Deflation or Hyperinflation?

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Deflation or Hyperinflation?

Deflation or Hyperinflation?  http://fofoa.blogspot.com/2011/04/deflation-or-hyperinflation.html

Although the post is rather long this is the best article I've seen on the deflation vs hyperinflation debate.  It caused Rick Ackerman to change his mind from being a deflationist to a hyperinflationist:

http://www.rickackerman.com/2011/04/at-last-a-hyperinflation-argument-th...

Charles Hugh Smith (http://www.oftwominds.com/blog.html), who has been a skeptic of the hyperinflation argument, commented that the FOFOA post included a "careful analysis" of his (Smith's objections).

 

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Re: Deflation or Hyperinflation?

 

There was also this excellent podcast on the financial sense with Nicole Foss, on the deflation side:

http://www.financialsense.com/financial-sense-newshour/big-picture/2011/04/23/02/nicole-foss/preparing-for-the-next-tsunami

 

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FOFOA's powerful insight to inflation
hucklejohn wrote:

Deflation or Hyperinflation?  http://fofoa.blogspot.com/2011/04/deflation-or-hyperinflation.html

Although the post is rather long this is the best article I've seen on the deflation vs hyperinflation debate.  It caused Rick Ackerman to change his mind from being a deflationist to a hyperinflationist:

http://www.rickackerman.com/2011/04/at-last-a-hyperinflation-argument-th...

Charles Hugh Smith (http://www.oftwominds.com/blog.html), who has been a skeptic of the hyperinflation argument, commented that the FOFOA post included a "careful analysis" of his (Smith's objections).

 

Hucklejohn,

Thanks for the follow-up regarding the developments to the FOFOA post.

I read this post over the weekend and agree it is a persuasive and compelling piece. After seeing the effect it's had I re-read it again today---despite it's length. I would agree that this is the most insightful offering in the whole inflation/deflation debate. Now I'm going to go back and read all the links to past articles. There is much to chew on here. And much to think about.

 

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Interesting, But Flawed

I think FOFOA certainly has a very interesting way of approaching the debate. It is a very long post, and travels in circles for some parts and becomes very repetitive in others. Essentially, this is the somewhat unique part that I distilled from all of what he wrote (in my words):

Monetary dynamics in any economy are fundamentally driven my political decisions (which includes central bank policy), just as we saw in Zimbabwe recently, and the massive dollar-based financial system is no different. The financial and political elite class, which is not necessarily unified, will take either a) high inflation or b) hyperinflation (distinctly separate events) over wide-scale deflation every time. The reason is because most of them will get first dibs on spending the cash after they dump debt-asets onto the Fed's balance sheet, and so they can effectively outrun the devaluation of the dollar by purchasing "hard assets".

That latter argument is based on a key and insightful observation - in periods of true HI, there is actually always a shortage of cash relative to real goods/services from the perspective of those within the economy. The hard money with intrinsic value, gold, will be the best means of preserving your wealth through this time (much much more so than RE), because there will be a severe deflation (falling prices) of all assets and goods when priced in gold.

As you may have guessed, I think there are some fundamental flaws in this argument. However, I'd like to be sure I'm accurately describing it first... anyone interpret it differently?

 

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Flawed or incomplete assessment?
ashvinp wrote:

I think FOFOA certainly has a very interesting way of approaching the debate. It is a very long post, and travels in circles for some parts and becomes very repetitive in others. Essentially, this is the somewhat unique part that I distilled from all of what he wrote (in my words):

Monetary dynamics in any economy are fundamentally driven my political decisions (which includes central bank policy), just as we saw in Zimbabwe recently, and the massive dollar-based financial system is no different. The financial and political elite class, which is not necessarily unified, will take either a) high inflation or b) hyperinflation (distinctly separate events) over wide-scale deflation every time. The reason is because most of them will get first dibs on spending the cash after they dump debt-asets onto the Fed's balance sheet, and so they can effectively outrun the devaluation of the dollar by purchasing "hard assets".

That latter argument is based on a key and insightful observation - in periods of true HI, there is actually always a shortage of cash relative to real goods/services from the perspective of those within the economy. The hard money with intrinsic value, gold, will be the best means of preserving your wealth through this time (much much more so than RE), because there will be a severe deflation (falling prices) of all assets and goods when priced in gold.

As you may have guessed, I think there are some fundamental flaws in this argument. However, I'd like to be sure I'm accurately describing it first... anyone interpret it differently?

 

Your interpretation is somewhat accurate as far as it goes, but distilling this piece down to your statement is a gross oversimplification. As one example of gross omission is any acknowledgement of his contention that TPTB (or Elite or whatever one calls them) have a disincentive for deflation as well as the incentive for HI that you did acknowledge. In other words they would avoid deflation like the plague because of the defaults that would accompany the deflationary process. Even minimum defaults would destroy the balance sheets of the TBTF banks as well as other major institutions resulting in instant death (unless bailed out by printing which causes the hyperinflationary outcome). So therefore, the premise is that the Elite, though obviously preferring to be repaid in full with money that has retained it's purchasing power, wouldn't have that option. Instead, when faced with a choice of a hand grenade to the balance sheet or being paid in full with debased currency which they get first crack at, then they'll take the HI route.

