Battle of Economists - Inflation or Deflation
My vote is that by the time the credit crisis finishes unwinding we will see some deflation. The causes of the hyper-inflation of assets was the loose lending standards and possibly fraud the way they were rated AAA and sold to investors to further hyper-inflate the money supply. Enough people and funds have been burned that, for example, there were no buyers for the $32 billion that Canadian funds are known to be stuck with. These things are not selling anymore and investor have wised up and better understand the enormous risk these things presented.
Bring these things back onto the banks balance sheet and tightening up the lending standards both mean a contraction of the existing money supply and hence deflation. There may be inflation of consumer purchases but overall, the money supply has to contract. The loose lending standards increased the leverage of the money supply by about 2.5 times without considering the stuff they moved off their balance sheets (I think).
So, I am a highly aggressive bear and I've hedged my bets entirely on deflation. So, Peter Schiff piece, Not Your Father's Deflation, certainly makes me second guess my analysis.
My deflation plan means I don't bother concerning myself with how to make my portfolio grow, but rather how I position myself to be the lesser loser through a deflationary correction. It means I've sold out of the market and split my funds to as many banks as necessary to ensure they are all covered by government insurance. It means I've said good-bye to brokerage accounts as I doubt their insurance models have considered deflation and I doubt their insurance would be solvent through a deflation. I just know a few people are going to be leveraged to the hilt and unable to cover their losses and I don't want to stand in line hoping to get my money back six years down the road. I can't see this not happening to at least a few people and I choose to ensure that I am not one of them. If banks screw up sufficiently well, government will at least print money for me and so I will see a devaluation of currency, but it will be a shared devaluation.
Of course, Mish, whom I think has an amazing ability for analysis and depth of understanding and ability to think out of the box, has countered Peter in his piece, "Not Your Father's Deflation: Rebuttal." The first quote is partly covers my thinking. It misses my view of the household budget for homeowners stuck in homes they can hardly afford. They are no longer participants in the economy, but simply exist to pay back debt, the debt slaves. Vancouver went through this, grossly declining disposible income, but our economy relative to North America is about 1%, so we had things like tourism helping our economy out. When you get into say 20-30% of your economy with these kinds of problems, well, you have less people able to help the economy (20-30% less) and you have 20-30 times as much of the economy needing help from somewhere to stimulate them. It is a leveraged difference of as much as 40. The rest of the economy simply can't help this level of hardship. I know I've talked with people in the US with my kind of qualifications going to jobs straight out of university paying twice what I could find in Vancouver with experience. Several US cities have also had high prices, but I don't think they've had as gross suppression of wages.
One thing I have to say about Schiff's assumption about falling demand due to recession and prices, well, I have been shopping this week. The one store simply was not crowded on Sunday, nor were the stores anywhere near as crowded today as xmas eve shopping of the past. I have waited an hour to pay for a purchase in the past. And, with the reduced crowd, I couldn't believe the deals I got these past two days. I am one happy consumer!
Anyway, Mish does a great job of countering the hyper inflation arguments and I am sitting in the deflation camp. I really have to agree on the psychology part. In Vancouver our last two bottoms occurred 5 and 7 years after the bottom. Bubble are a result of psychology, not fundamentals and when a bubble breaks, the revaluation happens slowly as people refuse to accept it and it takes years to slowly chase it down.