Skip to comments.Deflation Has Arrived
Posted on 01/29/2004 8:25:43 PM PST by Beck_isright
"The deflationary potential is historically large... we risk overwhelming deflation in every corner of the globe." - Conquer the Crash (2002)"
Virtually everyone - and I do not use that word lightly - believes that inflation will accelerate. Stock-market bulls think that the economy is going to boom, bringing inflation. Economic bears expect an inflationary, if not hyperinflationary, monetary crisis. Economists believe that the Fed can inflate at will and is committed to an inflationary policy. The general population is convinced that prices of their homes and property can only go up. The few articles mentioning deflation in recent months have declared the prospect for it "dead."
This consensus is not merely overwhelming but reflects a belief as vast and deeply held as a religion. Investment News in September reported a survey by the National Association for Business Economics in Washington. It revealed, "None of the respondents to the May survey, all of whom were responsible for making macroeconomic predictions, predicted a decline in the consumer price index during the next two years." USA Today confirmed the fact, reporting, "Not one economist [of 67 surveyed] said it was 'very likely' the economy would slip into deflation." That is a consensus!
Against this backdrop of opinion, M3 since September has fallen over two percent, its largest decline in 60 years. This is different from a lack of inflation. It is real, actual, deflation. What's more, M3 has declined despite the strongest quarter of economic growth in decades, the lowest interest rates in half a century and a central bank committed verbally and by action to facilitating the expansion of credit! There is no interest rate spike or recession to explain away the decline in the money supply.
The dichotomy between what is happening and what people think will happen is colossal. Inflation is dead. Deflation is here, now. The monetary trend is no longer close to the edge of the cliff; it is beginning to slide down its face. As this is written, not a single major newspaper, magazine or TV network has done a story on the dramatic contraction in M3. People are so drunk with inflationary certainty that they can't even see that deflation is happening. And if they do, they don't believe that it is meaningful.
Why is there such a consensus that deflation is unlikely, if not impossible? Many people believe that the Fed is virtually omnipotent and can manipulate the money supply (and therefore the stock market and the economy) at will. Is that so? On June 25, 2003, the Fed lowered the federal funds rate for the 13th time in a row, to one percent.
Most observers think that the Fed still has that one percentage point of "ammo" left. But consider: The U.S. has a thriving money-market fund industry, which costs one percent of assets per year to administer. As it stands now, investors are getting extremely low returns from money- market funds. If the Fed were to let its funds rate drop to zero and other short-term rates fell along with it, money- market investors' return after fees could go negative. This event would make holding cash more attractive than holding debt, a situation the Fed surely wants to avoid. The monetary system appears to have reached the point at which pesky reactionary forces will come into play if the Fed tries any more "deflation fighting," no matter what the mechanism.
Why did I put the term "deflation fighting" in quotes? Commentators tell us that the Fed is fighting deflation by aggressively lowering its interest rates, but is that an accurate assessment? After all, the result of deflation - its primary outward symptom - is lower prices. And what has the Fed been doing? It spent over a year lowering the price of renting money. Within that period, in fact, the Fed lowered prices more than anyone! It has participated in the initial phase of the deflationary process as if it were a merchant on the street discounting its wares to a disinterested public. It did so in response to slack demand for its product - credit - just as the auto manufacturers and others are doing with their products. Deflationary psychology brings about lower prices, and the Fed has been lowering its prices. It is powerless to stop the trend.
A persistent decline in the money supply will have consequences. Some things will have to give. One of them will be prices for goods and services. To the astute observer, a change in prices has been in the wind for some time. The PPI has been flat for three years, and now even the CPI has had a down quarter. A severe deflation will also devastate the economy, as it has done in each of the rare times it has occurred over the past 300 years. With M3 dropping, it should be only a matter of months before the economy follows suit.
Are economists concerned? Well, besides the deflation opinion cited above from last year's polls, the only other time that I have ever seen a 100-percent consensus in a survey was... a few weeks ago! In separate year-end surveys of economists, The Wall Street Journal and Business Week independently reported unanimity that the U.S. economy would expand throughout 2004. That's right: not one dissenter. If it is usually wise to bet against a large majority in finance, what does it mean when there is no detectable minority?
I think that the continual denials that deflation can happen, against a backdrop of evidence to the contrary, appear to be part of a typical social psychological progression toward a credit crisis, which in turn will lead to economic contraction. The money supply might rebound for a quarter or two as the stock market and economy top out this year, but at the largest degree of trend, the credit bubble - 70 years in the making - has burst.
In 2001, there was little talk of deflation. Statistics relating to newspaper stories show that by late 2002/early 2003, it had become a commonly used word, even if most writers used it simply to dismiss the idea.
