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Inflation V Deflation – Which Door Do You Pick?

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February 28, 2011 – Comments (13)

Another excellent post from Credit Writedowns. There are certainly strong opinions on both sides. I think the answer, as is the case with most economic debates, will lie somewhere in the middle.

Here are some of my thoughts on the matter:

- Under most circumstances government spending in excess of taxation results in inflationary pressures
   -- However government bond issuance for soverign currency issuers [such as the US, Japan, Australia, etc.] does not 'fund' spending and is not related to fiscal operations. They have relevance in terms of facilitating monetary operations, they don't fund anything anymore. Taxes do not fund anything either. But Federal Government spending [which is how money is created] in excess of Federal taxes [which is how money is destroyed] is the only way to money to accumulate in the private sector (assuming a nation runs a trade deficit, which the US does)
   -- The manifestation of price inflaton based on this activity is that the government spends extremely 'sloppily' and the funds to not distribute through the economy efficiently. When speculators get their hands on the funds (though investment banks usually) they bid up all sorts of things, including food / energy / speculative equities. In fact, by the time government created money gets to the consumer, it has passed through the banks / hedge funds / speculators / businesses , etc.
   -- Quantitative Easing and any Central Bank Open Market Operations (OMO, of which QE is simply a variant) is not inflationary. It is an asset swap, no new net finanical assets are created.

- However, simply because there is excess government spending does not mean that the outcome is inflationary. This ignores the key component in the US economy... consumers. The US Consumer remains in a balance sheet recession. We started in 2000 at around $4 trillion in private sector debt, it peaked in 2007 around $13 trillion, and the last I saw it was still around $10 trillion.
   -- Since this is case, I think there will still be weak overall demand for many years.
   -- Which raises a further point to the inflation / deflation debate: Are consumers participating in the inflationary / growth themes? Or are they saving the excess government spending and paying down debt? Most of the evidence points to the latter.
- Assuming there is not wage growth commensurate with commodity price increases, this is a driver to the deflationary argument.

- This means that there is a hugely speculative (and not necessarily inflationary) component to the price increases that we are seeing in energy, food, and speculative issues. Is the primary driver inflation or speculation? Nobody knows the answer, but there is certainly a non-trivial speculative component.

- Given this situation, massive inflation (or hyperinflation) is unlikely to be a major problem in the foreseeable future. I think core inflation will tend to be mildly inflationary or even deflationary, with food and energy periodically spiking and crashing as producers cannot pass higher prices onto consumers and they cut production. There will be alternating periods of strong inflationary pressures from rising prices that will then reduce since economic growth is not the primary driver for the increases. This will serve to periodically 'squeeze' consumers.

This is obviously not a 'solid' prediction. But I think it is more of a vague outline of some of the forces at work in the debate.

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Inflation V Deflation – Which Door Do You Pick?
Economy | Claus Vistesen | 28 February 2011 15:45

http://www.creditwritedowns.com/2011/02/inflation-versus-deflation.html

As the debate between the inflationistas and deflationistas appears about to rev up again, I thought that I would try to put pen to virtual paper and sketch out my thoughts on the matter.

The specific catalyst for looking into this is, naturally, in part the fact that oil looks set to do a round of catch-up with the rest of the frothy commodity space, but also this piece by the Pragmatic Capitalist citing David Rosenberg on the coming deflationary shock:

    David Rosenberg makes some interesting comments in his morning note regarding the price action in US Treasuries. He cites the rally as a sign that the world is concerned about the deflationary shocks from rising oil prices:

    “It is also interesting to see how government bond markets are reacting to the oil price surge — by rallying, not selling off. In other words, bond market investors are treating this latest series of events overseas as a deflationary shock.”

    I think Rosey has this one spot on. The risk of rising oil is not a hyper inflationary spiral, but rather a deflationary spiral. Oil price increases are cost push inflation of the worst kind and for a country still mired in a balance sheet recession that means spending gets diverted which only gives the appearance of inflation in (highly visible) gas prices while creating deflationary trends in most (less visible) other assets (have a look at today’s Case Shiller housing report for instance).