That's my perspective, but again, an oversimplification. There are other points made that should also be considered in any treatment of the piece. This was a long article that covered many aspests of a complex issue and was thoughtful enough to deserve being taken in it's entirety.

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Earthwise, I realize he made

Earthwise,

I realize he made many other observations in his article, but IMO, not much outside of what I summarized was unique to the HI argument.

For example, the disincentive for financial elites to pursue policies that promote severe deflation is nothing new, and it's obvious that they would not want all of their debt assets to become worthless through systemic loan defaults.

However, since that particular argument has been around for so long, there have also been many clear rebuttals to it by various people in the deflationist crowd, including me. For example, it is missing the fact that elites can paper over asset losses with false accounting, end of the quarter window dressing, etc. and also minimize their losses by passing them to taxpayers through fiscal and monetary asset purchase programs (QE). Such programs are not destined to cause HI by any means, as we have seen so far since 2008.

In a deflationary environment, the only debt-asset that they would want to hang onto is Treasury bonds, since their value is theoretically (and practically so far) backed by the "full faith and credit" of the US government, which basically means the government will not be allowed to default. It also gives them solidified fiscal control over what programs the government will spend on and what they will cut out.

Anyway, while all of this stuff is interesting and may have been mentioned in FOFOA's article, it is the standard back and forth between deflationists and HIs, so that's why I chose not to focus on any of it.

So my question is - what else contained in FOFOA's post struck you as a unique piece of evidence or argument supporting the HI position, either as a single observation or combined with several different observations? Personally, I couldn't find much more than I already wrote above.

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Nothing is certain....
earthwise wrote:

Your interpretation is somewhat accurate as far as it goes, but distilling this piece down to your statement is a gross oversimplification. As one example of gross omission is any acknowledgement of his contention that TPTB (or Elite or whatever one calls them) have a disincentive for deflation as well as the incentive for HI that you did acknowledge. In other words they would avoid deflation like the plague because of the defaults that would accompany the deflationary process. Even minimum defaults would destroy the balance sheets of the TBTF banks as well as other major institutions resulting in instant death (unless bailed out by printing which causes the hyperinflationary outcome). So therefore, the premise is that the Elite, though obviously preferring to be repaid in full with money that has retained it's purchasing power, wouldn't have that option. Instead, when faced with a choice of a hand grenade to the balance sheet or being paid in full with debased currency which they get first crack at, then they'll take the HI route.

That's my perspective, but again, an oversimplification. There are other points made that should also be considered in any treatment of the piece. This was a long article that covered many aspests of a complex issue and was thoughtful enough to deserve being taken in it's entirety.

Here is the problem I have with FOFOA.  He contends hyperinflation is certain, and I just don't think much of anything is certain at this point. I also think it is quite arrogant to think that because Rick Ackerman ( a blogger/investment manger that I doubt many have heard of ) has changed his opinion from deflation to hyperinflation, the debate is over and his side won.  If Mish/Stoneleigh/Prechter caused a similar minor player in the hyperinflation camp to switch sides to deflation, would that really change anything?

Because FOFOA believes that TPTB will do better under HI does not mean that it will happen, at least not as they want it.   He makes what I think is a valid point which is that those closest to the money creation process relatively will do the best during hyper or high inflation, but few would debate this point.   For HI to happen he admits that at somepoint those controlling government will make the decision to outright print to pay for government spending.  That may be true and I certainly believe that they would prefer that outcome over some sort of austerity but I can imagine scenarios where it does not happen. 

A lot of more people than ever before are becoming aware of the money creation process, and the inequities it causes.  Add in political movements like the Tea party (or progressive libertarians) and the rapid world wide communication of the internet and I think you can easily make a case that the printing press could get shut down.  If many more people lost their jobs and at the same time bailouts caused prices to start to run away, actions that overtly help the rich and powerful at the expense of the masses, could lead to riots and unrest and also cost the government its legitimacy.  An awaken populace with little to lose is a dynamic I would not want to try and predict.

I am not saying that the deflation camp is right and the hyperinflation camp is wrong.  I just don't think anything is certain.

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ashvinp wrote: Earthwise, So
ashvinp wrote:

Earthwise,

So my question is - what else contained in FOFOA's post struck you as a unique piece of evidence or argument supporting the HI position, either as a single observation or combined with several different observations? Personally, I couldn't find much more than I already wrote above.

