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Inspiration, Move Me Brightly



September 21, 2010 – Comments (17)

Restless.  Let's dive right in.

Deflationists lose again

A deflationist, in conventional meaning, is someone that believes deflationary forces are too strong, a sharp contraction of the money supply is near, a sharp drop in prices (usually asset prices, but some think all prices will fall) is coming, and anyone not holding cash will peril.

My definition is simpler: a deflationist is someone that forgets the world is run by central bankers.

Deflationists can never be right as long as central banks around the world exist, let alone have the power to intervene and prop up the bubbles they created whenever they can.  Deflationists are always wrong.  Remember that.  There has never been a persistent drop in the general price level in any country, even in Japan, since the 1950's.  If my math is correct, that's 50-60 consecutive years of persistent price increases.   Betting on deflation is like betting the money line on the Washington Generals.  You're going to be wrong so many times, you won't have any money left for when you are finally right.

Inspiration, move me brightly.
Light the song with sense and color;
Hold away despair.

Why the Stock Market doesn't crash

Among the deflationists, their major concern is another stock market crash.  Many will trot out charts with P/E ratios today, during the low point in March 2009, and historical P/E ratios in other crashes.

These charts have little value, but not for the reason you think.  The problem is current P/E ratios are distorted by inflation.  Allow me to explain.  

Let's say that in 1930, the P/E ratio for the DJIA was 8.  That meant is costs $8 to get $1 of earnings.  Let's assume that in 1931, the central bank tripled the money supply.  What's the new P/E ratio?  If you said 8, go to the back of the class.  You don't understand inflation.  If it were true that inflation increased everyone's bank accounts equally, and that every new dollar created out of thin air spread evenly across the economy, then you would be correct.  We would now have $24 in price and $3 in earnings, leaving P/E at an unchanged 8.

But the world doesn't work that way, and if it did, what would be the point of creating new money?  Hmmmm......  stew on that for a minute.  

Inflation rewards the people that get to use the money first: 1. governments, 2. government contractors, 3. bankers, 4. politically connected businesses..... Last place?  The poor.  
(Oh, progressives. When will you wake up and fight the real fight?)  

Along the way, a great deal of money is put to unproductive uses - that is, if you believe that money can be used in unproductive ways.  If so, you are smarter than legendary Keynesian economist Paul Samuelson, a man who made no distinction between the two yet was allowed to sell economics textbooks to millions of American students for a generation.  And you wonder why nobody understands economics.

So the amount dollars in the economic system is ever increasing, but the earnings of productive companies does not increase in step.  Earnings trail inflation and the spread gets wider over time.

Therefore, if you are looking at P/E ratios from the 1932 bottom and expecting the 2010 stock market to reach those levels, good luck to you.  It's going to be a long wait.  It's simply not possible.  

More than this I will not ask,
Faced with mysteries dark and vast.
Statements just seem vain at last.
Some rise, some fall, some climb, to get to Terrapin

More on the Markets

We like to assume that the stock market is a positive sum game, and to some extent it is.  But the truth is that in a world of unhampered competition, where anyone is free to compete for the market dollar without restriction, it is the consumers that gain the most.  Some businesses will gain market share, others will lose market share, and others will break through and develop new markets.  But always the consumer is the winner.  That's the real positive sum game.

With that in mind, the stock market fairy tale of perpetually rising prices for stocks can not come about through competition.  Without breakthroughs, like the development of Internet based businesses, the general level of stock prices would remain constant.  After all, what other factors could increase the amount of money in stocks?  Obviously as expectations of a great earnings season rose, money could be pulled in off the sidelines, but that would not result in a long term rise in the general price of stocks.

Keep in mind that I am talking about the stock market as a whole here, not the fortunes of individual companies, or sectors.

But the general rise in stock market prices America has witnessed since 1932 is almost entirely due to the printing of money.

Which brings me to my next point:  When the market rises on junk, this is a bad thing.  

Companies that spend money quickly, before prices rise, can report earnings that look better than they really are.  This is why terrible companies often lead rallies.  This is not the sign of a healthy economy.  This is the sign of a centrally planned economy run by technocrats.  

In this scenario, you might make a quick buck and pat yourself on the back, but the central bank and its conies are doing high-fives.  

As Jim Rogers said, the DJIA can go to 1,000,000 if the Fed creates enough money.  And trust me, you don't want that. 