Hang on for minute then. Do you mean to tell me that we have been running around worrying about QE2 leading to bubbles all over the place while the real danger is continuing and entrenched deflation? Well, yes this exactly what this means, but note the important distinction between the US (and the OECD) and emerging markets. Greed and Fear kicks off this week with the following point [1];

    (…) an oil-led commodity spike would clearly cause an intensification of the current inflation scare which has been hitting Asia of late with India the most vulnerable market. Still, as occurred in 2008, such a spike is likely to have the perverse effect of short circuiting the inflation scare in terms of duration. This is because sharply higher oil and food prices will hit current growing optimism on the US recovery. For ordinary Americans are not seeing the income growth to offset such prices increases.

......

And finally, just to make sure we get all sides of the argument we should never forget that stagflation is also looming as an increasingly likely outcome in parts of the global economy (hat tip: Global Macro Monitor).

(quote from the Economist)

    Historically, the margins of retailers and manufacturers have been remarkably stable, says Carsten Stendevad of Citigroup’s corporate-advisory arm. If commodity prices continue to rise, they will eventually be passed on to consumers one way or another. After years of goods getting cheaper, consumers may have to start getting used to everyday higher prices.

This highlights a crucially important issue, namely the underlying trend of inflation in the global economy. It stands to reason that if the trend of global headline inflation is up due to structural capacity issues, an increased prevalence of adverse supply shocks and low interest rates, then bouts of headline price volatility may incrementally find its way into core prices. And in a deleveraging world facing the effects of a balance sheet recession, this is tantamount to stagflation.

.......

13 Comments – Post Your Own

#1) On February 28, 2011 at 6:27 PM, awallejr (83.78) wrote:

And finally, just to make sure we get all sides of the argument we should never forget that stagflation is also looming as an increasingly likely outcome in parts of the global economy (hat tip: Global Macro Monitor).

That's the concern I am leaning towards.

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#2) On February 28, 2011 at 7:01 PM, lquadland10 (< 20) wrote:

I am in the camp of hyper inflation deflation. I just don't see salaries or housing or commercial land keeping up with inflation. We are now at the beginning of the monetizing of the Debt. Zambasway here we come. End of the dollar by Dec, 2012 unless..................... we change the mind of the FED Congress and the Pres. Time to end the Fed and print our own money like we did before 1911.

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#3) On February 28, 2011 at 7:14 PM, checklist34 (99.71) wrote:

another deflationary shock can't be avoided at this point.  Maybe the 3rd time will be the charm, and mark the end of the secular bear (following 08 and '10, a true deflationary shock and a rather impressive deflationary scare, respectively). 

Then folks can talk, pointedly and with vigor, about how dropping comomdity prices aren't deflation, and in fact deflation has never happened, even in japan.  And then, if/when they rebound, folks can talk about how rising commodity prices are proof of inflation, period.  lol

An "in the middle" outcome is of course possible (and, I guess, would be what the fewest people expect), but I tend to think that with the amazing lust for commodities by speculators, hedge funds, and so forth and Bernanke's (rational) contempt for deflationary scenarios a prolonged deflationary period rivaling the 30's is simply not in the cards.  But the fact of the matter is a wide variety of deflationary forces exist, as do potential catalysts.  

And I simply suspect a flopping between the two, flopflation, if you will. 

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#4) On February 28, 2011 at 7:15 PM, checklist34 (99.71) wrote:

can't be avoided "in my view", I should say.  I simply think that too many commodities have been bid up well beyond their fundamentals AND acknowledge the reasonable possibility that Chinas endless commodity bid may run into problems in the forseeable future. 

 

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#5) On February 28, 2011 at 9:30 PM, ChrisGraley (29.77) wrote:

Well I pretty much agree with all of the above.

First, I think that we are already in Stagflation.

I also think that we will see a deflationary moment when oil or food costs get out of hand. (Or some other unforseen event occurs.)

