Indeflation is Here
Gerry, a gentleman with whom I have corresponded in the past, has written a smart commentary on the present monetary tug of war.
I call this uncertainty about inflation versus deflation “indeflation”. It is a combination of the two words but it is also a play on the word indecision. The fact is that most people (many economists included) do not understand what inflation really is. I define inflation as the increase of money and credit in excess of the growth in productivity. Deflation is the opposite … a decrease of money and credit. Inflation is not a general increase in the level of prices … which is merely a symptom of true (monetary) inflation … as most financial “experts” would have you believe. The fact is that the world’s fiat currencies have been centrally managed by the various world central banks since the early 1970’s and one could argue that this process has occurred since 1944, 1933 or even 1913. The most influential currency manipulator during this period was the US Federal Reserve (Fed). In the past 40 years the Fed has increased money and credit greatly in excess of any increase in productivity in the US economy. Since the US dollar is the world’s reserve (fiat) currency this led to inflationary pressures in the US but even more so in the rest of the world. This increase in money resulted in increasing prices of all goods and services but especially so for commodities which saw a top in prices in early to mid 2008. Since that time we have been seeing falling commodity prices. How can that be since the Fed has continued to increase its monetary base since then … even more than doubling this monetary base over that period? Many financial gurus were calling for prices and wages to explode upward in an inflationary spiral reminiscent of the 1970’s.
The reason for this discrepancy is that the fall of Lehman Brothers and the bailout of AIG in the fall of 2008 resulted in a massive de-leveraging of the world banks and shadow-banks which is ongoing today. Remember that I said above that inflation is the increase of money “and credit”. It is the function of our banking system to take the monetary base created by the world central banks and lever (or “gear”) this money many times over through bank credit. Since the 1990’s this process went completely out of control and the banks geared to unimaginable levels using both legal and illegal methods. This has now reached a point where the banks have created so much credit that the world is awash in debt. In fact there is now so much debt in the world that the world income base cannot support the interest payments required to service the debt … let alone try to pay off the principal. This has resulted in a period of destruction of credit which by my definition above is deflation. However, this deflation has not yet resulted in a general decrease in the level of prices and wages. Why not?
Although the Fed has more than doubled its monetary base since the start of 2008, this new money has largely been quarantined or sterilized on the Fed’s balance sheet. In addition it is highly likely that the amount of new money created by the Fed during the past year (although massive) has not kept pace with the destruction of credit that we have seen during that same period. As a result, prices of most assets (housing, stocks, commodities and consumer discretionary goods) have either fallen (sometimes drastically) or remained flat.
I actually don’t think credit is contracting at this point so much as the availability of credit is decelerating. It was the acceleration of credit availability that fueled much of the world’s (not just in the U.S.) discretionary spending. All we’ve had is a mere stall in credit so far yet it has opened up a fearsome economic chasm. Should we get a meaningful contraction in credit there would be little debate about deflation vs. inflation given the number of people soon selling pencils on the street corner.
It will probably be a while before discretionary spending comes back (those of you who think it will never come back, please save your breath as we’ve all heard the argument before) and that could realistically reduce global GDP by 10%. A large portion of this reduction would probably be offset by government discretionary (stimulus) spending at least until governments were unable to borrow any more because they have displaced or crowded out all borrowing in the private sector. That is when (and only when) the odds of a hyperinflationary or deflationary monetary collapse will approach 100%.
Will food, energy and health care prices continue to rise in the meantime? I’m not entirely convinced. It is possible that the cost of such necessities will be rangebound during the next few years at elevated though not continually rising levels. Readers of Metal Augmentor know I’m talking about the model recently advanced by trader George Slezak. In such a model oil could trade around $50, corn at $5, silver at $15, etc. with periodic sojourns up or down but prices would eventually return to the mean. Hardly exciting but such price levels would be profitable for all but the most marginal producers (I’m looking at you, most of the Canadian oil sands) and this would be quite an accomplishment given the difficult economic conditions. In such a scenario gold and silver would have great potential for price rises and price spikes but the timing would not be certain. There would probably be substantial downside risk for leveraged gold and silver traders, speculators, explorers and miners.