Counting stars by candlelight,
All are dim but one is bright
The spiral light of venus, rising first and shining best.

What is a good regulator? 

Let's assume for a moment that I'm right: big business writes regulation to protect itself from competition.  This is a bit different than regulatory capture theory, which says that well-intentioned bureaucrats get captured and held hostage by big business to write favorable regulation.  On the contrary, it is my belief that big business is the driver, pushing regulations from the start to protect themselves from upstarts.  It's a subtle but important distinction.

If I'm right, what type of person, ideologically speaking, would big business most want to have as regulators: conservative, liberal, or libertarian?

Let's start with conservative.  The conservative isn't expected to do much, hence the name.  He won't aggressively investigate and repeal old regulations that hamper competitiveness.  Name the number of major pieces of legislation ever repealed by a conservative Congress in America since FDR.  I'll give you hint: it's less than one.  Bringing in a conservative rewards me with the status quo.

Up next, the liberal.  The liberal is expected to aggressively pursue new policy options.  This is good for me.  It's also highly doubtful that the liberal will investigate the worthiness of old regulations, since he begins with the framework that all government action is necessary and most business action is immoral exploitation.  This is also good for me.  Finally, for the liberal, the ability to regulate is power.  So we can expect them to be active in finding new ways to regulate my industry.  That means less opportunities for newcomers.  If I'm lucky, we'll all be sued, and I can get a guaranteed monopoly for the rest of my life, like Marlboro cigarettes, all in the name of the public good!  

Finally, we have the libertarian.  The first thing the libertarian is going to do is investigate existing regulations, the majority of which have no benefit for the consumer, but benefit me by keeping out my competition. He will tear up any regulation that I have helped to craft that keeps my profits secure.  I hate libertarians.  And he will resist any push for further regulations, no matter what crazy scare tactic I use. 

In other words, Big Business can't wait to get Elizabeth Warren in power. 

Oh, from the Northwest corner
Of a brand new crescent moon,
While crickets and cicadas sing
A rare and different tune, Terrapin Station

The Biggest Hypocrite of My Generation

Karl Rove.  Seriously, someone needs to slap that man across the mouth, twice.  What a colossal scumbag.  I don't really care what chances that woman in Delaware has.  I don't really care that she's not a libertarian.  If Karl Rove dislikes her, she's ok in my book.  I wouldn't vote for her, but I wouldn't vote for anyone Rove likes either.  I just find him to be the most repulsive hypocrite to ever appear (briefly) on my television (in the split second it takes me to change the channel.)

While you were gone
These face filled with darkness,
The obvious was hidden
With nothing to believe in 

Parting Shot

It can be distressing, disappointing, despairing, etc. to be interested in the truth in economics and politics.  You find yourself awash in a sea of deceit and naiveté.

Cheer up, cobber.  You got along fine before you knew the world is run by liars and idiots.  You'll get along just fine with that knowledge too.

Buy things of value.  Don't hold cash.  Reject everything told to you by the MSM, the government, and educators.  Reject it and investigate it on your own.  Work for yourself.  Build your resume.  Add skills.  Learn web design. Learn to fix things. Get on the Internet.  Provide something of value to the market.

Reject the assumptions of egalitarians and politicians.  Reject their moral high ground.

Embrace counter-culture. Then reject it. Reject collectivism.  Reject the ordinary.  Embrace the creative and the spectacular.

Earn everything.  Take nothing for granted. 


David in Qatar

17 Comments – Post Your Own

#1) On September 21, 2010 at 6:59 PM, starbucks4ever (79.83) wrote:


1. Every once in a while the government will let the market go down. By letting it go down, it can bankrupt the banks without connections (e.,g. Lehman) and award their assets to the chosen banks who got the heads up in advance (e.g. JPM). 

2. The government does not want to increase money supply at one steady rate. It wants to be predictable but not too predictable. Otherwise inflation will rise too quickly and people will lose all faith in the currency. Therefore it wants to keep the suspense, and doesn't want your investments in inflation to be totally risk-free.

That's why one should never overleverage even when one prepares for inflation. 

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#2) On September 21, 2010 at 7:20 PM, russiangambit (28.67) wrote:

> With that in mind, the stock market fairy tale of perpetually rising prices for stocks can not come about through competition

Exactly. What I don't get is why most americans believe it. Truly, you have to be born in the US (the land of milk rivers and jello banks) to believe it, nobody else does. Everybody else calls such a phenomenon a ponzi scheme. But americans think they've discovered a perpetuim mobile, where something is produced out of nothing ad infinitum.

