Why Deflation Fears Are Overblown (Debt-addicted Washington sees bailout in higher prices)

Forbes ^ | 07/30/2010 | Michael Pento

[SeekAndFind]

Given the dire deflation warnings that have become the standard talking points of most economists, American investors can be forgiven for reaching for their Prozac. I believe their anxiety is misplaced. Unfortunately modern economists don't understand what deflation is or why, in reality, we have much more to fear from inflation.

Moderate deflation is actually the natural trend for a productive economy. If a producer can increase his output per unit of input, then he can afford to expand his market by lowering prices and still increase profits. In that way, deflation allows consumers to buy items that they may not have previously afforded. It also promotes savings, which is essential for investment and capital development.

Deflation is also the natural consequence of a contracting economy. In a recession producers cut back output, and there is a reduction in the amount of goods and services available for consumption. To keep prices from rising (due to shrinking supply) under such circumstances, the central bank should allow the money supply to decline in line with the reduction in output. Consumers also put downward pressure on prices during an economic contraction by responsibly selling assets to pay down debt.

[SeekAndFind]

Many economists mistakenly claim that the 1930s Great Depression was caused by a 30% contraction in the money supply. The truth is that all depressions are caused by the reversal of a massive credit expansion. The reduction in money supply is part of a healing process that returns overall prices to a sustainable level.

Looking at today's situation, just because we have a few months of sequential declines in consumer and producer prices doesn't mean that deflation has become a secular trend. Year-over-year growth in the M2 money supply is 2%; therefore, since the money supply is still growing, we are experiencing inflation rather than deflation.

[Daveinyork]

the great depression was certainly exacerbated, if not caused, by a contraction of the money supply by a Fed that didn’t know what it was doing.

With the government spending a trillion and a half more than it takes in, and the fed pumping out money to finance it, there is a greater danger of INflation, than DEflation. How can we have INflation in a recession. one word - 1970’s.

[ClearCase_guy]

Psychology and Economics seem like two fields where no one really knows much of anything. We have a lot of people with degrees, a lot of people writing books, a lot of people with a lot of ideas. But I'm not sure that anyone really knows anything at all in either field.

[catnipman]

I’ve never heard more nonsense that sounds like it might mean something since, uh, Obama’s last speech.

The folks who posted comments on this article at Forbes tend to agree.

[econjack]

Psychology and Economics seem like two fields where no one really knows much of anything.

The standard joke I always heard (I'm an economist) was: If you take all the economists in the world and laid them end-to-end, they'd never reach a conclusion.

The problem is that economists try to forecast human behavior and that's imprecise, at best. What really bothers me right now, however, are the idiots on TV and in print who say: "If you're concerned about the deficit, how can you even think about a tax cut?" This shows incredible stupidity. Just look at what happened to gov't tax receipts after the Kennedy and Reagan tax cuts. Those people should also take a look at the empirical evidence associated with the Laffer curve.

[Incorrigible]

I’ve been waiting for inflation for a few year now. When?

[SeekAndFind]

RE: I’ve been waiting for inflation for a few year now. When?

---

Do you notice the price of oil, food when you buy groceries, new cars, energy, gas, college tuition, tolls, and if you live in mass transit cities, train and bus tickets ?

The prices of all these things that affect the common worker are UP, even as the salaries of ordinary workers are STAGNANT or even going DOWN.

Also, yes, we have lots of money... the problem is banks, companies and INDIVIDUALS are HOARDING THEM. The money supply is there but the VELOCITY OF MONEY ( the rate at which it is being spent and circulated ) is VERY SLOW. That is the one preventing prices from going up.

[ClearCase_guy]

I remember when the housing crisis first seemed to hit a few years ago. There were many stories of people who could not pay their mortage. Although I personally would never have recommended it, I really did expect the government to actively push for Inflation. Hey, if your hourly wage is suddenly $100, I guess paying off your fixed rate mortage, at $1500 a month isn't going to be too painful, huh?

Sure, that's crazy economics. People shouldn't see rampant inflation as a smart way to pay down debt. But the government does crazy stuff, and I thought they might try to sell that idea. But they didn't.

Now, here we are, kind of expecting inflation to arise, not as a policy, but simply as a result of basic economic forces. And yet, we still see no inflation. All of this debt. All of this spending. All of this money floating around. No inflation.

Wanted or unwanted, I would expect to see inflation. It seems odd.

[Incorrigible]

Do you notice the price of oil, food when you buy groceries, new cars, energy, gas, college tuition, tolls, and if you live in mass transit cities, train and bus tickets ?

In New Jersey, compared to a year ago and especially 2 years ago, I see the following:

Oil - Down
Groceries - Down
Restaurants - Deals can be had
New Cars - Deals can be had
Energy - PSE&G lowered my natural gas rate this past winter, electric not as high this summer
Gas - Way down
College Tuition - Up but so are tuition aids from loans to out-right grants (All the government interference makes it difficult to know the real cost of education)
Tolls - Up (not the 800% that Gov Corzine wanted, but up)
Mass Transit - (NJ Transit, NYC Subway) Up - Government Run

The value of my home - Way, way down!