The quickest way out of that deflationary moment will be to increase the velocity of money. (Here in the US, we always take the quick way out of things and not the best way out of things) 

An increase in the velocity of money will bring us to high inflation. If we use that inflation to create jobs, we may be able to kick the can further down the road. If we don't use it to create jobs, we will either have to print even more and risk hyper-inflation or deflate and take some pain before trying to inflate again. When we re-inflate, it will need to be big to change the consumer reaction to deflation. If it doesn't take, we need to deflate again, rinse and repeat. Each time we repeat the cycle, we'll have to make the QE bigger and bigger and if we don't get it right in a few trys, we'll be forced to suffer the same fate as Japan for quite a while.

All of the above are still on the table in my opinion. The two things that I'm most certain about though, is the current stagflation and the upcoming deflationary moment. The rest depends on how we react. 

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#6) On February 28, 2011 at 10:11 PM, binve (< 20) wrote:

awallejr,

I personally think and have talked about this option too. I think we will get something akin to stagflation. The problem with this description that people point out is that in the 70s where we had real stagflation, was that high commodity prices could 'stick' because we had nominal wage growth keeping up. So producer price increases could be passed along.

Today is different in that when we have spikes in commodity prices, they won't stick because they can't be passed along, because wages are not keeping pace.

So we have the recipe for something like stagflation, but with food and energy spiking and crashing periodically instead of sticking. I think this will be ugly / messy / volatile for years to come.

lquadland10,

I am not quite that dire and don't think that the comparison with Zimbabwe is apt. However, I agree that the Fed does not always have the American public's best interest in mind, at least not (especially not) above Wall Streets.

checklist34,

>>And I simply suspect a flopping between the two, flopflation, if you will. 

I very much agree. When you first proposed this idea, I thought it was right on and the more I think about it, the more I am convinced it is on the right track.

Price increase would 'stick' if wages were keeping up with inflation (like in the 70s when we had official stagflation). But they aren't. Which means that when commodity prices get highly bid up, producers will not be able to pass along their input cost increases (because consumers are in a balance sheet recession) and will cut back on production. In this case, high commodity prices really will burn out their own momentum and crash.

So we have a case that will look periodically like stagflation (when the prices are getting bid up) and periodically like deflation (when the consumer spending can no longer keep up with prices increases). I think 'flopflation' is a very apt description

ChrisGraley,

>>First, I think that we are already in Stagflation.

See my response above to awallejr and checklist. I think we will have periodic stagflationary episodes that won't stick because of the lack of wage increases (consumers are in a balance sheet recession and their budgets remain only slightly elastic). Which leads directly to your deflationary observation.

>>The quickest way out of that deflationary moment will be to increase the velocity of money. (Here in the US, we always take the quick way out of things and not the best way out of things)

The problem (actually, I am glad this is a problem since it will prevent that monetary 'game' from being played) is that velocity is not an indepedent variable that can be manipulated. This is one of the stated goals (by Bernanke) of QE, to increase system wide bank reserves in order to lower interest rates and to spur a new wave of lending. The are massive problems with that line of thought: http://caps.fool.com/Blogs/follow-up-qe-is-not/533092.

I actually don't think velocity will pick up substantially while consumers are deleveraging. And this is ultimately a good thing. Consumers need to save and pay down debt. They need to repair their balance sheets.

>>The two things that I'm most certain about though, is the current stagflation and the upcoming deflationary moment. The rest depends on how we react.

Excellent synopsis, very much agreed.

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#7) On February 28, 2011 at 10:15 PM, MoneyWorksforMe (< 20) wrote:

If we have a major contraction (deflation) soon (within a year or two) we have a currency crisis and a depression...If we don't inflate until we get out of this mess--if you believe inflating has beneficial economic effects--we are screwed. It's either high inflation/stagflation until the economy rights itself (I don't believe it will) or right into severe deflation if the fed ends QE and begins to raise interest rates soon...

I think we are experiencing the early stages of stagflation and the fed will continue with very low rates and QE until the masses are convinced it is having little to no effect, and/or bond vigilantes show up, and/or there is a run on the dollar, at which point we endure a major recession or more likely, a depression... 