The next word that should begin to slide into the public lexicon is depression. I would like to offer quotes from authorities on the low likelihood of depression, but my diligent staff can find literally no mainstream economists, academics or Wall Street strategists even discussing the possibility. It is too remote even to mention! The term " depression" is where the word "deflation" was a few years ago, i.e., outside the general consciousness. Although no one is using that term now, in coming years it will be everywhere. The first phase will be widespread insistence that a depression can't happen, which will be a big clue that it is happening.
The two "d" words at the end of the subtitle to Conquer the Crash, i.e., "Deflationary Depression," were anticipatory. The book was published at a time when the likelihood of these two events occurring was (and still is) considered - as one economist said at the time about deflation - as remote as "being eaten by piranhas." My advice: Keep your toes on the riverbank.
Inflation -- practical, real live, what one pays for goods inflation, higher and higher, is here right this second. And the general cause (there are exceptions) is the USD's gross near-collapse over the past two years.
Of the goods priced internationally in USD, every single one of them has risen in price, on a currency-adjusted basis. Even coffee, which is in general oversupply worldwide, and has been since 2000.
Roll up a fat one, Beck -- might as well, you haven't a clue otherwise (AND, I'm entirely willing to present very hard price data to demonstrate this point, at your convenience).
Never trade mkts if your trading ideas are based on your politico-economic views. Seek the (always available) statistical advantage, instead.
Feel completely free to disregard or denigrate this particular view here. I can use the money (g!).
Don't worry, it happens to most men one time or another, and it's not permanent. It is suggested that if deflation continues, go see a doctor.
The timing of Robert Prechter's article, theorizing that the Fed is trying to inflate but can't do it because there's no room left for it to cut interest rates, has to be rather embarrassing to him. On the same day, the Federal Reserve issued hints that it will soon raise interest rates.
If the government didn't inflate the money supply in the first place, deflation would be a normal and highly desirable economic condition. When productivity improves, and more and better products and services are made available, competition will naturally drive down prices. That's what we've seen for years with computers and DVD players and cell phones and all kinds of other high-tech products. Quality and capabilities go up while prices plummet, and everyone benefits.
I love deflation.
Deflation is sitting just below the surface and has been. It has only been kept at bay by the FED's and government's ability to massively expand debt. There are limits and I think that we are getting close to them. Without debt expansion, the deflatinary monster is going to eat us and everything in sight. More helicopter money from the government coming soon. After that, turn off the lights cause the party is over.
You fool! You blew my cover!
Not this again. This is like the Art Bell show. After the world didn't end in 1999, he moved up the date to 2012.
All those people predicting a crash in 2005-06 were also predicting that big crash in 2003 (Bill Gross, Fleckenstein, Sornette etc...). It didn't happen, so they keep predicting, but they extend the date little by little.
Prechter's recent accuracy has been what? Not too good.
M3 is lower because people are moving money into stocks out of money markets. How can you tell? Stocks are going up. This article fails as any reasonable sort of analysis that a busniessman, economist or trader would come up with. It is pure guru style hype.
Deflation,the opposite of inflation, is easily cured. Just do what causes inflation, print money. The Fed prints it and buys Treasury Bonds from the banks with it. The banks have to loan it out, it does them no good to leave it in the vault. They lower rates, consumers borrow and spend.
I think it's too early to ring the bell on this. There are relatively liquid financial assets out there that do not get counted in M3. If money that had been parked in a bank savings account ventures back out into the stock market, that's going to look like a decline in M3.
We do see that happening. Stock prices bottomed out last Spring, and by Fall even the doubters were starting to get antsy that they were missing out on a good thing my keeping their money "safe" in a low-yield savings account.
With a stock market turnaround, it's reasonable to expect some months of this kind of flow, from the "safety" of bank accounts toward a stock market that looks like it's going to go up for a while.
There is another phenomenon at work here that also fuzzes things up. The "money supply" isn't just a function of the quantity of money, it is also a function of its velocity, i.e. how often it is changing hands. That is something that will rise as an economy leaves a slow period and heads into an expansion, which it is doing now. There can therefore be some amount of contraction in the quantity of money during such a period without causing deflation.
If this is still happening after the "scared money" is done leaving the banks for the newly-revived stock market, then there is certainly cause for concern. I think it's too early to say that, though.
By the way, if a year from now we can definitely say that deflation is dead and that this guy was wrong, all the people who are constantly telling us how bad Alan Greenspan is, have to bow down and genuflect to the man for the second time in five years. This author is absolutely right to be worrying about deflation, and to suspect that we may have already drifted inside the event horizon and that it's too late to get out. Sane people should be worrying about that. But we don't know for sure yet that we haven't escaped. If we did, it was close. And if we did, Alan gets another trophy.
I know people don't like the guy, but he's damned good at what he does.
It seems to me that the Fed has been very cautious and consistent in indicating the type of monetary policy it is following. When it hints that it will soon cut or raise interest rates, it then does so.