A lot of it was unique to me, mostly because I'm not that well versed in these discussions. Sorry. Although until the fall of '08 I couldn't tell fiat from a flapjack and bullion was something you made soup with, since then however I've tried to make up for lost time. (sorry for the overuse of food metaphors-it's dinner time as I write). You point out that "that particular argument has been around for so long........"  but it's not an arguement I've heard 'till now. What's interesting is that I have heard this before : "The reason is because most of them will get first dibs on spending the cash after they dump debt-asets onto the Fed's balance sheet, and so they can effectively outrun the devaluation of the dollar by purchasing "hard assets"   whereas you find it unique.  I think this is standard fare in the Austrian school.

I would point out though that  "minimize their losses by passing them to taxpayers through fiscal and monetary asset purchase programs (QE)." is a part of the HI process FOFOA outlined that may very well be under way. I dont' find a lot of comfort in your assertion that: "Such programs are not destined to cause HI by any means, as we have seen so far since 2008".   Don't you think it's a little premature to make that call? Even though the jury is still out it doesn't seem that the deflationists have the facts on their side. By invoking recent history it forces one to look at the immediate evidence which favors the inflation side of things. But then, of course, the flat-Earthers have the immediate evidence on their side too.

What I found compelling is a clear path to HI with all the players lined up and in position with the incentives to play their part. A holistic explanation, if you will. I haven't seen that from the deflationist perspective. Yet.

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There Is No Deflation/Hyperinflation, Only Wall Street Profits

A friend of a friend of a friend of a computer algorithm told me that deflation and hyperinflation are just trading strategies. Wall Street's lucrative game is simply to play one scenario against the other over and over again until the "house" has captured all the chips. The most beautiful part of the whole shebang is that there are some players believing that the investment banks can't profit from their own game.

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JAG,   I am picturing you

JAG,

 

I am picturing you as a wise little bald girl right now.

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earthwise wrote: I would
earthwise wrote:

I would point out though that  "minimize their losses by passing them to taxpayers through fiscal and monetary asset purchase programs (QE)." is a part of the HI process FOFOA outlined that may very well be under way. I dont' find a lot of comfort in your assertion that: "Such programs are not destined to cause HI by any means, as we have seen so far since 2008".   Don't you think it's a little premature to make that call? Even though the jury is still out it doesn't seem that the deflationists have the facts on their side. By invoking recent history it forces one to look at the immediate evidence which favors the inflation side of things. But then, of course, the flat-Earthers have the immediate evidence on their side too.

What I found compelling is a clear path to HI with all the players lined up and in position with the incentives to play their part. A holistic explanation, if you will. I haven't seen that from the deflationist perspective. Yet.

Since 2008, TARP, the Recovery Act and QE have by no means caused sustainable inflation in the productive economy. You may say that the dollar has weakened some, and that food/energy prices have gone up for many people, but that would be the equivalent of saying homes were relatively expensive in 2005... we saw what happened a few years later. Meanwhile, economic growth continues to stagnate or decelerate, the housing market continues to show price weakness, debt levels are still very high across the board, unemployment is probably worse than it was last year (esp long-term unemployment), wages are not improving at all, etc.

Even FOFOA admits we are facing a severe deflationary episode in the absence of massive money printing, but he thinks the latter is inevitable once a tipping point in dollar confidence is reached. Hence, they will print to save the dollar and that will make the devaluation infinitely worse. I really don't see how this is a "clear path" to HI from now until then, as there is really nothing to explain why the tipping point will occur except either sovereign debt concerns (this will happen eventually, but not likely to be anytime soon) or concerns over money printing (this is on the supply side of monetary dynamics and can therefore be controlled by elites). They will continue to monetize, and maybe at a larger scale than before, but only once deflationary fears have fully taken hold again.

IMO, FOFOA has not made a good case at all for why the financial and political elites would want HI or would even risk it to avoid loan defaults. Deflationists, on the other hand, have made a great case for why they would want mild to moderate deflation and their policy decisions/mindset seem to confirm that at this point.

 

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Still a deflationist

This is the most bizarre theory of money/gold that I have ever read. FOFOA discusses gold/money in the most abstract terms imaginable - if this, therefore that - and makes many assumptions/assertions that do not seem grounded in common sense.

The argument assumes that there will be a financial collapse of paper assets but is not very specific as to which paper assets other than the US$ in it's various forms i.e. greenbacks,  T-bills, T-notes and T-bonds. He does not really define how a dollar will crash, except against gold. What about the dollar versus the S&P500, commodities and the Euro? Will the euro skyrocket? Will food become so expensive that nobody can afford it? It is certainly true that equities, commodities and many currencies have been gaining against the greenback but it has not been a crash. If commodities keep rising, will equites do the same? Will companies pay increased wage demands? Will the general public continue to buy fuel at higher prices? It could be argued that all these prices will remain constant relative to one another but the general public will pay more attention to nominal prices because cost of living increases invariably remain ahead of income increases.