As for possibility of deflation - I see some of it now, where people simply refuse to borrow even though they are punished for saving by the FED. But I don't know how logn this deleveraging lasts since everybody of power - businesses, governemtn, FED, MSM all working so hard against it.

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#3) On September 21, 2010 at 7:27 PM, whereaminow (< 20) wrote:


It's interesting to consider the forces that work pro and con to assign winners and losers in government intervention.  For example, the big winner in the tobacco lawsuits was Big Pharma.  How it all ended up rewarding Marlboro with a permanent, untouchable monopoly is something of a head-scratcher but it's easy to see how Big Pharma gained.

To follow up point #1, I think it's sad that few people want answers to the point you've raised.  Investigative reporting is truly dead, if it ever really existed.

Point #2 is interesting.  It certainly appears that you are right. This also is a dangerous game on their part, and it is arrogant to assume they can control so much.  However, arrogance is a prerequisite to government service.


If a deflationist were to say to me, "yes, but they can't do this forever." that is a line of reasoning I can understand.  But until what point?  I believe the point comes where the Fed must choose between bailing out government debt or saving the big banks.  The Fed will choose the banks and screw the government.  That's when we'll get deflation.  But predicting when this will happen is extremely dicey stuff.

David in Qatar

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#4) On September 21, 2010 at 7:36 PM, 100ozRound (28.51) wrote:

Damn good stuff David!

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#5) On September 21, 2010 at 7:58 PM, whereaminow (< 20) wrote:


Thanks! Glad you enjoyed it.

David in Qatar 

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#6) On September 21, 2010 at 8:07 PM, rd80 (94.78) wrote:

I believe the point comes where the Fed must choose between bailing out government debt or saving the big banks.

Right now, it's doing both.  Fed gives money to banks at near zero, banks buy Treasuries.  Props up gov't debt and the banks make money on the spread.

That's when we'll get deflation.

I'm curious why you see this process leading to deflation instead of inflation.

Pulling the thread to when the Fed wants to raise rates, yields on Treasuries held by the banks will set a ceiling for how far the Fed can bump rates before it wipes out the spread and jeapordizes the banks.  At some point, that artificially holds Fed rates down and keeps it from being able to fight inflation.

Where did I make a wrong turn?

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#7) On September 21, 2010 at 8:21 PM, whereaminow (< 20) wrote:


You could be right, so don't assume that I know more.  

Here's my understanding, and I draw on Mises' Theory of Money and Credit for this:

At some point the Fed will have to make a decision. Keeping rates low and buying treasuries will lead to a collapse in confidence in the dollar.  This can set off double digit inflation or worse.  This scenario could destroy the major banks, if it gets so bad that people start pulling money out of banks.  

(By the way, I'm uncertain as to whether there would ever be another bank run or not.  It doesn't really work like that.  The average person owes more to the banks than they have in the banks.  I think "bank run" in the modern sense, is when large foreign investors get jittery and demand dollars held in American banks.  Just a few of those can close any bank in America.)

The FDIC would go belly up.  Citibank and JPM get cracked.  

The Federal Reserve cannot let this happen. 

In order to save the banks, the Fed will tell the Treasury to stick it.  No more bond purchases.  Rates will be raised.  The government will default on its debt payments.  Rates will skyrocket.

Deflation will crush leveraged Americans.  Home values will plummet (remember, in this scenario we've entered double digit inflationary period already). Stocks will plummet.  Gold, silver, everything will go down hard.

But the banks will be saved, and they'll comfort us by reminding us how much worse it would have been had they failed. =P

Then we start the cycle all over again. 

David in Qatar 

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#8) On September 21, 2010 at 9:13 PM, rd80 (94.78) wrote:

Thanks for the explanation.  I guess if you step back far enough, the results have a lot in common.  Treasuries become worth less (or worthless) through either inflation or default.  Not a pleasant picture in either case.

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#9) On September 21, 2010 at 10:02 PM, whereaminow (< 20) wrote:

I'm glad to see that the people are already ahead of me.  Reject the MSM.  Evening news lost 739,000 viewers last year.  That is fantastic news.

