My recent comments on deflation have prompted some interesting responses. Here’s one from Gary Tanashian, proprietor of www.biiwii.com (“Not bullish or bearish, just dealing in what is!”).

“I couldn't agree more with most of the ideas put forth, and I am one of those inflationists. I think those of us talking about inflation or hyperinflation, at least those who bother to think out the details, know that the whole argument revolves around how we get to our final destination, which is of course a deflationary reckoning of levels of excess layered one over the other for decades. [Those ‘levels of excess’ include a derivatives market valued at over $200 trillion – an outlandish sum when you consider that global GDP amounts to less than $40 trillion per year. RA]  

“In my view, the inflation game is played against the deflationary impulse or need to correct.  It is the Fed and other forces pushing on a string, and one day they will find the string simply goes limp and all the inflated chickens will then come home to roost. [I agree, of course. Credit cannot expand unless there’s an asset that can be used as collateral, and we’ve pretty much exhausted the big one: real estate.]

The ‘Good’ Deflation

“I am a friend of [a well-known guru whom you also know], so you may guess where some of my influence comes from.  But also, I am a manufacturing guy, and I have witnessed productivity first hand in the form of automation and other progress through technology and ideas.  The crux of the way I see things is that deflation (at least in capital flowing to the US manufacturing sector) has been a good thing, driving progress and productivity; but it has been perverted in recent years/decades to the point where it is cast as bad, while inflationary policy is cast as good.  This scenario makes me ill when I think about it, because it has become a self fulfilling prophecy.  Deflation is a wellspring of progress and resulting lower prices that has been poisoned by the easy money crowd.

“Anyway, thanks for the well thought out review of the situation.  I swear after a while it all sounds like "inflation blah blah blah...........deflation blah blah blah" and meanwhile, 95% of the people are sleeping right through the debate. […to be rudely awakened someday. Thanks for weighing in, Gary.]”

Point-and-Counterpoint

And here’s a note from reader Ken D. that has given me plenty of opportunities for counterpoint:

 "I completely agree that in the long run, a credit collapse resulting in the shrinkage of all dollar-denominated assets, including all measures of money supply, is in the cards.  The deflationist argument against the Federal Reserve is the 'pushing on a string' argument, where the Fed stands ready to lend money but nobody takes them up on the offer. [As I’ve noted above, all such lending is predicated on some inflatable asset class that can be used for collateral. We’ve used up housing in this way, and all it’s gotten us so far is the weakest post-recession since the Great Depression.] 

“However, the Fed has argued that they will monetize any and all debt necessary to ward off deflation. [That implies a hyperinflation, which by definition is unsustainable. What do you get when hyperinflation comes crashing down? There is only one possible answer: deflation.]  I believe that with all of today’s financial-transaction technologies, the Fed could essentially monetize a tremendous amount of debt right down to the individual level. [I don’t think so. A one-month bank holiday would be more likely, since, in a crash or panic, the problem of sequencing payments so that all debtors and creditors remain technically solvent is beyond the scope of human or even mechanical reckoning.]

Dummy Corporation

“Couldn't the Fed create a dummy corporation to essentially buy up houses in areas where prices are sagging? [Prices everywhere would sag, but it is for just that reason that you may be right. In the end, the mortgages that we now service may be revised to resemble rental agreements. It’ll be interesting to see how long it takes for some genius to securitize the stream of payments thereof.]  Think 'webuyuglyhouses.com' and '4closureinvestors.com'.  They could essentially do this with any asset today. They could create dummy corporations to buy up everything on eBay and auto trader online and then destroy it.  [Buy up all the houses? With whose money? Remember, we’ll all be broke.]

“The potential result of this could be a massive destruction of consumption goods, essentially removing the supply of things from the marketplace (no different from a massive natural disaster. Do you remember all of the economists claiming what a great thing the hurricanes were last year for Florida’s economy?). Consumers liquefied in this way would have fists full of cash relative to a shortage of goods, i.e. the standard definition of inflation. This is a scenario that wasn't really possible in the 1930's because we were not in the electronic age. [You’ve lost me here, Ken. Still, we’re going to need optimists like you when the time comes, so stick around.]