The argument assumes that money and financial assets are driven by supply and demand. Robert Prechter has made a very compelling argument to show that is simply not true. The gist of the Prechter argument is that financial markets are not subject to the economic paradigm whereby increasing price of goods stimulates production forcing prices to drop until an equilibrium is found. This is because people more or less know what they want to pay for a product and will find a cheaper alternative or forego consumption. Only new and innovative products can set their own price for a while until competition enters the market place. People buy cheap and sell expensive. Financial markets do the opposite.  Financial asset markets tend to be in a more or less permanent state of uncertainty. The only thing that changes is the perception of the "investor". There are times when the investor is more certain or confident, which is what drives bull markets and vice versa in bear markets where confidence evaporates. The dynamics of the market are driven by herding behaviour in a direction which defines the trend, until the trend changes.  This happens on a minute by minute basis as well as on any longer timescale. I defy anyone to tell the difference between a minute chart, an hourly  or a daily one without a scale. FOFOA discusses feed back loops - contracting economies and falling markets lowering confidence and thus causing further falls. This is getting cause and effect back to front. If there was a feed back loop then you could expect markets to continue on upwards because the higher they go the more confidence building is the feedback loop. The reverse would be the case in a falling market. That does not happen. Markets are constantly dynamic and not mean reverting - they tend to go from one extreme to another, thus passing right through the mean. Prechter's theory is elegant in its simplicity and is backed up by other's observation that, from a trough, markets climb a wall of worry with many setbacks to start with, enter a middle period of sustained rises which tends to be the longest wave and then enters the final wave in which the majority come aboard because everyone becomes certain, only to peak and turn down again. Most people enter in the final phase  and stay in on the slope of hope and leave towards the end. That is why most people lose in the markets.

The credibility inflation that FOFOA discusses is exactly what happens in markets. It is what Elliott Wave theory describes as a positive mood. With regard to the Treasury market, it has happened many times over the last 30 years. Bonds go up and down in small cycles but the trend has been up over the period. Clearly there is a limit because rates cannot go negative, although Bernanke is doing his best to turn the beast inside out. It is as though a snake were eating its tail and is now getting toward the head, to the point where it swallows itself completely or turns inside out. The point is that we are at a point where all sorts of conflicting things are happening - a proliferation of unintended consequences. Inflation is happening - price inflation of many of the most important things in peoples lives. Notably food and energy but also government services like healthcare and education. It is also true that the total of credit outstanding is falling - the graph which has been rising for 80 years has tipped over. That is deflation. So are falling residential real estate prices. The real estate bubble of 2003-06 was the ending flourish of a long period of property asset inflation which had more or less been going on since the mid 70s. In fact you can really time the start of it with the Nixon abandonment of the Bretton Woods agreement. There was the initial gold frenzy, which was a period of catch up after almost 60 years (from 1913 when the Fed was created) and typically over-compensated before settling back to an average of around half its peak for just under 20 years between the early 80s and late 90s, and now there is another period of catch up. If you overlay a 10 year gold chart on a 10 year Dow chart, you will see that the trend of both has been in the same direction.  The Dow was in full downward flight during 2008 and gold had been falling too but in late October  it bottomed (and the US$ made a top) while the the Dow continued downwards until March 2009. Hardly coincidental, the following month the Fed announced QE1. In March the parallel trend of gold and equities resumed. I think there is no doubt that without a QE3, the upward trend in gold and equities will fail. It is also notable that despite QE1 ( the Fed purchased roughly $1 trillion of assets between November and March of which $600 billion were MBS) it took until March for the downward equity stampede to be halted.