In any case, those are my thoughts on “indeflation”. The odds of the situation continuing at the present level of uncertainty for several years are frankly not very high but it is entirely possible that we will have a temporary, partial and weak recovery a few months ahead followed by renewed economic decline and another weak recovery and so on and on. That might very well look in retrospect like a prolonged period of “indeflation” and it could also explain the prices of essential commodities trading at elevated levels without necessarily embarking on a new bull market (while not being in a bear market either).
silveraxis,
do you mean by “credit” “excess dollars in circulation balanced by an equivalent amount of “debt”?
Example: bank gives me loan of $1000 (credit). I spend loan. But I ow bank still the $1000 (debt).
In this case I tried to make the distinction between available credit and outstanding debt. People tend to spend money when they have credit available to them, even if they are out of work and even if they already have a lot of debt, as they did during the recession in 2001. On the other hand, people cannot spend money even if they wanted to when their credit lines have been maxed out as a result of banks reducing available credit. If this reduction in available credit becomes a permanent elimination, that will start to eat meaningfully into outstanding debt and the entire fractional reserve lending system will collapse just like deflationist such as Mike Shedlock predict. We are not in a deflationary spiral as long as some credit remains available to the private sector, but the risk is that government borrowing may actually crowd out the private sector and cause the very collapse that it seeks to prevent. I’m not saying this is a certainly, only a risk, but it needs to be understood for the situation to make sense. Hopefully I’ve been able to do that but I’m considering a “translation” of the Professor’s recent work which essentially promotes the same theory.
“I define inflation as the increase of money and credit in excess of the growth in productivity”
Another factor might be ‘in excess of population increases’.
An increase in the number of participants in money commerce
would tend to absorb more of the fiat money without causing
a general price increase.
Certainly given the enormous expansion of China and India
in the past couple decades hundreds of millions of people
have now joined those who must use money to provide
for their everyday needs. Previously, these people were
living in agricultural/subsistance circumstances and had
little or only marginal use of money.
The typical resident of the developed world of course is
nearly 100% dependant on the use of money to meet needs.
During the 30’s depression this was not so. Large portions
of the population were still agricultural, much more
self reliant, and less dependent on the exchange of money.
This modern 100% reliance on money exchange
tends to accelerate money velocity and magnify the
price increase effect of inflation.
Note that it is Gerry’s definition, not mine, but you are right that both productivity and overall size of economy (population) are factors in inflation.
While modern financial and banking practices have contributed to accelerating monetary velocity, this has been offset in great part by the very expansion of China, India and other emerging economies as these billions of people and millions of new entrepreneurs have reduced labor scarcity and created significant overcapacity in many industries especially with the huge expansion in world trade over the past 20 years. Note that there is always additional labor and entrepreneurial capacity in places like Africa and much of Latin America should today’s emerging economies become developed economies in the next few decades.
I do agree that inflation is unavoidable but the primary driver at this point would be stimulus attempts by governments that are successful in bringing debt burdens back down to reasonable levels without causing a monetary collapse. And the only way this is possible is to inflate the entire global economy and price structure while NOT inflating debts by the same amount (or more). One of the few ways that is both possible and credible from historical experience is to use gold in something like a Treasury gold certificate. Longer term the world does face serious resource constraints but these are unlikely to be near-term factors (let’s talk about these in 2012 or beyond).
When the FED prints money, it also creates a debt obligation at the same time correct?
Thus, curing the contraction in credit by new credit does not work at the end, because the “new credit” to pay off the “old credit” needs to be paid off as well! LOL
Then why does the FED no just prints money WITHOUT creating a debt obligation to reduce the debt (credit) burden? I mean this literary: just print green pieces of paper while NOT making a notation in your books.
It matters for whom the credit is created. The government cannot supplant the private sector in anything longer than the short term. At the same time, the government has virtually unlimited credit. Yet if the private sector has no available credit, it essentially becomes a circle jerk of government borrowing more and more to make up for bigger and bigger private sector shortfalls (please excuse the vulgarity). The reason the Fed cannot just print money is because the Fed is not authorized to print money under the Federal Reserve Act, it can only acquire discounted assets. On the other hand, the U.S. Treasury is authorized to issue money and before all is said and done I believe they could very well do so although if not based on gold and silver it will probably turn out not very dissimilar from the Weimar episode. Several times on this site I have already proposed how the Treasury could issue Treasury gold certificates but it looks like I’ll have to keep repeating it (Jim Sinclair and Prof. Fekete to my knowledge are the only others who has proposed something similar to this simple, straightforward and practical approach).
