Tuesday, October 22, 2019

Inflation Or Deflation, Which Defines The Road Ahead?

The central banks claim the lack of inflation is the key force driving their QE policy and permitting it to continue. This is central to their ability to stimulate. The moment inflation begins to take root much of their flexibility will be lost. Today those who see inflation in our future are back on their heels and off-balance. Many people see falling commodity or stock market problems as proof deflation is at our doorstep, however, it could be argued that QE has produced a state of oversupply.  These people see the low commodity prices as proof prices won't soar as a result of the creation of massive amounts of newly printed money. A word of caution, we should not be deceived or led to believe that lower oil and commodity prices will in themselves bring about deflation. Often falling prices in both commodities and goods reflect a lack of demand or temporary supply imbalance that will correct itself. When that happens prices tend to rapidly adjust to reflect the "new reality of the day."

Panic Buying Equals Increased Demand!
A keyword in the prior sentence is "rapidly",  I recall a piece I wrote years ago titled, "Surprising Facts About Inflation" that detailed the inflation that hit Germany during the 1920s, close examination shows the worst of the inflation hit took root over a very short period.  If a similar scenario were to unfold today it would be prudent to factor in the idea it would happen much faster now that we live in an age of instant communication.

In the past, I have put forth the idea that inflation could rule the day even if central banks are unable to keep the wheels on the bus and the economy collapses. This theory also known as stagflation is partially based on or dependent, on which way the dominoes fall. By this, I mean which debt goes bad first or is allowed to go bad. This theory also extends into how quickly debt spoils. In a comment, a reader several months ago wrote,  It is fairly obvious that not all IOUs are deemed as trustworthy, and as trust drains from this over-indebted system, shakiest issuers' debt will lose value fastest. Junk debt is thus a Hindenburg in search of a spark all its own. Wait until corporations discover how difficult it may be to roll over all this share-buyback debt of the last few years.

A key factor in the inflation-deflation debate is that not all debt is created equal. While a parent often absolves a loan to their child the bank seldom forgives a loan on an automobile. Sometimes like in the reality game show Survivor it comes down to who is left standing. I contend winning does not always come down to who is the best, strongest, or smartest, but that luck and many other factors also come into play in how things unfold. For example, imagine two widget factories on the hill outside of town and both with the same pricing and quality product but financially weak, if a storm knocks out production at one factory resulting in its closing the other would benefit from inheriting its customers and maybe even able to raise prices.

click to enlarge
At some point, this again comes down to the idea of old fashion supply and demand. Pricing tends to revolve around the supply of money just as much as it does to the supply of the commodity it is being used to purchase. This is why we should question the formulas used to compute inflation. The 2% inflation target central banks have deemed optimum or to be the point at which inflation will produce the most favorable and best possible economic result is not grounded in reality. It is also not related to the prosperity of Main Street. Instead, it is all a convenient cover allowing for the transfer of massive power to the world’s central bankers during the last two decades.

When it comes to assessing real-world inflation that is having a direct impact on consumers, the Fed is conspicuously absent from the conversation. The purpose of the consumer price index (CPI) is to reflect just how much inflation is eating into both our incomes and our savings but the numbers are political and do not reflect true inflation. This so-called 2% target only survives because it serves the interest of the Wall Street elite, the world’s politicians, and fiscal authorities alike. It has allowed those in power to run up endless public debt because the central bankers buy it under QE and drive the cost of carrying debt to virtually nothing. As a bonus, the top 1% of the financial elite cannot get enough of the 2% inflation hoax because it means free carry trade money will remain available.

Time and time again we have heard central bankers ticked off a litany of reasons why prolonged weak inflation, or sustained falls in prices known as deflation, worries them. This is done to justify the massive stimulus they have put forth. They note how falling prices may cause consumers to put off purchases if they expect that trend to continue. As further justification central bankers indicate that official consumer price measures may even overstate the extent of inflation. It is clear central bankers want to persuade households and financial markets that, whatever it's current reading, the inflation rate will be around their target and that inflation expectations are under control. Mario Draghi, President of the European Central Bank has even warned of a possible “de-anchoring” of expectations if the inflation rate remains low for a long time, and particularly if oil prices fall further. “These risks have gone up and we want to be vigilant,” he said.

click to enlarge
Venture too far down a path that does not reflect honest price discovery or real value is dangerous. When the gap gets too wide an adjustment always takes place. Today people have developed a "false" belief in financial security and the idea of "controlled" inflation. For years inflation has been used as both a political and economic tool. When people look at how much more they are earning now than in the past they acquire the perception that if they go into debt it will be easier to pay it off with inflated income. For decades people have been given pay raises to keep up with inflation meaning the vast majority of pay raises have nothing to do with either a person's work or performance. While an increase in salary tends to make a worker feel better and that they are worth more many raises are simply given to reflect an escalating cost of living.

My favorite definition or rule about inflation, its effect on the economy, and how it impacts savings goes like this, "Inflation is a thief that robs those who are improperly invested, and gives the money to those properly invested."  This would, of course, be referring to those who had the foresight to position their investments for its emergence. The same can be said about deflation, it mimics in reverse the process, also acting as a way to transfer wealth between parties. The problem is to timing and identifying the approach of these two strong economic forces. I have found the mindset of investors and of the "money people" often shifts into overdrive when opportunities for speculation arise. The distortion caused by easy money from Federal Reserve policy coupled with political and social compassion for affordable housing, medical care, has obvious implications as debt and promises continue to rise.

Most economists agree the Central Banks are not in a position to tighten the money supply at this time because such a move would have a devastating effect on markets, this would filter down into pension funds and retirement schemes. Remember, so many of the things we invest in are merely promises and such, hard assets are rare. A word of caution, while hyperinflation does not occur that often when it hits the speed at which it can occur surprises and it is clearly a game-changer. I continue to contend the primary reason that inflation has not raised its ugly head or become a major economic issue is because we are pouring such a large percentage of wealth into intangible products or goods. This includes currencies, equities, and all forms of paper promises. If faith drops in these intangible "promises" which have become the foundation of our financial system money would suddenly flow into tangible goods seeking a safe haven. This would cause inflation to soar.


  1. Thanks for your insight and explanation, i thought i had a hole in my pocket.

  2. For you statement
    "Inflation is a thief that robs those who are improperly invested, and gives the money to those improperly invested."
    did you mean to say
    "Inflation is a thief that robs those who are improperly invested, and gives the money to those properly invested." instead?

  3. History rhymes but does not repeat. I think there will be consequences of the monetary insanity, which will culminate in a currency crisis. That doesn't mean the dollar must fail, just there will be consequences. But the inflation you insinuate I am having a hard time understanding. Housing prices rise crazy? People demand wage increases and strike? Energy prices go up? (solar costs?), USA based food prices soar (Adopting hydroponics, genetic advantages, etc).? I just dont see it. I do see a possible rebalancing of currency values and that causes price spikes between nations, which will raise price of imported goods. (think TV's, iPhones, etc)

    But that will depend on the counterparty being 'better than USA'. Does anyone think China has less of an economic disaster with their decaded of malinvestment?

    USA is still the better options around absolutely insane options. Until that changes, I can't see material inflation. I welcome having a chat over this :) (add gmail.com to my name for email)

  4. CENTRAL banks have printed 20T.....what if that number was 40T....would you expect reflation then?