The best thing the government could do right now is endorse massive austerity measures, have the fed end QE and begin modestly raising interest rates, and stop passing new legislation. The economy would endure short term pain in the form of a moderate contraction, but we would have a very quick and robust recovery, that would be self-sustaining.

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#8) On February 28, 2011 at 10:29 PM, binve (< 20) wrote:

MoneyWorksforMe,

>>I think we are experiencing the early stages of stagflation and the fed will continue with very low rates and QE until the masses are convinced it is having little to no effect, and/or bond vigilantes show up, and/or there is a run on the dollar, at which point we endure a major recession or more likely, a depression.

Agreed we are in the early stages of stagflation, with the caveats above in my responses to awallejr and checklist

I am not in agreement on this issue of the bond vigilantes. This is non-issue for the US Government. Same as Japan. There are bond vigilantes in the Eurozone, because their currency system is not like ours. Their are bond vigilantes for the US States, because they are currency uses, not issuers, and hence they need to issue bonds for financing. But for an sovereign entity that is issuer of its own currency, there is never any default risk, bond vigilantes have no threat. Because bond don't fund anything for a soverign currency issuer. I explored this topic here: http://caps.fool.com/Blogs/the-matter-of-deficits/435457

>>The best thing the government could do right now is endorse massive austerity measures, have the fed end QE and begin modestly raising interest rates, and stop passing new legislation.

Actually, I don't agree with this at all. Please see my thoughts in this post http://caps.fool.com/Blogs/the-deflationary-shock/543137 comments #8 thru #17. I think austerity right now would be a major misstep. But I also agree that the current path is unsustainable. See comments #15 and #17 especially for some thoughts on that..

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#9) On March 01, 2011 at 12:49 AM, ChrisGraley (29.77) wrote:

binve I am always impressed with your responses to replies in your own blog. It is probably the biggest reason that you are one of my favorites. You always seem to have a well thought out but open response to anyone that has well thought out, but opposite opinion.

It's funny because this time I'm the guy that has the opposite opinion and that's pretty rare because I normally agree with your opinions on just about everything.

OK, so all that being said, now I've got to argue with you since we are on the whole oppposite opinion thing. 

First, I think that the lack of increase in wages is the reason that we are in stagflation instead of inflaftion. We are purposely holding back the velocity of money. The huge amount of money that we are printing is being handed out to the banks with an expectation of of them hoarding it at low risk to increase their asset base enough to decrease worries about their liabilities. I'm sure the government gameplan was to hand the money over to the banks and let them buy t-bills that were created to in order to hand more money over to the banks. The problem is that the banks know that t-bills can't compete with inflation so they decided to use the money to speculate. 

So we printed a bunch of money that doesn't create jobs. We handed it over to banks that not only want to hoard it, but want to take advantage of the inflationary pressures on commodities.

We ignored jobs.

I'll argue that yes we can increase the velocity of money and I'll argue that we can do it in 2 ways.

The best way would be to create jobs. (Note to everyone reading this, I think that increasing the velocity of money is a bad thing and will have long term bad effects) The other way to increase velocity is to put money directly in the hands of the consumer. (Again, in this country we like shortcuts and I think we'll just hand money to the consumer in an emergency.) 

Helicopter Ben loves to give away money and he likes the fact that he's important because he hands out money.

Our economy will not improve until jobs are created and Ben understands that  if he creates jobs, the increase in the velocity of money is something that he can't control.

He'll create jobs when he has to and when he does, he'll increase the velocity of money.

In my personal opinion, I see the stock market as inflated right now. If the velocity of money increases even a little bit, it will lead to a crash. I think Ben knows that. The jobs aren't coming because Ben's afraid of the velocity of money.  

We still need jobs to recover.

The velocity of money eventually has to increase or we are Japan part 2. 

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#10) On March 01, 2011 at 10:08 AM, Rebkong1 (< 20) wrote:

ITs called both STAGFLATION we are in it now

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#11) On March 01, 2011 at 10:10 AM, binve (< 20) wrote:

ChrisGraley ,

Thanks man! I really appreciate that. The whole point of this blog, and the reason I maintain it, so for an open (and hopefully reasonsed) discussion on these important issues. Thanks.

