We had staked out a short position in Citigroup on Thursday’s close, selling March 20 calls naked for almost two bucks apiece, but the stock, aided by short covering, swam against the tide on Friday and finished with a mere 17-cent loss. So much for Friday Follies. By tradition, the stock market is supposed to act a little crazier than usual on Fridays, but all we saw was the same old teeter-totter action between nervous bears and complacent bulls. The bulls lost in the end – the Dow finished off 147 points – but it could have been worse, since the blue chip average was down as much as 220 points with just an hour remaining in the session. A report that non-farm payrolls had fallen by 63,000 workers didn’t help, especially since an unchanged picture had been expected, but there have been days when such news might have caused stocks to go into a tailspin. The fact that investors took the report more or less in stride suggests they may be coming inured to talk of recession. Unlike TV pundits, news anchors and economists who continue to speculate on whether recession is imminent, just about everyone else seems to understand that we’ve been in one for months.

Looking on the bright side, albeit superficially, we would hazard a prediction that inflation won’t be much of a problem eight to ten months from now. The bad news is that it will be because deflation has taken its place. We recently had an exchange of e-mails with hardcore inflationist Eric Janszen of iTulip.com, who sees this as most unlikely. Eric believes stagflation lies ahead, but we have already explained why that would be a relative fairy-tale scenario compared with the full-blown wage-price-asset deflation that is coming. Another point of disagreement concerns whether commodity prices can continue to rise even if physical demand collapses in a global recession.  Eric argues that commodity price-inflation is a leading indicator of wage inflation, and that wages are therefore all but ordained to play catch-up. Our response is that this commodity inflation is very different from others that have occurred simply because it has been fueled, not by physical demand, but by torrents of speculative capital fleeing rapidly deflating financial assets. If ever there were a trend that could not continue for long and which is likely to end in a crash, this is it.

Big Fat Raises for Autoworkers?

As for the odds of a wage/price spiral, it is something we are unable to imagine, even if Eric remains all but certain that economic theory will make it so. If it turns out we are wrong, then a year from now we should see airline employees and autoworkers getting fat raises to help them pay for $6 gasoline and $4 cartons of eggs.  But we think Eric’s logic goes off the deep end when it addresses the shortfall of consumer borrowing that has begun to push the country into deep recession. He says the government will take up the slack: “What occurs when the credit markets become dysfunctional and consumers and business reduce borrowing, the government steps in.” Anyone who actually believes that the government will be able to revive this economy, or even keep it afloat, by “stepping in” must imagine that the next WPA will have lots of cushy jobs for unemployed bond traders, LBO specialists, arbitrageurs and Ferrari dealers.

Vaporous Assets

Eric makes a further point, that you cannot have commodity price deflation in a depreciating reserve currency. That is of course true by definition, but we believe that long before the dollar depreciates to the point where Americans can no longer afford to import much of anything, its de facto status as the world’s reserve currency would have shifted to another currency, perhaps even to gold.  Eric also likes to define economic inflation and deflation as, respectively, an increase or a decrease in the money supply. True enough. But as far as we’re concerned, such definitions are useless to anyone who would seek to prepare for the very difficult times that are coming. We suggest instead that you think of deflation as an increase in the real burden of debt, since that is symptomatically how we will experience it until the speculative mania in commodities breaks. That in turn will trigger the onset of a more devastating phase of deflation marked by precipitous declines globally in asset values, wages and pricing power.

Meanwhile, anyone who sides with Eric and the inflationists implicitly believes not only that those fat raises for airline employees and autoworkers are coming, but that our homes are about to increase in value dramatically. Trust us on this: hyperinflation is not coming, and debtors will not ultimately be bailed out by a depreciating dollar. Vastly more powerful deflationary forces are already well in motion, drawing strength from the implosion of tens of trillions of dollars worth of vaporous financial assets.  The impending credit collapse is about to smother the last-gasp inflation that has been pushing commodity markets into a speculative frenzy. If you expect the economy to somehow muddle along, as Eric evidently does, you will be dangerously unprepared for the catastrophe that lies just ahead.