Sorry, I'm not seeing inflation. Like ClearCase_guy, I thought by now we'd be full on Carter economy.

The only thing I can think of that's preventing this is all the manufacturing being done in China and the minimal flux allowed in the relationship between the dollar and the yuan.

 

[Zakeet]

... I'm an economist ...

John Williams (Shadow Government Statistics) convincingly argues that the government cooks the numbers to the point where they are almost meaningless (e.g. deletes food and energy costs from the CPI used to index Social Security payments -- but diligently includes housing costs sans property taxes and vacation expenses). He also maintains inflation is currently running at a 5 to 10 percent rate (retail vs. wholesale prices).

Many other economists now predict that inflation will break hard. The consensus estimate on timing seems to be sometime during the second half of 2011 to the first half of 2012, although some believe we could be paying for our sins as early as the 4th quarter of this year.

As an economist, what say you?

[econjack]

You've pointed out a real problem. The gov't "redefines" how things get measured, which makes comparisons over time difficult at best. The "shopping basket" of goods has been totally redefined since I first started studying it 50 years ago. In all cases, those "refinements" have attempted to define away problems that might be manifested in the data. Also, why does the gov't, virtually every month, "adjust" the previous month's figures (e.g., unemployment, CPI, etc.) If they can't get it right the following month, keep your mouth shut and take the extra time to massage the data and then issue a correct number.

My own feeling is that deflation seems more likely for the next 12 months than inflation. Inflation implies a situation where demand exceeds supply, thus pulling up prices. I don't see that. Both business and consumers are sitting on their cash waiting to see what those idiots in Washington do next. The uncertainty about taxes and spending is forcing consumers to the sidelines. Until Washington takes a clear, long-run solution to cut taxes to both business and consumers, I see deflation more than inflation.

Finally, to those idiots in the MSM who say: "How can you even consider a tax cut in the face of such massive deficits?" they clearly have not done their homework. Look at the tax receipts after the Kennedy and Reagan tax cuts. Also, the Laffer Curve gives a theoretical explanation of the way consumers think. Until Washington gets into and passes Econ 101, especially Obama, I see no hope. Gees...a fin-reg bill of 2700 pages that doesn't even look at Freddie and Fannie?? Unbelievable!!

[Fee]

Mixed bag. Food is inflating, prices the same but content is getting smaller. Fuel is inflating, should be much lower due to low demands but weak dollar is keeping the prices up. Housing and large items are deflating, because no one has the money to buy. Overall feds are trying to inflate while capacity and demand is deflating. Both forces may be cancelling each other out. Thus feds will double the effort by QE. Problem is when inflation ignites with all this cheap money it will take off before the feds have a chance to snuff it out. Can we say interest rates in double digits??!!!!

[PSYCHO-FREEP]

I disagree with the author.

What the he failed to take into account, is the Federal Reserve chairman Ben Burn-yank-me. This idiot will keep on reducing interest rates because he believes that high interest rates will not only increase our difficulty to pay back the National Debt, but they will also kill the economy due to the deterring effect it will have on people and business, borrowing money to fuel the economy.

In reality the very opposite is what is happening. Only MaObama and Ben-boy are too stupid to know the difference.

[Toddsterpatriot]

John Williams

He's a joke.

(e.g. deletes food and energy costs from the CPI used to index Social Security payments

Since they don't index Social Security with CPI, your claim is meaningless.

He also maintains inflation is currently running at a 5 to 10 percent rate (retail vs. wholesale prices).

He makes lots of silly claims.

[Wyatt's Torch]

Unfortunately modern economists don't understand what deflation is or why, in reality, we have much more to fear from inflation.

Moderate deflation is actually the natural trend for a productive economy. If a producer can increase his output per unit of input, then he can afford to expand his market by lowering prices and still increase profits. In that way, deflation allows consumers to buy items that they may not have previously afforded. It also promotes savings, which is essential for investment and capital development.

This is hysterical. He says that economists don't understand deflation and proceeds to define it incorrectly...

[Zakeet]

Why does the gov't, virtually every month, "adjust" the previous month's figures (e.g., unemployment, CPI, etc.)

They are pumping out propaganda in order to cover their liberal butts as much as possible. Don't know if you saw this, but labor now has the unemployment figures so screwed up (think birth-death models and various "adjustments") and census now has their unemployment figures so screwed up (think telephone surveys trying to reach cell phones) that neither figure can be reconciled to the other or to any outside source (e.g. ADP). Look for the mother of all annual corrections in February, a time which is safely past the election and barely into the new congressional term (whose critters can't possibly be blamed for past sins because they haven't had time to foul their and our nest).

