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John Hussman: Inflation Myth and Reality



January 19, 2010 – Comments (0)

John Hussman of puts out a Weekly Market Comment (which I highly encourage you to read every week). This one is particularly good. It very much goes with what I have been saying in many of my posts, including quite comprehensively in this post: The Dow / Gold Ratio - The fact that simplistic anlaysis of the form "inflation causes stocks to go up" is not strictly true all the time, which is equivilant to it being wrong. There is *never* only one cause and one effect in economics, and stocks can fall within an inflationary environment. Inflation Expectations and Stock Valuations within the inflation cycle make a huge difference as to whether the next phase continues stock growth. Moreover, commodites and stocks are positively correlated ... until they are not. All correlations are transient and subject to macroeconomic influences and expectations. And anyone who thinks the macroeconomic picture is the same now as it was back in March needs to do some more reading and thinking.


Inflation Myth and Reality
John P. Hussman, Ph.D.
January 19, 2010


Fortunately, we have enough data both domestically and internationally to analyze inflation-prone environments with the expectation of dealing with them effectively from an investment standpoint. To understand the investment environment is to know how to respond. Presently, the greatest uncertainty for us continues to be the dichotomy between typical post-recession market dynamics and the much more difficult environment that we may very well actually be in, if previous credit crises in history are any guide. We share none of Wall Street's confidence that the more difficult possibility should be dismissed, and suspect that it is premature to declare the credit crisis over.

Inflation Myth and Reality

Will Rogers once said "It ain't what people don't know that hurts them. It's what they do know that ain't true." That observation certainly applies to the myths and realities about inflation.

Mainstream economists and Wall Street analysts hold two very specific views about inflation almost without exception. The first is that inflation is caused by monetary policy, and specifically by excessive money creation. That view is often accompanied by a slight modification that inflation can also be caused by excessive economic growth. The second view is that there is a predictable relationship between inflation and unemployment, known as the Phillips Curve, such that high unemployment is associated with low inflation, and low unemployment is associated with high inflation.

These views are either incomplete or inconsistent with actual economic data. But what's more interesting is that they're actually misinterpretations of economic theory. In order to fully understand this, you have to briefly suspend what you know, and carefully walk through a little bit of economic theory and what it implies about reality. Reality, as it turns out, behaves very much as theory suggests ... and not much as Wall Street believes

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