>>First, I think that the lack of increase in wages is the reason that we are in stagflation instead of inflaftion. We are purposely holding back the velocity of money. The huge amount of money that we are printing is being handed out to the banks with an expectation of of them hoarding it at low risk to increase their asset base enough to decrease worries about their liabilities. I'm sure the government gameplan was to hand the money over to the banks and let them buy t-bills that were created to in order to hand more money over to the banks. The problem is that the banks know that t-bills can't compete with inflation so they decided to use the money to speculate.

There are a few points here that I disagree with. And I didn't used to. But I have really been rethinking my macro stance over the last 6 months especially and doing a lot of research into our monetary system. I am am convinced that I was misunderstanding it before. If you have not read these posts yet, I would highly recommend it, many of my answers have better and more detailed explanations here: http://marketthoughtsandanalysis.blogspot.com/2011/02/one-of-smartest-comments-i-have-read.html and http://caps.fool.com/Blogs/follow-up-qe-is-not/533092

First with stagflation vs. inflation:

Periods of inflation is characterized by an increase in money supply that is accompanied with economic growth. The economy heats up based on increased (and hopefully legitamite and sustainable) economic activity. Demand for goods and raw materials increases. Prices increase based on this demand, than includes both for the price of goods and labor (wages). The main reason why price increases 'stick' is because consumers have the ability through either wages (80s/90s) or private sector debt expansion (00s: hence our current mess and balance sheet recession) to buy them and support them

Stagflation is different in that economic activity is not the primary driver of price increases. Inflation expectations are high. But they key reason why price increases tended to stick in the 1970s is that wages tended to keep pace with price increases. The data shows this and from what I have read, there was a lot of unionization and collective bargaining at the time that allowed wages to remain high despite a slump in economic activity. What is most striking during that time is if you look at the SPX or DOW on a nominal chart the low takes place in 1975, but if you look at in on a real (inflation adjusted) chart, 1982 is a clear lower low. Inflation was rampant but economic activity was slow.

That is similar is some respects but also very different to the situation we have now. Right now we have the private sector in a balance sheet recession. We still have extremely high debt (off the peak but still historically very high) and the main asset on the balance sheet (housing) is down by 30-50% in many cases. At the same time, unemployment is high and wage growth has been practically non-existant for the past several years. So those are the differences. The similarites are the commodity prices spikes. But the reason they are not sticking is because the consumer literally can't afford them. Energy affects gas prices (obviously) and it affect producer input costs. If consumers cut back at the gas station (like in 2008) and they forgo big ticket and discretionary purchases, then these price increases can't get passed along. We saw oil rise to $147, then down to $30. Now its back up to $100. I don't think this oil spike will persist. I think it will reach a climax (like in 2008) and consumers shift habits again and prices won't stick. As Jim Rogers would say: 'the cure for high commodity prices is high commodity prices'. That is not always true, but I think it is very true in this environment.

Money Printing:

So Ben gave the famous 'helicopter drop' speech. And it has stirred up a lot of sentiment (including from me). The problem is, he can't do that. Not in the way we assume.

The key is to understand how the bank system works and how the money that the Fed prints (in reality or electronically) enters the market. Or more specifically, how it doesn't. I talk about this in much more detail in the links above, but here is the abbreviated version.

The Fed's main reason for existence is to maintain its target Fed Funds rate. Things that affect the rate are a system wide deficit or surplus of bank reserves. Interbank lending with bid up or bid down reserve lending rates based on this surplus or deficit. What the Fed does is liquidity management operations (typically though OMO) to soak up or drain reserves, so that the Interbank reserve lending rate matches the target policy rate. Reserves are soaked up or drained by the purchase or sale of Treasury bonds. Banks also make the internal decision to hold Treasuries vs. reserves based on Interbank lending rates, reserve requirements, and their own settlement needs.