My own feeling is that deflation seems more likely for the next 12 months than inflation. Inflation implies a situation where demand exceeds supply, thus pulling up prices.

You're thinking in classical terms. Sometime check out the admittedly heterodox Austrian School's thinking on prices -- these guys have been hitting the mark as of late. Economic historians have also had a lot to say lately, none of which is encouraging. Then consider the implications of vastly increasing the supply of money (look at the discontinued, for obvious reasons, but still competently estimated M3, not M2) in light of the Quantity Theory of Money. Then add another healthy dose of "Quantitative Easing" (which is not included in the deficit totals incidentally because the Feds assume they will be paid back in full). As Ambrose Evans-Prichard recently wrote, "The Federal Reserve is soaking the kindling with kerosene."

Bottom Line: I don't think either the demand-pull or cost-push models apply in our situation. I look for either an Argentinian type of chronic hyperinflation or a Weimar Republic type of acute hyperinflation depending on the extent to which the U.S. defaults on its sovereign debt. I regard default inevitable within the next year or so, given the magnitude of deficit spending and the month-to-month roll in existing debt (currently in the range of $400 billion), the monthly amount new debt (currently in the range of $200 billion), and the amount of interest that will be required once the public "figures it out." I also look for hyperinflation to strike fast and hard when, as has almost always been the case historically, the "bubble pops."

Both business and consumers are sitting on their cash waiting to see what those idiots in Washington do next. The uncertainty about taxes and spending is forcing consumers to the sidelines.

Helicopter Ben recently called this "Unusual Uncertainty." I like that term. I also liked his comment that an audit of the Federal Reserve would "undermine the confidence in the whole system." That's probably the only truthful testimony these imbeciles have given in months.

Finally, to those idiots in the MSM who say: "How can you even consider a tax cut in the face of such massive deficits?" ...

Actually, I have more to say to those idiots in the MSM who FAIL to ask, "How can you even NOT consider slashing spending in face of such massive deficits?"

Until Washington gets into and passes Econ 101, especially Obama, I see no hope.

I would settle for them reading and comprehending Hazlitt's Economics in One Lesson. And quite frankly, I see virtually no hope even if they do.

[Zakeet]

[John Williams is] a joke ... He makes lots of silly claims.

I have followed the guy closely for the past year or so and he is almost always spot on. Furthermore, he clearly explains the basis for his conclusions and I have consistently found his arguments well reasoned and based on fact.

Since they don't index Social Security with CPI, your claim is meaningless.

According to the U.S. Social Security Administration:

Legislation enacted in 1973 provides for cost-of-living adjustments, or COLAs. With COLAs, Social Security and Supplemental Security Income (SSI) benefits keep pace with inflation. ... The Social Security Act specifies a formula for determining each COLA. In general, a COLA is equal to the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of one year to the third quarter of the next.

Sometime, check out what the Bureau of Labor Statistics does and does not include in its definition of CPI-W. Pay particular attention to changes made during the Clinton Administration.

[Toddsterpatriot]

(look at the discontinued, for obvious reasons, but still competently estimated M3

What do you feel is the obvious reason?

"Quantitative Easing" (which is not included in the deficit totals incidentally because the Feds assume they will be paid back in full).

Why should the QE be included in the deficit totals?

I regard default inevitable within the next year or so,

You think the US will default on dollar denominated debt?

I also liked his comment that an audit of the Federal Reserve would "undermine the confidence in the whole system."

Yeah, giving Frank and Dodd control of monetary policy would undermine confidence.

[Mase]

I have followed the guy closely for the past year or so and he is almost always spot on.

John Williams is a doomer who likes to creates charts of doom but never really explains how he arrives at his numbers. He makes a lot of money selling his doom, in the form of a scary newsletter, to other doomers who believe the world as we know it is doomed.

John can never explain why the inflation he sees is many times higher than what the bond market sees. His 5%-10% inflation claims (that's quite a range, don't you think?) are never reflected in the bond market - Five-Year Treasury yielding 1.71%; Two-Year Treasury yielding .6%.

Williams is good if you like being scared but his arguments are not well reasoned or based on facts. He doesn't like sharing his facts, only his conclusions.

[Toddsterpatriot]

I have followed the guy closely for the past year or so and he is almost always spot on.

Yeah, his fantasy GDP numbers are funny.

Since they don't index Social Security with CPI, your claim is meaningless

According to the U.S. Social Security Administration:

Legislation enacted in 1973 provides for cost-of-living adjustments,

I thought you were discussing indexing?

Indexed earnings used to compute initial benefits When we compute a person's retirement benefit, we use the national average wage indexing series to index that person's earnings. Such indexation ensures that a worker's future benefits reflect the general rise in the standard of living that occurred during his or her working lifetime.

National Average Wage Index

Sometime, check out what the Bureau of Labor Statistics does and does not include in its definition of CPI-W.

It includes food and energy. Did you have a different point?