My guess is that at that time, the Wall St insiders were tipped the wink by the Fed and gratefully exited equities and bought gold and the euro instead, thus adding to the woes of the plunging equity markets. The action of the Fed was, from the point of view of Elliott Wave theory, an act of enormous complacency and confidence in its power. It was what you might expect in terms of a mood change after a year of relentless market falls. It was certainly contradictory of one half of the dual mandate, controlling inflation, but could excuse itself on the grounds of returning the US to full employment. As we now know, that simply has not happened. The general population can give up consuming many things but food and energy for warmth are essential. As people cut back on other things to make sure of their ability to maintain the survival essentials, so the domestic economy suffers. The equation simply cannot be squared. I doubt that Bernanke will have the stomach for QE3 or that the politicians or escalating public unrest would let him. It is a failed experiment that has added to the wealth of the small percentage of the population that works for the TBTF banks but done precious little for anyone else.
It may be true that government has a grand record of stiffing lenders through the process of inflation but the US is not Zimbabwe. Most of the so called printing is actually just book entries. Of course, large amounts of money are entering the public arena through government spending on salaries, programs, general expenditure etc but the majority of the $2 trillion of Fed asset purchases has been kept closely held by the large financial institutions. It is being leveraged enormously and used to drive up commodity and equity markets to the point where inflation is having massive inflationary side effects which is bringing on political consequences. It is interesting to note that for most of his Fed career, Greenspan was a hero. He was feted everywhere and knighted by the Brits. It was only after the housing debacle which came after his retirement that his career was looked at in a different light. Bernanke,on the other hand, had only a few months of calm before the financial world blew up around him but he has also overseen a remarkable stock market recovery. However, he has never had hero status amonst the general public. I think the reality is that this is not a recovery that anyone really believes in. It is a temporary reprieve with bubble like qualities.
I do not think gold will continue upwards unless equities and commodities go with it. I cannot see that happening for equities with the present unemployment level and the inflation of essentials. There is another world beyond Wall St and government. It is angry and well armed.
The people who run Wall St  are so far removed from the lives of ordinary people, ordinary jobs, the lives of farmers and factory workers, shop assistants, doctors, nurses, and teachers - in short everyone who produces something real and useful. The money people and their acolytes - the politicians, who seem more dependent now on the money rather than their constituents, have removed themselves to a world of trading and dealing in dollar numbers so vast as to be beyond comprehension. Of course they are driven by self interest and will try to convert paper to gold or any number of other commodities or stocks but in so doing they are destroying the very people upon whom they depend. The world is run by people, not algorhythms and computers. It is all very well driving up food prices for example by massive speculation in the commodity markets but if no one can afford to buy the food, it will go to waste. Maybe such events will have to happen before these master traders realise that food has a purpose - it is for sustenance of the workers, not something to be leveraged, swopped, sliced and diced or subjected to any of the wonders of derivative flim flam before it spoils or the people starve.
Debt will have to be written off and that is why we will have to deflate. It is better to simply get on with the deflation rather than have a hyperinflation followed by a deflation. The German hyperinflation of the 20s did nothing but create an enormous amount of unnecessary misery, certainly helped bring Hitler to power but did not avoid the deflationary depression of the 30s.
There is no way I could prove that we will not have a hyperinflationary period, it is possible, but I suspect that equity markets will fall under their own weight and drag everything else down too. The only exception will be the US dollar, which from a contrarian point of view, is certainly due a breather.

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He does not really define

He does not really define how a dollar will crash, except against gold

Thats the point!! Gold IS money, not the useless FRN's.

It is certainly true that equities, commodities and many currencies have been gaining against the greenback but it has not been a crash.

The greenback has not been around since the assination of Lincolin and the end of a U.S. Gov.  issued currency. If we sitll had the greenback we wouldn't be in massive debt to the banksters.

 

The gist of the Prechter argument is that financial markets are not subject to the economic paradigm whereby increasing price of goods stimulates production forcing prices to drop until an equilibrium is found. This is because people more or less know what they want to pay for a product and will find a cheaper alternative or forego consumption.

The "People" are no longer involved in the financial markets and couldn't care less. How are they going to forego gas, food and heat which is taking an ever larger percentage of their income EVERY DAY?

 

Debt will have to be written off and that is why we will have to deflate. It is better to simply get on with the deflation rather than have a hyperinflation followed by a deflation

What debt do think will be written off? Who is going to take the haircut? What will happen to interest rates when you start to wirte off (read default) the existing debt? Then how will we service the interest alone. If you deflate the money supply you only hurt the average family because they will not have a job to pay their bills and then the banks will foreclose on the collateral.

"If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered."    Thomas Jefferson

This is exactly what was done in 1913 with the creation of the Federal Reserve. You are advocating deflating the money supply and letting the banks take everything.

I think you should really consider what the consequence's of your proposals would be.

IMO there is no saving the system, we are at the end game. The dollar will collapse along with most of the worlds economy's. Gold and Silver will hold their true value and all the fiat paper will burn.

Rich

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Affordability vs. Price
doorwarrior wrote:

The "People" are no longer involved in the financial markets and couldn't care less. How are they going to forego gas, food and heat which is taking an ever larger percentage of their income EVERY DAY?

Rich,

Many people could be forced to forego their current levels of food/energy consumption precisely because it consumers a larger % of their income every day (because their income is falling faster than nominal prices, which feed back into unemployment).This is also why falling private interest rates for consumer loans does not mean debt is "cheaper", because the real interest burden increases as inflation decreases.

I agree with you (and Jefferson), however, that a severe deflation is not necessarily "better" than HI, especially if the elites manage to stay in control during most of it, but of course a lot of that depends on the specific context and will be very hard to judge until it is actually happening or is already over.

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Gold is not money

Gold is no more "money" than is a share certificate, a property title or a sack of rice. Actually, a sack of rice is far more useful than a bar of gold because it is practical and usable. An ounce of gold is worth US$1500 which is a bit much for the weekly shopping. What would you accept for change?
I do realise that the US$ is only worth perhaps 5% of it's 1913 value but I am not discussing the dollar's value over a century but over a decade.

Anyone who is saving or investing in a mutual fund or insuring their health or their property has a stake in a financial market.

