Deflation? I think not!

A Look At Our Future!

Deflation? I think not! For a while I was one of the people concerned we would see the world tumble into a massive deflationary cycle as debts went unpaid and credit collapsed. It appears the central banks of the world have made the crux of their existence a balancing act between the forces of inflation and deflation. With the poor results they have had at creating economic growth through QE do not be surprised if any new round of easing to combat future slowdowns is even less successful at getting economies moving forward.

The magic of QE and ever lower interest rates is losing its luster as the money finds its way into the pockets of the bankers and the rich or quickly flows into distorted stock markets and other intangible asserts. The more and more I study derivatives it now appears the main goal of QE may have been to hold up the underlying value of assets that feed into and support the massive derivative market more than help the economy.  In other words, the entire economic policy of the United States has been dedicated to saving four banks that are too big to fail. Yes, the main purpose of QE is to keep the up prices to support the debt on which big banks have loaned money.  The staggering size of the derivative market is beyond science fiction or anything that we can comprehend.

QE has up to now stopped an implosion of derivatives and the resulting contagion and shock that would have spread throughout the financial system. One of the main reasons the stock market has benefited so easily from all this money is that it is highly liquid and both easy to enter and exit. This is a big advantage in uncertain times when valuations can change rather quickly. Unlike real estate that has a high bar of entry with many fees and often taking months or even years to sell, stocks can be exited in a blink of an eye. The wild card in where our economy will take us is inflation. Currently velocity (the speed at which money flows through the economy) is very low but many people think if it rapidly increases "more money" will be chasing the same amount of  goods resulting in more inflation.

Other factors are also driving today's current short-term investment insanity. Many Americans with savings have taken on a much higher degree of risk in search of yield. People have grown complacent after years of being told it is safe to again invest in the markets. They have loaned their hard earned savings out to corporations by buying bonds and this in turn has allowed companies to lower borrowing cost and shift the savings to their bottom-line. This constitutes a onetime increase in profits that we are unlikely to see ever again. All the cheap money has also created a binge of stock buybacks by companies that choose to please shareholders by raising their share prices rather than investing in an economy where demand remains weak.  

The danger is that once inflation takes root it can take on a life of its own and feed on itself creating a hard to control "positive feedback cycle." How the central banks can get out of the corner they have painted themselves into and if it can be done in a safe manner is yet to be determined. One thing is clear, we cannot remain on this artificial growth path forever. We have seen much of the effect wear off from prior bouts of easing, in the past each wave acted as a tailwind pushing us towards recovery. Now as central banks begin to taper and resume more normal policies many economist fear that efforts to return to normal interest rates and policies will become a major drag on the economy going forward.

I ask you to consider the possibility that what we have been going through the last six years was the "deflationary period" that many of us were looking for and expecting. This would mean the "major deflationary period" is mostly behind us and it has not been disinflation as much as inflation being kept in check because of several factors, including where the money flowed, weak demand, dropping velocity of money, and the onetime benefit of lower interest rates. As we edge towards the edge and total economic collapse expect central bankers to print even more paper money. I think they will print enough to "literally  cushion our fall" and in doing so the reality of hyperinflation will be completely unleashed.

Before you discount the possibility that we will move directly from where we are into stagflation then hyperinflation please consider that hyperinflation paves the way for governments and those in power to make a transition to a replacement currency and a reset of the whole system. When a system becomes too difficult to repair people tend to look for the promise of an easy and fast fix. The one thing we can count on is that things seldom progress as expected. Sadly, knowing the quality of those guiding our economy and ship of state we must wonder if this was their intention all along or merely an  accident they failed to see coming from the incestuous ivory towers in which they live.


  Footnote; Please feel free to explore the blog archives and as always you comments are encouraged. This article ties together several post I have made over the last few months. The article below makes a case for inflation and predicts it will bring about economic chaos.
http://brucewilds.blogspot.com/2014/04/inflation-seed-of-economic-chaos.html