Greenspan is extremely cognizant of the fact that markets like predictability and don't like surprises. So he tries to say little and move slowly. As a result, the markets believe the hints that emerge, and are able to digest them in manageable bites.
Yesterday's hint, in which the Fed stopped saying that it would keep interest rates low "for a considerable period", was properly interpreted by the markets as meaning that the Fed would slowly boost rates within several months. I fully expect the Fed to follow through on that. It is the traditional response to the rapid economic growth we are starting to experience.
|If the government didn't inflate the money supply in the first place, deflation would be a normal and highly desirable economic condition.
Let's debate this. You have your position there, and I will take the position that chronic deflation is an absolutely horrible idea that would produce tremendous human misery in the form of continuously low economic growth leading to chronic high unemployment; a rigid caste system with very little upward social mobility; and a bass-ackwards allocation of resources away from the generation that is raising the society's children, toward the generation that is nearest to leaving for its heavenly reward.... basically the social and economic conditions we would associate with a feudal society of 400 years ago.
You can go first. Tell us why, and by what mechanism, "deflation would be a normal and highly desirable economic condition."
That little change in wording was for the benefit of Japan and Germany who are both making noise about no longer supporting our ponzi scheme. No way No how do we get an interest rate increase this year. The economic recovery is debt induced smoke and mirrors for political purposes.
What do either of those things have to do with how much faster I can spend money online with a credit card today than I could twenty years ago by going to a dpeartment store with cash or mail ordering something from Sears before Fed Ex flew its first flight?
The velocity of money is a critical economic measurement, but no one really knows how to do it very well yet.
How do we tell how much faster money is going from consumer to supplier to employee and back again in today's fast-paced techno-world?
It's not a trivial question.
Yeah, when it comes to trends, Prechter has me beat. What wave are we on now?
Good Evening, Southack.
What do you propose as an alternative?
The velocity of money is a critical economic measurement, but no one really knows how to do it very well yet.It's not a trivial question.
Sir Prints-a-lot has already admitted difficulty in measuring and defining *money* itself. I scarely expect he will be able to measure the speed of something he can not define.
Macro or micro? On a personal level, if you are owed money and have savings in cash and don't rely upon consumers at any level, then deflation makes all that you have worth more every day. That's the whole thing about deflation: everything costs less for you because your money is worth more.
On the other hand, deflation slows the speed of money because people know that "Tomorrow" prices will be cheaper...so they delay purchasing something today knowing that it will be cheaper tomorrow. Personal computers have been a great example of this phenomenon. Everyone now knows that whatever you want today in the tech world will be cheaper tomorrow. No longer do people replace PC's at a whim.
Slowing the speed of money drags down entire economies. Look at how Japan has been bashed with ten years of deflation. It's not pretty.
Deflation also frightens people away from borrowing money. That slows down the pace of investments. No longer do companies expand to fill brief surges in demand. They lose their taste for the risk of exposing themselves to loans that get bigger even as they pay them off.
What is it you are "breaking" to me? It's doing exactly what I said it would. (And I didn't peek! I just know how this stuff works.) Velocity rose during the early expansionary phase around the time Clinton took office, it coasted for a while, and then it started going down. So far, so good. There isn't enough data in your graphs to capture the start of the most recent turnarund. There's that little twitch upward in the Spring of 2003, as I would expect, but then the data runs out.
OK, so I'm on the hook for saying that when we see data for the rest of 2003 and 2004, it will look like the period 1991-93. Unless this guy is right and everything falls in the tank. Which I do not dismiss as a possibility. I think we may have narrowly escaped, though. But it's too soon to know for sure.
Quantity and size of wire transfers each day. Quantity and size of all credit card transactions each day. Retail monthly sales tax collection figures. Number of Fed Ex / Overnight shipments. Number of packages delivered by U.S. Postal Services. Number of truck transports actively driving. Number of train cars being hauled on tracks each day. Amount of natural gas being delivered in pipe lines. Amount of electricity being transmitted by wire. Amount of overall internet data traffic. Amount of house permits per month. Amount of business permits issued, etc.
And one whopper of a formula to put it all together for some team of computers to munch on every day.
I mean, how else do you tell just how fast money is changing hands?
The velocity of money is NOT a trivial question.
Technically speaking, it should decline in value.
HOWEVER, there is this little problem. Our debt based economy can not tolerate deflation because everbody from the Federal government to the consumer to the state governments are up to their wazoo in debt and deflation makes debt just awful...How awful?? Game over, do not pass go, do not collect $200. It would result in systemic failures of the banking system, the GSEs, etc, etc.
At which point gold starts to get interesting again even if it really is just an ugly yellow metal surround by a bunch of superstition.
If deflation is here, I did find a nice cave that has a trickling spring, and few rattlesnakes. I'm set.
If its really deflation, you put your cash in cash, dude.