The reason that the "people" may have to forego gas, food and heat is because of inflation. A deflation would hold prices or even lower them. The fact that the "people" could not care less is half the problem - why are they not hammering down the doors of their congressional representatives?

Anyone who is indebted will take a haircut. Holding debt in a deflation is not a good idea because the purchasing power of the unit of currency can gain faster than the debt can be paid off. It is a good question as to who will take the haircut when it comes to very large amounts of debt - will it be the borrower or the lender? Most likely both - I certainly realise that it will be very messy for the largest financial institutions (who outside of nation states are the largest borrowers and debtors) when they start turning on each other.

I don't understand why you think that a deflation will result in the banks taking everything. The banks will be the biggest losers of all. No doubt job losses will be greater but the system will not come to a halt - it did not do so in the great depression. Life goes on, people will help each other, food and other necessities may be bartered for a while but people will organise themselves. The major financial institutions will be decimated, assets will go from weak hands to strong hands. The strong hands are not those which have been bailed out by the government. They may appear strong now but there are still billions, if not trillions of worthless assets festering on the balance sheets of the largest institutions including the Fed.

It is assumed that all interest rates will rise. I doubt that Treasuries will rise by much but the spread between high quality (T-bills/notes/bonds) and corporate/municipal debt will widen dramatically again as it did in 2008.

As the deflation takes hold and credit creation slumps so will the nominal value of most assets. The real value of assets - that is the utility offered by a roof over one's head (which means the utility of all those commodities that go towards providing our shelter and the energy for heat and transport) will remain but relativities may change. For example, the relative value of food to shelter may increase. A century ago we spent 75% of income on food and 25% on shelter - the reverse of today's expenditure. That may even up. The nominal value of assets will decrease which implies that the purchasing power of the unit of currency will become greater as there are less units of currency in existence (because of the deflation).

The consequences are certainly going to be rough on everyone. Do you really expect that we can escape the profligacy of the last 3 decades without consequences? The consequences of the present course that the Fed/ US giovernment/ Wall St has taken will be far worse for everyone because the bill is being passed on to the "people" and those who have not even been born yet. An economy cannot grow on money plucked from thin air. It requires willing workers, resources, low debt levels, low taxes (in the long run), fair property laws and a system that encourages saving by paying a reasonable interest rate for that deferrred expenditure. None of these conditions are being met. The notion that America can inflate it's way out of debt is laughable. America has been inflating since Bretton Woods and look at the pickle it is in now. Does anyone really believe that one country could have a defence budget that is the equal of the next 8 or 9 largest country defence budgets if it had not been having a subsidy from the rest of the world simply because it could print the reserve currency in which all commodities are paid? America has had an enormous advantage for 60 years. I accept that it has not all been one way - the Marshall plan, kick starting Japan and being the world's policeman for much of that time has a cost but the advantages have outweighed the costs by a huge margin. The game is coming to an end. The sooner the "people" wake up to this inconvenient fact, the quicker America can re-invent itself into an idea that both works and is sustainable.

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goes211
Status: Diamond Member (Offline)
Joined: Aug 18 2008
Posts: 1114
Leaning towards deflation but....

timeandtide,

I really like your posts but I have a few questions.

timeandtide wrote:

Gold is no more "money" than is a share certificate, a property title or a sack of rice. Actually, a sack of rice is far more useful than a bar of gold because it is practical and usable. An ounce of gold is worth US$1500 which is a bit much for the weekly shopping. What would you accept for change?
I do realise that the US$ is only worth perhaps 5% of it's 1913 value but I am not discussing the dollar's value over a century but over a decade.

Anyone who is saving or investing in a mutual fund or insuring their health or their property has a stake in a financial market.

I basically agree with you here.

timeandtide wrote:

The reason that the "people" may have to forego gas, food and heat is because of inflation. A deflation would hold prices or even lower them. The fact that the "people" could not care less is half the problem - why are they not hammering down the doors of their congressional representatives?

Yes during deflation prices might decline but it will hardly be as nice as it sounds.  If you have no debt and continue receiving income, deflation is not too bad, however that is not what will happen to most people.  Society in aggreate will see a decline in wages larger than the decline in prices (very bad) due to so many people losing their jobs, or they will be heavily in debt (even worse).  Either way it is a serious decline in standard of living.

timeandtide wrote:

Anyone who is indebted will take a haircut. Holding debt in a deflation is not a good idea because the purchasing power of the unit of currency can gain faster than the debt can be paid off. It is a good question as to who will take the haircut when it comes to very large amounts of debt - will it be the borrower or the lender? Most likely both - I certainly realise that it will be very messy for the largest financial institutions (who outside of nation states are the largest borrowers and debtors) when they start turning on each other.