THAR’S A STORM BREWING….
I read from a FEB 2009 Farm Journal Magazine recently. This is what is stated:
AS OF MID DECEMBER 2008 a Survey shows that 52% of CORN GROWERS and 46% of SOYBEAN GROWERS with 500 ACRES or MORE had not Finalized their 2009 planting intentions. Here’s why they are waiting:
78% Waiting to see if fertilizer costs decline
74% Waiting to see of Corn Prices improve
52% Waiting to see if Soybean prices improve
46% Waiting to see if Seed Prices Decline
34% Waiting to see if Crop Protection Costs Decline
Most farmers will make their decisions by the end of March. So we will see what is instore.
People need to remember….the GREAT COMMERCIAL AGRICULTURAL EXPERIMENT over the past 70-100 years may turn up to be one HELL OF A DISAPPOINTMENT. When the farmers first took the Plow to the Field we had between 16 and 36 inches of GOD GIVEN TOPSOIL. Well, that has drastically disappeared. Furthermore, we have created what I call CANCER OF THE FARM BELT.
CANCER of the FARM BELT is using up the healthy part of the soil while only injecting harmful commerical additives. Basically, the soil is nothing more than a LIFELESS SPONGE to which a SOUP of HAZARDOUS CHEMICALS are INJECTED. A plot of ground that is constantly added with organic compost and natural fertilizers actually increases the fertility as time goes by. What we have today in the FARMS of the MIDWEST is a widespread case of TERMINAL CANCER.
This has serious INFLATIONARY IMPLICATIONS. At some point in time, the United States will have to start trading Stuff for Stuff….and not the BENJAMIN BUCKS as of LATE. At that point….all that wonderful OIL and Diesel that RUNS the Backbone of the FARM BASKET and the INTERSTATE HIGHWAY SYSTEM will be significantly reduced. That will be CHAOS.
This will be the STRAW that BREAKS the CAMELS BACK. The Perverse Financial Engineering has fed the Insane Practice of FRANKEN-FARMING. The days of farmers saving their own CORN to plant the next year has been replaced with the RETURN TO SERFDOM POLICY of large corporate entities providing LABORATORY CONCOCTED HYBRID SEEDS to which the FARMER is ENSLAVED.
Even though we had some Chemical use back in the 1930’s, many FARMS did not use this kind of practice. We did not have the CANCER in the MID WEST FIELDS that we do today. This indeed is extremely INFLATIONARY.
TOM….I have to say….I enjoy your LOGIC and WISDOM in the field of TRADING, METALS and etc. But I will say this….many an ANALYSTS might be missing the FOREST FOR THE TREES. I am not saying you are one of these….but I hear many talking about having a PORTFOLIO with this PERCENTAGE or THAT PERCENTAGE. I think those DAYS will be over at some point in TIME. In time as the WATER makes its way up through the TITANIC…..those bickering onboard about how they are going to spend their fortunes, just might end up 6 FEET UNDER.
I don’t know if many of you watched the movie I AM LEGEND…..but I have to say, witnesseing the PROTESTORS and RIOTERS in LONDON today….is the beginning of the end. Its like seeing the FLASH BACKS that Will Smith (in the Movie) watched before the FAN HIT THE SHEET.
To me….there are TOO MANY NAILS in the COFFIN for the PHAT WHITE MAN. At least during the time of the FALL OF ROME people could go back to the country and make a living from the soil. Today…the chances are SLIM to ZIP for that to take place. Too much of the FARM LAND is WASTELAND ready to IMPLODE on its own ENTROPY.
We can DEBATE INFLATION and DELFATION all day long. But at some point in time the PIED PIPER will play his FLUTE and the GRIM REAPER will want his POUND OF FLESH. The days of Bickering about ASSET ALLOCATIONS will become as MEANINGLESS as the words of LIL TIMMY GEITHNER.
word to your agricultural extension agent……………