Reject the educators:  Have any of you discovered the amazing Khan Academy?  The classroom is dead.

David in Qatar 

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#10) On September 22, 2010 at 8:00 AM, pj19 (20.76) wrote:


Let me first say I am a big fan of your blogs and I think you have a firm grasp of the libertarian way of thinking.  I think your biggest strength is the way you can explain libertarianism to people who just don't get it.  Keep up the good work.

I have a question about your ideas on inflation and the money supply- the credit market is way bigger than the actual money supply, right?  And companies and individuals are de-leveraging  and paying off there debt, thereby decreasing the amount of credit out there.  Despite the increase in the money supply, the overall purchasing power (money supply + credit) is shrinking.  It seems to me this would cause a deflationary pressure.  

Let me know what you think. 

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#11) On September 22, 2010 at 9:15 AM, GeneralDemon (26.62) wrote:

Hi David,

Excellent post as usual!

"Deflationists are always wrong.  Remember that.  There has never been a persistent drop in the general price level in any country, even in Japan, since the 1950's.  If my math is correct, that's 50-60 consecutive years of persistent price increases."

I've personally have only gone through recessions since 1974, but shouldn't we be going back to 1931?

Somewhere I remember reading that labor cost is the defining factor regarding deflation/inflation. A person has to adapt to the labor market; commodities can just remain sitting in the ground.

Everyone I know, and I mean everyone is making due with less income right now. My own unscientific review of costs at the supermarket reflect deflation. My kids Kelloggs cereal costs $1.88 a box - a two-liter bottle of pepsi costs $0.88. I haven't paid these prices in over twenty years.

I see couples walking hand in hand to the supermarket. The house next to me sits empty (for over two years) because the bank won't forclose because it already has too many forclosures.

I am a self employed professional - I asked a head-hunter friend what my salary would be right now - he said it has gone from "easy to get $130+K to lucky to get $70 K.

I have a second property whose value has gone down 75%.

Is your argument for no deflation based on the paper credit the FED has extended to the Banks? Or is it the money our grandkids are expected to pay back? Catch my drift?

Reject collectivism - amen to that, brother!


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#12) On September 22, 2010 at 9:15 AM, dbjella (< 20) wrote:


But the world doesn't work that way, and if it did, what would be the point of creating new money?  Hmmmm......  stew on that for a minute.

Good point!

Do you think there is a conspiracy amongst central bankers or is this an institutional thought process, God complex....  I am not one for conspiracies, but I can't understand why deflation is bad. I love it when prices go down.

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#13) On September 22, 2010 at 10:46 AM, FreeMarkets (40.96) wrote:

Karl Rove is the reason why we're in this mess today.  Making politics into "winning" and forgetting ideology.  RINO Republicans just put the Republican Approved sign on a Socialist Agenda (prescription drug plan, biggest gov't agency ever created [Homeland Security], spending on every pork project imaginable, etc.).

The sooner he's out of the Republican party the better - and that goes for Dick Cheney as well.

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#14) On September 22, 2010 at 10:55 AM, whereaminow (< 20) wrote:


Thanks for the kind words.

Your analysis of events is correct (though some have argued that the credit "crunch" was overblown, the personal savings rate was 10-15% lower than historical averages, meaning everything was being bought on credit that disappeared.)

But remember that deflation is not the popping of a bubble, unless you really really want to stretch the definition.  Let the lawyers and politicians stretch definitions until words are meaningless. 

Deflation is a persistent drop in the general price level.  My assumption until proven otherwise is that the Federal Reserve will avoid even the slightest temporary drop in prices at all costs.  That makes real deflation impossible. 


Thanks again to you!  My response to you analysis is similar pj19.  You might be right that prices have fallen, although I would argue that the general price level is flat (and much higher than it should be).  My point is that once the Fed gets a whiff of this, it's going to create more money.  And the people predicting a long, painful price drop will be wrong again.

Granted, it gets confusing because people in power (intentionally) keep changing the meaning of things.  In classical terms, inflation is merely an increase in money beyond the amount demanded.  It was understood that this would eventually lead to price increases. 

Now inflation is defined as price increases, which deftly ignores the cause - governments/central banks printing money.

That's important because it's the only reason we are having this discussion in the first place.  If inflation remained defined the classical way, no one would be arguing about whether prices will go up or down.  The Fed doubled the money supply.  Prices will eventually rise.  End of story.  Instead, people are fighting over whether or not a .1% CPI drop and popped asset bubble is a harbinger of further price decreases. 

