A Probabilistic Assessment of Short-Term Inflation or Deflation

3 posts / 0 new
Last post
ashvinp's picture
Status: Gold Member (Offline)
Joined: Jan 20 2010
Posts: 412
A Probabilistic Assessment of Short-Term Inflation or Deflation

The following is my "2 cents" on the controversial inflation/deflation debate in the blogosphere. I attempt to use what I see as the most influential factors (what power elites prefer and what the administration/fed can accomplish) to broadly sketch some probabilities for mild inflation, hyperinflation, mild deflation and severe deflation. Here is the first section:


      The blogosphere has been rife with debates over whether the U.S. economy will experience inflation or deflation over the next year or two. Typically, those on either side of the debate believe that, regardless of the specific outcome, it will be severe and destructive, but there are some who believe it will be a milder process. It has also become clear that those on either side of the debate are almost certain that we will experience the outcome they advocate. I am of the view that the best we can do in our complex financial economy (which is highly inter-connected to the global economy) is discuss the broad factors that make one or the other more likely to occur. It appears to me that there are at least three critical questions which should be answered to determine probabilities of outcomes in the controversial inflation/deflation debate:

1.      What do the financial elites want to happen given the current economic circumstances?

2.      Will the Administration (includes Congress for this discussion) and/or Federal Reserve attempt to pursue policies that accommodate the elites' preferences?

3.      If the answer is "yes" to #2, can the Administration and/or Fed be successful in achieving these goals?

      After considering how much wealth is controlled by the elites (top 1% holds 43% of financial wealth) [1], and therefore how much political influence they exert, we can assume the answer to #2 will almost always be "yes". This answer is further reinforced by past political experience and a bit of common sense. That leaves us with #1 and #3, which are difficult questions to answer with high levels of certainty. However, many insightful analysts have attempted to answer these questions using facts, data, trends and experience, and have produced very plausible predictions.

First, I must note that the following discussion will be based on several different assumptions for the sake of simplicity. Instead of mentioning them within the discussion, I will just list them up front and let the readers decide whether they are reasonable or not:

         · The financial elites do not want severe deflation or hyperinflation, since these outcomes would wipe out the value of their numerous   debt assets or wipe out the value of all their dollar-denominated holdings respectively. 

         · The Administration/Fed will almost always attempt to pursue the policies that the elites want them to (95% of the time for inflation; 90% for deflation).

         · The financial elites cannot unilaterally (without Administration/Fed) make decisions that will affect the probabilities of inflation or deflation (we will assume they will make self-interested lending decisions).

         · The Administration/Fed’s attempts to inflate, if they choose that option, will not be significantly counter-acted by currency devaluations of  other countries. They may have a temporary effect, but financial/militaristic incentives to work with the American power elites and threats of protectionism will balance this dynamic out.

         ·Hyperinflation will only occur when financial elites prefer inflation, and severe deflation will only occur when elites prefer deflation.
·         Issues associated with peak oil/resources will not be a factor within the next few years.

The following definitions of inflation and deflation, borrowed from The Automatic Earth, will be used [1]:

Inflation - Marginal increases in the amount and velocity of credit money relative to goods/services.

  • Deflation - Marginal decreases in the amount and velocity of credit money relative to goods/services.

If anyone thinks the above assumptions are very unrealistic, I'd love to hear about that and how it could be modified, thanks.

Full piece - http://peakcomplexity.blogspot.com/2010/11/probabilistic-assessment-of-short-term.html

Ayala's picture
Status: Member (Offline)
Joined: Feb 24 2010
Posts: 23
Re: A Probabilistic Assessment of Short-Term Inflation or ...

There is another huge factor: what is *possible* given the current environment. In other words, the "elites" may prefer stability and growth, but that may not be possible given the huge amounts of debt, peak oil, etc. Here's the short version of the issue:

1. We have ungodly amounts of debt and a deficit that's expected to continue in the trillion dollar/year range for the foreseeable future. The only way that deficit is going to be reduced is if spending is cut AND if the economy and thus tax revenues grow significantly.

1a. Our ability to grow significantly over the next 10-20 years is limited by peak oil.

1b. Our ability to significantly cut spending is limited by the electorate and those representing them. Good luck to whoever tries to cut Social Security, Medicaid, etc. 

1c. So, it is a fair assumption that our deficits will indeed exceed $1 trillion per year. It's worth noting that these are Obama's numbers and built into those already disastrous levels is the assumption that the economy grows faster than 5% a year. That's exceptionally optimistic; my guess is that our deficits will be even higher.

2. With spending running out of control and deficits running over $1 trillion/year, there are only a couple ways of financing that debt:

2a. We could depend on China, our largest creditor to suck up all that debt. China currently holds around $840 billion of US debt which has been accumulated over many years. There is NO WAY they or any other country is going to be able to absorb $1 trillion/year. It ain't gonna happen.

2b. We could depend on the rest of the market to buy our debt. The fact is, there just aren't enough other buyers out there to absorb that much debt at current rates. Would you buy the US' long term debt? Me neither. In order to entice that kind of investment, interest rates would have to go WAY up. Interest rates cannot go way up, because our government couldn't afford it. If interest rates on our debt were to climb by 10%/year, that would cost us an extra $1.3 trillion or so per year in additional interest payments - which would have to be borrowed as well. We have so much debt, we'll go bankrupt if rates go up significantly. Rising rates would also tank the economy.

2c. The Fed monetizes our debt. In other words, they buy the debt with newly "printed" dollars. This is the only realistic option. It is, unfortunately, also highly inflationary.

3. Or we could default on our obligations and/or debt. This is highly unlikely and politically a last option.

Regardless of what the elite want, they are constrained by the above options. And when you have so much debt, your resiliency goes way down. Even if the bankers, the Fed, and our government want one thing, the market can move against them and surprisingly quickly. As soon as the market wakes up to the fact that we are going to be forced to keep interest rates down, the Fed monetizing our debt, and inflation spiraling out of control, there is going to be a rush for the exits in the bond market. You could have a "flash crash" of epic proportions and nobody is going to be able to do anything about it except monetize even more debt in a vicious cycle. Banks and other companies will quickly become insolvent and the whole system breaks. This could literally happen overnight.

I sincerely wish that the situation was good enough that there were "elites" who could steer the ship out of these troubled waters. Unfortunately, the only options which can realistically be implemented is to continue inflating the system and kicking the can down the road until... The Crash. 

I hope the above adds to the discussion, Ashvinp.

ashvinp's picture
Status: Gold Member (Offline)
Joined: Jan 20 2010
Posts: 412
Re: A Probabilistic Assessment of Short-Term Inflation or ...
Ayala wrote:

There is another huge factor: what is *possible* given the current environment. In other words, the "elites" may prefer stability and growth, but that may not be possible given the huge amounts of debt, peak oil, etc.

This is what question #3 focuses on in my discussion - what can the government and/or Fed accomplish politically AND economically. As stated in my list of assumptions, however, I do not factor in issues dealing with peak oil/resources. I think it's somewhat reasonable to assume those won't influence the outcomes much in the next year or two, but I could be wrong about that.

For anyone that reads the full piece, I apologize for the format. I'm having trouble with blogspot and am not sure how to fix the the alignment of text.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Login or Register to post comments