I don't understand why you think that a deflation will result in the banks taking everything. The banks will be the biggest losers of all. No doubt job losses will be greater but the system will not come to a halt - it did not do so in the great depression. Life goes on, people will help each other, food and other necessities may be bartered for a while but people will organise themselves. The major financial institutions will be decimated, assets will go from weak hands to strong hands. The strong hands are not those which have been bailed out by the government. They may appear strong now but there are still billions, if not trillions of worthless assets festering on the balance sheets of the largest institutions including the Fed.

You are correct that in a fair system, deflation would not result in the banks owning everything.  They should face insolvency because of the massive hit to their balance sheets due to haircuts on their loan portfolios value, but that is often not the case.  For examples see the current exetend and pretend bank recapitalization or the historical ability in the old gold standard days, for banks to suspend specie payments during a bank run while continuing to require loan payments.  In tough times, banks usually don't seem to have to play by the rules.  Actually they often seem to make their own rules.

timeandtide wrote:

It is assumed that all interest rates will rise. I doubt that Treasuries will rise by much but the spread between high quality (T-bills/notes/bonds) and corporate/municipal debt will widen dramatically again as it did in 2008.

As the deflation takes hold and credit creation slumps so will the nominal value of most assets. The real value of assets - that is the utility offered by a roof over one's head (which means the utility of all those commodities that go towards providing our shelter and the energy for heat and transport) will remain but relativities may change. For example, the relative value of food to shelter may increase. A century ago we spent 75% of income on food and 25% on shelter - the reverse of today's expenditure. That may even up. The nominal value of assets will decrease which implies that the purchasing power of the unit of currency will become greater as there are less units of currency in existence (because of the deflation).

The consequences are certainly going to be rough on everyone. Do you really expect that we can escape the profligacy of the last 3 decades without consequences? The consequences of the present course that the Fed/ US giovernment/ Wall St has taken will be far worse for everyone because the bill is being passed on to the "people" and those who have not even been born yet. An economy cannot grow on money plucked from thin air. It requires willing workers, resources, low debt levels, low taxes (in the long run), fair property laws and a system that encourages saving by paying a reasonable interest rate for that deferrred expenditure. None of these conditions are being met. The notion that America can inflate it's way out of debt is laughable. America has been inflating since Bretton Woods and look at the pickle it is in now. Does anyone really believe that one country could have a defence budget that is the equal of the next 8 or 9 largest country defence budgets if it had not been having a subsidy from the rest of the world simply because it could print the reserve currency in which all commodities are paid? America has had an enormous advantage for 60 years. I accept that it has not all been one way - the Marshall plan, kick starting Japan and being the world's policeman for much of that time has a cost but the advantages have outweighed the costs by a huge margin. The game is coming to an end. The sooner the "people" wake up to this inconvenient fact, the quicker America can re-invent itself into an idea that both works and is sustainable.

I really can't decide which way this thing is going to go. 

I think those that believe hyperinflation is certain or immenent are making a big assumption that the government/FED will always have the political cover to continue to print.  I can easily imagine millions of unemployed / under-employed joining protests if their costs start to spiral away from their incomes.  It seems to me that there are far too many voices on the internet and radio that are pointing at the government / FED as the creators of this problem for them to be able to silently enrich their Wall St cronies and defense contractors via endless money creation, without serious political consequences.

The one thing that bothers me about deflation is, what about all the USD's outside of the US in soverign wealth funds and foreign central banks?  If the owners of this money feel it it could be defaulted on, could a quick repatriation to buy everything that is not nailed down, of just the money that has already been created, cause hyperinflation?  If this is the case, it does not matter if the government / FED creates any additional money because it is already out of our hands.

It seems to me that both deflationist and hyperinflationists largely agree on the problem and what will be the end result.  They both agree that we have a debt problem and both foresee a major decline in the standard of living for most people.  They only differ on the mechanics of how it will happen.

doorwarrior's picture
doorwarrior
Status: Silver Member (Offline)
Joined: Oct 13 2009
Posts: 166
Gold IS money

timeandtide

Gold has been used as a medium of exchange for just about all of recorded history.

 http://en.wikipedia.org/wiki/Money   I would add that it needs to be divisible. You could also rewatch chapter 6 of the Crash Course.

Rice, a share cert or a title doesn't fit any of the critera for money. For that matter niether does the dollar any more because it is no longer a store of value. With negative real interest rates being the norm with most fiat currencies these days how can any of them be considered money? 

Before you say that anyone "saving" has a stake in the financial markets you have to define how a person is saving.  I, for instance, have NOTHING invested in any type of savings or retirement account that is part of the system. I do have many other types of investments that are as far from the system as possible and I consider this for my retirement and to pass down to my children. As Dr. Martenson has said many times it is "things" we should be investing in.

The reason they are not hammering down the doors of congress can be found in a recent article by USA Today

 http://www.usatoday.com/money/economy/income/2010-05-24-income-shifts-from-private-sector_N.htm

Another reason is because of what  people have been taught in public schools. They are taught to be sheep. To get along and not to think for themselves. The gov. will take care of you don't worry. People are not taught how the world really works or how the monetary system works. They are fed a bunch of BS from the MSM and they believe it.