I have never seen anyone define inflation/deflation by labor cost.  Labor costs are going to be affected by monetary policy, but this is probably another ex post facto justification that attempts to lay blame for inflation anywhere else but at the feet of the money cranks.  Obviously, I would have to investigate that theory further but that's my gut feeling.

Finally, what we are experiencing right now used to be called a crash, as in a crash back to Earth or back to reality.  Governments, as we know, want to put off reality for as long as possible.  One of the ways to do that is to rename it.  You call it a Depression rather than a crash. It's no longer just reality catching up with you.  It's a 'market failure.'  That way you can intervene and power grab.  But then people don't like the term Depression since it implies government failure nowadays, so they don't call it that today either.

It's silliness.


The Federal Reserve is the #1 employer for economists, so if you're an economist and you want some job security, you trade in intellectual honesty and prostitute your mind.  =D  That's my take.

I don't have the exact quote and reference on me, but John Law, the architect of the Mississippi Co. bubble, wrote succinctly about the reason governments (and he) love inflation some 300+ years ago, something to the effect that 'inflation is a tax that is stealth and therefore preferable for governments, and that it falls most heavily on the poor, who no one cares about.'

So it's not like these economists don't know what they're doing.

Finally, for anyone interested, the "inspiration" for this blog was the book The Moon is a Harsh Mistress by Robert Heinlein and the song Terrapin Station (medley) by the Grateful Dead.

David in Qatar

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#15) On September 22, 2010 at 2:08 PM, miteycasey (28.85) wrote:

I've personally have only gone through recessions since 1974, but shouldn't we be going back to 1931?

No, because we were on the gold standard then. Completely different set of rules to playing the game with fiat money.

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#16) On September 22, 2010 at 5:29 PM, QualityPicks (78.32) wrote:

I agree, we should buy hard assets, like gold, but be wary of bubbles in assets. When the government prints money, it is not divided equally among the whole economy. Governments and banks decide where this money goes to.

Governments can't print gold. That is why people say that Gold can preserve your money much better than dollars. But watch out for bubbles. Gold could become a bubble too, if everybody decides to store their money there and prices are pushed beyond any fundamentals and logic.

About 10 years ago I started shifting my thinking from nominal dollars to assets. What is wealth? If I own a 3 bedroom house worth $100k (all paid for), and nothing else, I'm worth $100k. Now let say, that the housing bubble hits, and my house is now "worth" $500k. Am I really wealthier? Nominally yes. But you still only have one 3 bdr home. You are not really wealthier, it is just that money is worth 5 times less. Now, if you buy an ounce of gold at $800 and it goes up to $1,200, you still own only one ounce of gold. You are not really wealthier.

So there you go, money will keep chasing the best assets out there. It doesn't spread evenly. That is why we had a housing bubble, and a tech bubble. They were just supposed to go up "forever", so it was the best way to preserve (and even gain relative to other assets) your wealth.

Since March 2009, we have had major inflation (which was preceded by major deflation). At one point market forces will likely kick in again and cause deflation. However we have Bernanke and all the central bankers around the world in "high alert". They have made it clear they are ready to print as much money as necessary to make sure the business cycle doesn't correct again.

So we might have a positive GDP, but will we be wealthier? It will be all smoke and mirrors. Some will benefit more than others like you say, but overall, nothing of value happened.

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#17) On September 23, 2010 at 12:55 AM, FleaBagger (27.52) wrote:

If you want to go back to 1931 (or 1929) in a discussion of inflation/deflation, we can do that. It's a relatively simple situation: the bursting of an asset bubble caused prices to drop across the board, except for wages. President Hoover, in his economic wisdom, bullied employers into maintaining wage rates at artificial highs during what was otherwise deflation, resulting in layoffs and business failures, a one-two unemployment punch. Hoover issued numerous executive orders interfering with the economy, and signed the atrocious Smoot-Hawley Tariff Act, further hamstringing employers. When FDR succeeded Hoover on a campaign of free markets and fiscal discipline (i.e. damned lies), inflation was kicked into high gear by way of the theft of Americans' gold, and numerous regulations and boondoggles kept the labor force from doing anything productive.

Nothing but cause and effect.  

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