So when the Fed 'prints money', it is buying assets that exist in the market already. The Treasuries exist on the bank balance sheets, and if it needs reserves, it will sell Treasuries. The Treasuries are sold on the open market. So they might sell to the Fed, or the might sell to Primary Dealers. But this is all managed through OMO on the Fed's part. And the key to undrestanding this is that OMO is not inflationary. It is all asset management composition by swapping net finanical assets that all already exist in order to manage the amount of reserves to meet the target rate.

Whether the bank holds reserves and Treasuries (which are the most liquid asset on the planet next to cash) or it holds just reserves, a swap between Treasuries and reserves is just an asset swap. Moving back and forth from one to the other is not inflationary and does not change net financial assets in the banking system. Therefore, absent any vertical money creation, at any point the amount of Treasuries held by banks + Bank Reserves is a fixed number. This means the banking system by itself cannot increase or decrease the amount of net reserves in the system. It can swap reserves for Treasuries, or vice versa. It can lend reserves amongst each other. But it cannot affect the net amount of bank reserves in existence.

All transactions within the banking system net to zero (for every asset on somebody's balance sheet, there is a corresponding liability on someone else's balance sheet. When a loan is created, a corresponding deposit is also created). This is why all transactions within the banking system are called 'horizontal'. This includes actions taken by the central bank. The Fed cannot arbitrarily print money and give to a bank [maybe it will be given that power in the future, but it does not have that power today. However you may rightly point out that the Fed bought essentially worthless MBS's at phoney market rates from banks. This is tantamount printing the money, buying worthless paper in exchange for new reserves, so that the bank now has reserves that it could buy Treasuries with and the Fed is stuck with worthless paper. So while the technicality of the asset swap was maintained, the Fed knowingly overpaid. I would argue that instances like these are inflationary if the Fed never tries to unload that paper.]. Whenever the Federal Reserve 'prints money', it is always buying something that exists already. So just like interbank transactions net zero, so do most central bank transactions [again, there are some exceptions to this rule, but OMO is the policy tool of choice and nearly all activity engaged by the CB is OMO. And the point being that OMO is an asset swap].

The way that net reserves in the banking system change is through Congressional spending.

This is why Ben's 'helicopter drop' speech is misleading. Because he doesn't have the power to do what was implied / what people interpret that he can do. He can't 'push' money into the system. He can buy Treasuries (that already exist), He change the asset composition on the bank balance sheets to try to build up reserves to encourage lending (read my links above to the problem with the approach), but he can't force people to borrow and the can't print money and literally drop it from helicopters (or randomly mail checks).

Two observations

1) QE and similar policies is focused on the supply side of the lending equation. It is not inflationary. Moreover, if consumers don't want to borrow (because they are in a balance sheet recession) then they won't. Changing rates by a couple of points won't change the fact that they are underwater and don't want nor need new debt. Also, reserves never figure into a banks decision to lend. They are never reserve constrained operationally. Their main constraint is capital constraints

2) The only way for a 'helicopter drop' (or similar) activity to take place is from the Treasury. The Treasury is the only part in our financial system that can create money at will. It does so every day by enacting Congressional spending. Federal Government spending (via the Treasury) is the only way that net reserves are creathed and Federal Taxation is they only way that net reserves are destroyed.

So addressing a build up of reserves as inflationary or that it will make banks more prone to speculation:

This is not actually true. Bank reserves are not lent out, they are not (and cannot) be used for speculation.

A bank can make a loan at any point at any time to any borrower. This can be termed 'money creation', but it misses a key point. For every asset created in the banking system, there is also a liability. Loans create deposits. This is why all that activity nets to zero. But if a bank wanted to make a loan to a hedge fund so that they could speculate in stocks, an increase in reserves does not affect that decision. Banks are never reserve constrained when they make lending decisions. The bank makes a loan and finds reserves afterwards. It will either acquire interbank or at the Discount window. The Fed will manage liquidity (reserves) such that the demand is satisfied at the target rate (remember this is the Feds reason for existence).

So QE has not given bank the ability to do anything that it couldn't do before. QE has given no more 'ammunition' to the system to buy things.

If the private sector wants to go on another debt binge, like they did in the 2000s, they can. QE doesn't make that any more likely to happen, based on everything that I talked about above. So is a debt binge inflationary? ... No.

