Any increase in prices will mostly likely be based on the increased price of commoditgy inputs.

All in all, food, energy, metals may rise while housing, cars, and anything else typically debt-financed will fall in the coming years.

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#3) On February 22, 2010 at 7:09 PM, FleaBagger (27.57) wrote:

Check this out:


And if don't like that, maybe you can answer 10 questions.


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#4) On February 23, 2010 at 9:15 AM, JakilaTheHun (99.92) wrote:

I don't think anyone is predicting dramatic deflation, FleaBagger.  The Federal Reserve will prevent that from happening in all likelihood. 

The links you provide ignore a lot of information.  For one, Japan experienced moderate deflation in spite of using policies that many claim would produce "hyperinflation."  The takeaway --- if "hyperinflationary" policies were creating moderate deflation, then there would have been severe deflation otherwise.

The other point worth nothing here is that the author claims that "central banks" created inflation in 1933.  Well, (a) moderate inflation was needed to escape a deflationary spiral and (b) it was removing the US from the gold standard that eliminated deflation.  Either way, the economy finally started to slowly recover once we escaped the severe deflationary spiral that had lasted from 29-33.  

I don't have a problem with currencies backed by commodities (in fact, I support them), but the exchange rate shouldn't be fixed.  It should create natural inflation of about 3% - 4% per year.  Fixing the price of a currency to a particular good creates monetary distortion of sorts. 

Economist Silvio Gessell, who unfortunately is mostly forgotten today, wrote the penultimate work on inflation and deflation in the 19th Century, The Natural Economic Order.  Gesell proposed a system of naturally inflating money that, in its limited applications, was highly successfully and created economic recovery in one-town in Austria during the Great Depression (before the Austrian government forced the town to end its experiment).  

The problem with most concepts of currencies is that they ignore what currency is --- holding cash should never be a "major investment opportunity."  It should be exchanged for economic resources (goods, servcies, physical capital, etc).  In a deflationary environment, people are unwilling to invest in productive technologies because they will likely make a greater return on their investment by simply holding onto cash and doing nothing with it. 

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#5) On February 23, 2010 at 9:23 AM, alexxlea (59.55) wrote:

So, everyone is talking about things, and almost none of it matters, because they REFUSE to talk about overpopulation as a threat to the quality of living of, well, humans and everything on the planet.

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#6) On February 23, 2010 at 11:57 AM, dwot (28.84) wrote:

Jakila, thanks for answering that.  I looked at it and thought the holes in the analysis were massive, but putting together a good response would be very time consuming.

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#7) On February 23, 2010 at 5:33 PM, FleaBagger (27.57) wrote:

Jakila (and, by extension, dwot): That's a pretty poor answer, because you never addressed anything that was linked to. It's like you're just hoping that no one follows those links and trusts you. 

Here it is in brief:

1) Prices are rising 10% annually, and the government-run BLS pretty much lies about it. You can see inflation in all the necessities of life, particularly food, energy, and medical care, as well as higher education. The apparent deflation in optional consumer goods like electronics is overweighted in government statistics.

2) Deflation that is beyond a central bank's control is impossible, and furthermore it is in a central bank's interest to cause inflation, ergo: deflation will never happen.

3) What will prevent a bank from lending money when it is borrowing money at 0% (or 0.5%) interest from a central bank? Anything? What does government spending cause, if not inflation?

A few closing thoughts: if no one's predicting dramatic deflation, why not invest in the stock market? Dwot has famously divested completely from the stock market, which is a ludicrous step to take if one expects a mildly deflationary recovery due to the wisdom and benevolence of the Fed. 

Also, it does some violence to Gesell's views to associate him with Keynesian central bank inflation, though that is precisely what Keynes wanted when he pointed to Gesell from the safety of his graveside. I don't think Gesell was perfect in his economic or monetary theory, but his views, like mine, seem completely incompatible with the view that it is necessary or helpful for a central bank to "reflate" the currency by funneling interest-free or nearly interest-free loans to banks to lend out at much higher interest.

Again, can you come up with any time deflation caused a problem that could not be attributed to wage controls, cartelization, and tariffs?


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#8) On February 23, 2010 at 5:48 PM, FleaBagger (27.57) wrote:

And here is a link to a blog that is better grounded in economic reality:

Inflation or deflation?

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#9) On February 23, 2010 at 6:27 PM, TigerPack1 (33.50) wrote:

You guys and gal are aware of the major revision to how CPI is calculated starting with the last report, correct?

The government is continuously revising CPI lower, as all the the "inflation" adjusted bond interest payments and the cost of living adjustments to Social Security are affected by the CPI.

2010 saw the first "zero" raise in Social Security payments despite nearly 5% annual "inflation" for regular goods and services under any rational and fair statistical construct.  The government is severely understating CPI already to "game" the interest payouts and federal expenditures necessary for TIPs and SS.  You can play along if you like.

Commodity indexes, wholesale inflation, import price gauges, utility bill increases, postage stamp rate jumps, and more are showing about 5% year-over-year price advances currently.  Even FedEx and UPS raised their basic fee structure around 5% at the beginning of 2010.

Ben desperately needed this revision to shield the growing talk that mindless money printing is flooding the system with too much liquidity. The biggest stock rally in your lifetime and a doubling in commodity prices last year are NOT deflationary; 2+2 is not a negative number. I had hoped the math skills were better than that from some of you.

Few on Wall Street believe the CPI number, and many use other inflation gauges in their forecasting models.

You may now continue with your deflation fantasy talk.  Ben and the FED are hoping the truth is not something you will investigate on your own.  If you did, you would be screaming for Ben's head and the end of the current Federal Reserve banking system.

As an aside - TIPs or Treasury Inflation Protected bonds are one of the biggest lies put out by our government. I hope investors realize what this snake oil really is!

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#10) On February 24, 2010 at 9:08 AM, TigerPack1 (33.50) wrote:

To be clear, deflation is still possible if the economic circumstances "change" from today.  Ben's fear of future deflation is his main excuse for record money printing.

Given a stock market crash in 2010, or an economy that slips back into recession (negative GDP readings), mild deflation at the good and service pricing level could still show up.

However, if the stock market is flat to higher this year and the economy continues to grow, even slowly, deflation will remain a myth in modern history.  Under our current Federal Reserve monetary policy system, with no checks on federal spending or money printing with a gold standard, inflation to whatever degree you want to debate is here to stay.

7 consecutive months of RISING home prices in the U.S., as announced yesterday, and skyrocketing REIT pricing the last 12 months, tell a different story about real estate values, than you read in the scary newspaper headlines (which are scary to sell newspapers and attract readers).

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