The reason banks will get everything in a defaltionary event is because they hold the notes on all of the debts. Collateral will be taken when a person cannot make the payment because they lost their job. Bank losses will be covered by the FED as they have been since this all started back in 2007. It will be a simple matter to make BK impossible and TPTB will just take everything else that is of value to settle any typeof debt. The will manipulate the law in whatever way they see fit, just as they have done recently( although this is not new it is just more pronounced lately).

As for your last paragraph I agree completely. There will be  consequences of the most drastic sort. Food and energy prices will skyrocket. Wages will not even begin to keep up with inflation (created by the FED to bail out an insolvent Gov.and financial system) People will starve, lose their jobs, crime will increase exponentailly, and civil unrest will spill into the streets nation wide as people start banging on congress's door. But it will be to late, its too late now.

I agree with much of what you have said however I come to very different conclussions.

 

Rich

doorwarrior's picture
doorwarrior
Status: Silver Member (Offline)
Joined: Oct 13 2009
Posts: 166
the directon doesn't matter

Goess 211

It seems to me that both deflationist and hyperinflationists largely agree on the problem and what will be the end result.  They both agree that we have a debt problem and both foresee a major decline in the standard of living for most people.  They only differ on the mechanics of how it will happen.

To me this is the essential point. There is no way to save our standard of living as it is today. Whichever path we go down the system, as it is today, is done. We can only hope to make ourselves more resilient and prepare for that future.

Rich

timeandtide's picture
timeandtide
Status: Bronze Member (Offline)
Joined: Apr 3 2010
Posts: 67
deflation or inflation

I really cannot answer your questions - I do not know which way it will go but I do think that deflation will be the marginally better outcome because Ibelieve that deflation is the more honest way to go.  I am in my mid 50s and in my life I have seen more or less constant inflation. Not only does it destroy savings, which I believe are the only honest way to build capital for investment, provide jobs and improve people's lives, but it makes it very hard to know what the real value of anything is. The incentive in an inflationary environment is to borrow for all you are worth and spend madly at the same time. It has encouraged rampant consumerism and a loss of the values that I was brought up to believei in. Such things as thrift, prudence, taking care of possessions, building things to last, valuing people over things and so on. The problem with excessive borrowing is that it requires excesssive growth to pay the interest on the loaned money which was created out of thin air in the first place. It is a vicious circle which requires endless growth. As Jeremy Grantham pointed out in a recent newsletter ( http://www.gmo.com/websitecontent/JGLetterALL_1Q11.pdf ) we probably aspire to a regular growth rate of 4.5% which is just not sustainable. As an example he points out that if the ancient Egyptians had started with a cubic metre of possessions, how many cubic metres of possessions would they have had at the end of the dynasty some 3000 years later? The answer is impossibly high - about 10 to the power 57 cubic metres. It would not even fit into a billion of our solar systems. Natural systems barely grow beyond maintenance except when there is a catastrophe and growth is remarkably fast until the "gap" is filled again. A truly sustainable rate would be way less than 1%. 

Unless we stop the madness, we are leaving appalling problems for the next 2 or 3 generations. We have enough already without adding another 2-4 billion people. I think that Malthus will be proven correct and at some point this century we will be visited by the four horsemen again. For these reasons I feel far more comfortable with deflation as being an agent of reality than with the fictional wealth of inflation.

timeandtide's picture
timeandtide
Status: Bronze Member (Offline)
Joined: Apr 3 2010
Posts: 67
The Four Horsemen

I have to remain optimistic to remain sane. I do not dispute that gold is a store of wealth but when things break down I would find more value in a sack of rice or a gallon of petrol to run my water-pump. I agree with you that gold has been both money and a store of wealth through history but I am also reminded of the story of Mithras. I think there are more useful things than gold which would be of more value in a time of strife/shortage/ civil unrest etc. By the same token, the banks could foreclose on every home or business that gets into arrears but they then have a problem of looking after these "assets" which are diminishing both physically and in value. Who will they rent them to if the former occupiers/owners have lost their jobs? The banks are actually in just as much strife because they are basically broke with huge ongoing liabilities. People on the other hand can walk away but the banks would be better off with people occupying their (the banks) homes.

The idea that the banks will get everything may be true but those banks are mostly beholden to foreigners who cannot take the assets away from the US, the UK, Ireland, Spain, Portugal, Greece etc because the collateral is mostly residential real estate. The buildings, if unoccupied are deteriorating, and the land is immobile. I have no idea who the ultimate creditors will be but it does not make sense to me that we will return to some sort of feudal system run by the banks.

America still has a great constitution and there are 300 million of "we the people".  I do not think people are taught to be sheep but I do think most people look for leadership which is clearly lacking right now but I believe it will come. 

If not the Four Horsemen surely will.

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