Remember, everything in the banking system is horizontal. Every asset has a corresponding liability. So when the private sector wants to buy stock or RVs or vacations, etc. through debt spending, it gets those assets but has to have the liability (debt). Same with the banks, some banks get deposits but the other have the loans. It all nets to zero.

This is why calling the 2000s an 'inflationary boom' is highly misleading. It was a debt boom. But debts have to be unwound eventually, because they are horizontal. There is some inflationary component too (because the Government ran a budget deficit, and Federal Governemnt spending in excess of taxation is the only way for a net accumulation of FRNs in the private sector to occur, assuming the country runs a trade deficit, which the US does), but what was the driver? Private sector debt.

And that is why the future has an inescapable deflationary component. Because that debt is being unwound now, and there is no way around it. It will either get paid off or defaulted on.

So that is all a long winded response to why the Fed has no independent control over the velocity of money. The Fed can only control the supply side of the lending equation. It has no control whatsoever on the demand side.

>>We still need jobs to recover.

Agreed. David and I had an excellent conversation along similar lines. Please read this post http://caps.fool.com/Blogs/the-deflationary-shock/543137 comments #8 thru #17.

>>The velocity of money eventually has to increase or we are Japan part 2.

I think we are Japan, at least to some degree. The part of our economy (private sector balance sheets) that gave rise to the deflation problem in Japan exists here as well. I don't think there is a more apt macroeconomic situation that is more similar to the one we face now. It is far from identical, but I think it is the most useful case study out there.

Thanks!.

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#12) On March 01, 2011 at 1:42 PM, leohaas (32.18) wrote:

Unfortunately, I've got too little time to participate in this discussion.

But mostly, binve is right. Let me shoot from the hip anyway on a few issues brought up in this blog and the comments.

1) Stagflation is NOT here. It requires prices AND WAGES to go up. We can debate what the real inflation numbers are (I stick with the official numbers; no doubt some here will call me naive; I call them government haters). But wages are not going up (OK, I got a raise but that is the exception). Therefore, there is no stagflation. I am fearful though, that we will have a period of stagflation in the future when we return to full employment.

2) The economy is still deleveraging: foreclosures way high, companies improving their balance sheets, consumers and companies borrowing less, banks having stricter lending standards (thank God), consumers saving more, and so on. Deleveraging is deflationary because the money supply goes down. Bailouts, stimuli, tax cuts and credits, easing, and lowering interest rates are designed to fight this deflationary trend, but they are not enough to maintain the amount of money in our economy. Check the M3 numbers as calculated by Shadow Government Statistics (yup, the guy who usually sticks to the official numbers actually refers to statistics calculated by a skeptic). For inflation to occur on a large scale, M3 would need to increase. So stop talking about hyperinflation being already here or just around the corner. I am not saying it cannot happen, but we'd need to see a jump in M3 first before you can conclude it is happening.

3) It can be argued (and if you are a free-market believer you should argue) that the increases in commodity and food prices are due to supply and demand rather than because of "Helicopter Ben". About 2.4 billion people in China and India alone (and about a billion or so more outside those two countries) getting richer every year in leaps and bounds have an enormous impact on world markets. Their increasing demand is what is driving prices of oil, copper, corn, and so on up.

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#13) On March 01, 2011 at 2:10 PM, binve (< 20) wrote:

leohaas,

Thanks for the comments

1) I agree. We have a mix of inflation and deflation right now, so it is something akin to stagflation in that respect. However, the price sticking situation is completely different. So calling it stagflation is misleading and leads to incorrect conclusions. I like checklists 'flopflation' description much better

2) I agree. This environment is not hyperinflationary and the drivers that caused hyperinflation in other economies in the past do not resemble the current environment in the US. I also completely agree with your M3 observation.

3) This is a very valid observation. I definitely agree, that is one component to it. The problem I have right now is how many commodities across the board took off that the same time (Aug 2010). Since QE is not inflationary, which was the point of my posts on the topic, this has a speculative (not demand driven or inflationary) stench all over it...

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