ARCHIVED COMMENTARY
Readers Skeptical
Of Deflation Thesis
For edition of January 20, 2006
We resume our discussion of deflation today with some interesting letters from readers. If you’d like to respond, please cite the specific passage and the author. First up is Marv Anderson, who says that the question of whether inflation or deflation will do us in is not black-or-white.
Marv writes as follows:
Although I am inclined to favor inflation, your arguments supporting deflation are very compelling. But why is this being framed as an either/or, black and white issue?
Reality is seldom that simple, and this situation is far more complicated than most. It is clear to any but the most ignorant observer that there are very powerful inflationary forces at work, and also clear that there are equally powerful deflationary forces. There is no need to identify them, as this has done hundreds of times in dozens of forums.
I liken the world economy to a car in which the driver is simultaneously pressing the accelerator (inflation) and the brake (deflation) as hard as he can. The engine is under enormous strain, and the brakes are being stressed to the max. Something has to give, and the question is: Will it be the engine or the brakes, or will they both collapse simultaneously? In any of these three scenarios, the car suffers massive damage, and the driver is in deep s__t.
It seems silly to try and anticipate whether inflation or deflation will win, because in any case we all lose. How can anyone question that we are in a period of inflation? Even the staunchest deflationist recognize that currencies are being debased at a record pace, which is clearly monetary inflation. How can anyone question that there will be an eventual deflation? Even the hyper-inflation fans realize that a currency collapse is inevitable, which is clearly monetary deflation.
The important questions to ask fall into two categories:
Economic
What damage will occur to our economy?
How can we minimize the damage to ourselves?
How can we profit from this process?
Social/Political
What damage will occur to our political and social structures?
How much can we avoid suffering from this process?
(There is no way to profit in this area, unless one is a sociopath of some kind.)
Let's stop arguing about the unknowable by trying to force the outcome of this mass insanity into a simplistic single scenario. Let's focus on trying to find a way to protect ourselves from being crushed by the forces of history which are currently sweeping us along. (X-treme surfer types are going to love this ride !!)
Personally, I think that it will be difficult to go wrong buying precious metals and energy. We should make so much money in these two areas by buying solid assets, at bargain prices when possible, that we can ignore most other markets and many of the details of this coming debacle. With solid metal and energy positions, we can let the rest of this morality play unfold as it chooses, knowing that we are as secure financially as it will be possible to be. Perhaps living on a self-sufficient well-defended organic farm wouldn't hurt, either.
It's likely that the result will be a major surprise that will confound all of our most astute prognostications anyway.
John Geltemeyer says a new currency would not bring deflation:
I throw a few thoughts into this ongoing discussion to hopefully educate myself, because a few things remain unclear to me. First that all hyperinflations must end in deflation seems correct on the surface, but is it? The final move may be, as in many other hyper inflations, the reissue of the currency and they require you to trade $10,000 green dollars for 1 red "Newdollar."
I assume all such revaluations in the past have been done at a loss to all but the biggest insiders. Under such circumstances is it really a deflation in the truest sense? I realize that this situation is different from any in the past because so much of the inflation is occurring in the ether as opposed to printing it on paper. But, how many past hyperinflations have ended without a reissue and the original currency being worth more than when the inflationary period was in progress? I don't know of any.
The ultimate question would be, what do you plan to be sitting on, on the other side of the great deflation? Do you have a back up plan for a currency reissue? You might be able to eat dollars more than you can gold, but ultimately the nutritional quality is the same.
Thanks you for any insights you may provide,
Mark Richardson has more questions than answers. Readers?
I am writing in regards to your article dated 12/22/06 entitled Inflation vs. Deflation. I have a rudimentary knowledge of the markets and economics in what might be loosely called "normal" times and am even more confused on these issues in the so called "new economy." While I hold the view that to keep the economy going we must "inflate or die," I am also of the view that we will experience deflation. Perhaps I am confused. I think the powers that be will use every trick in the book, and then invent new ones, to keep inflation going -- only to be confronted with hyperinflation realities similar to that experienced by Germany in the 1930 - 1940's [sic].
Would the result be a deflationary crash? I think gold will explode to the upside in monetary terms due to inflation, and in a crash will retain its value against all other hard-asset classes. It may actually increase in relative value to physical assets such as homes, because the growth of physical assets around the world has also increased substantially over the decades while gold has not as much.
Whether the outcome is deflationary or inflationary, I think the only question which remains after the fall, whenever or however it occurs, is how will assets and labor be valued, and against what human resources? Productivity? Other intangibles? Gold and silver?
I’d be grateful if you could clarify the possible outcome for each scenario, or perhaps direct me to a resource where I could determine how Germany’s hyperinflation was resolved economically. I think the outcome would be the same here. Meanwhile, thank you for your time and attention in this matter as well as for the many fine articles which I have enjoyed weekly.
And here’s an addendum from Rene Schaub, whose thoughts were featured here yesterday:
I wish to add something I've discovered through connecting-the-dots that might convince you that the influence of foreign selling of dollars truly will have monstrous inflationary effect. Let's lay out the facts (approximately):
- China has $800+ billion reserves. They are the world's third biggest trade country in dollar terms, and with purchasing power GDP (as defined by CIA) should be number one right now, once the numbers come out.
- China owns $200 billion in US Treasuries. This amount has not gone up for most of 2005! Neither have Japan's holdings, btw.
- So, China has about $600+ in USD cash, and still growing like crazy
- Total foreign ownership of US Treasuries has grown to about 2 trillion USD, out of a total of 8 Trillion. That is only 25%.
- HOWEVER, about 4 of those 8 trillion are 'held' by US got agencies! Those 4 trillion don't exist, because in practice, it's the same as if they didn't. The y are not 'assets' (see social security debate). When they need to be sold for cash, it's the same as raising cash through treasury auctions (i.e. new issues), except on the secondary market.
Foreigners Hold Key
In conclusion, foreigners hold 50% of outstanding real US government debt! In addition to which they hold even bigger amounts of USD. When those USD and Treasurys start really flowing out of central bank coffers, a portion of them will wind up back in the U.S., for the assets that they still can buy (= inflation), and the rest will be sold to foreigners who are still willing to take them at a great discount (= falling dollar, rising rates).
We are seeing this right now. The US$ is being used to buy gold internationally. As there is an oversupply of USD, eventually this will lead to a rebalancing of exchange rates (dollar free fall).
Oh, I forgot the cherry on the cake:
You mention credit dollars being eliminated, resulting in deflation. I don't think this will happen. Defaulting on debt has two sides: The IOU becomes bad debt. But for the debt to come into existence, some bank will have created a new bank deposit out of nothing for the borrower, adding to the money supply, possibly two-fold: once for the deposit, twice if the IOU is securitized. As the borrower defaults, this money is gone, obviously not sitting in his account anymore. It's sitting in some other bank accounts now, as payment for the stuff the borrower bought. I.e. the debt money never ceases to exist! The only way for this to happen would be if all the borrowers were still sitting on their cash, then they could swap one for the other to eliminate both. But that's extremely unlikely.
In conclusion, at least 50% of the inflationary money is still in circulation even after a default. If the holder of the I OU is bailed out, or if the IOU is not part of the money supply, then it is 100%.
Another counter deflation argument is that it is much easier now than maybe 20 years ago to raise new cash. Essentially banks create as much money as they want into existence, at the cost of fed interest rates. There are no reserve requirements anymore effectively (thanks to 1994 regulatory changes that allow banks to classify everything as money market, on which there is no reserve requirements). This makes bailouts or debt monetization much easier, as now any commercial bank can be enlisted, not just the fed.