Inflation No Threat in Collapsing Economy


I’ve harped endlessly on the point that stagnant-to-falling incomes, soaring joblessness, imploding credit and collapsing asset values make inflation nearly impossible at this time. Here’s our friend Senor Cuidado once again, explaining this more lucidly than I have.  He is responding to statements (in boldface) posed in the Rick’s Picks forum by “Edward,” who is needlessly concerned about $9-a-gallon gasoline and other supposed inflation threats:

Gas will be 8 or 9 bucks a gallon — and people will pay for it, because they will have no choice, just as they don’t in Europe already.

“Edward, the U.S. is not Europe. Our geography requires a lower gas price in order to keep our transportation grid flowing. Our economy would experience a devastating deflationary shock from $8-9 gas. I suppose the people might ‘pay for it,’ but then they won’t have any money to go to restaurants, or buy any clothes, or go to the dentist. A quick tripling of the gas price from the current level would cause an extreme unemployment spike when discretionary income retailers are simply wiped out. Or prices will collapse along with demand for other items and services.


“But I say the $9 price is not even possible because domestic gas demand will fall rapidly in response in any climb above $4. We were in the red zone at $4 gas last year. Even a $6 gas price probably means total defeat for most sitting politicians in the U.S., and radical new political pressures on the Saudis/OPEC. And $8 gas is radical: It probably means an outright military takeover of the Saudi Oil fields or the sudden end of new car sales in America.

 Groceries and Gas

“The price of oil is also the basis of the price of food. If Americans will be spending all of their money on gas and groceries…then that means a nasty deflationary outcome for every other sector of the economy. Debtor nation status, de-industrialization and off-shoring (global wage arbitrage) preclude a 1970’s outcome here for the U.S.

I suggest you read Jim Sinclair to understand that the dollar is on its way to a devaluation and what that means. Also, you aren’t up to date on your Denninger, because he is changing his tune about the prospects for hyper-inflation.

“I read Sinclair and Denninger regularly. A dollar devaluation does not necessarily equal hyper-inflation. We hit Peak Credit as per the Mish Shedlock thesis, and we are nowhere near a reversion to a corrective level of credit. Consider that the coming vote of no confidence in the American finance sector is going to collapse credit much further from this level of August 2009. That trend will be hyper-deflationary. The dollar will take the haircut, and balance things out a bit, but the credit collapse prevents inflation of the total money supply.

Credit Is Key

“The credit collapse is the key to the inflation-deflation debate. Best to believe the Mish maxim which states there is no inflating out of the backside of a real estate bubble. So it is possible to take a massive hit to the currency yet still have deflation within the rules of our system…because of the collapse in credit. Think: Since 2006, we’ve already taken a big hit to the dollar, right alongside a huge deflation in asset prices (equity markets, houses, cars, boats etc)…because of the contraction in credit. I am simply saying that this dynamic continues to wind its course, which is much further from here.

“Notice Sinclair passes off any higher gold price prediction than $1650 to Alf, or whomever. I think he’s smart to do so. Volatility will be extreme, and Sinclair’s pegged the $1600 area as the new future fixed-gold price. OK, fine. But credit will be in a state of complete collapse by his target date of early 2011 (very few businesses or persons will have credit lines aka we have a cash economy). Meanwhile the oil price will face huge demand-drop pressure and huge geopolitical pressure and not go through the stratosphere, and imported foods will face drastically lower demand and mostly disappear from shelves.

 Strong Gold, Weak Stocks

“It’s all going to be extremely chaotic…and deflationary. I will stick with a prediction of a strong gold price in the neighborhood of Sinclair’s target in response to the credit collapse, plus an equity market collapse as a response to the credit collapse, plus a substantially weaker dollar (as foreign investors respond to our credit collapse). That will be the new status quo. And, yes, the sum total situation will be deflation as defined by: Deflation = Reduced Supply of Money AND Credit.

“At some point the oil price might reach, say, $5, but it can’t stay that high for long. And the dollar can briefly rally again in the panic…but it’s going to take the big haircut and then stabilize at a lower “new normal.” It’s not the 1970’s all over again, but it’s not the 1930’s exactly either. The dollar would have gone to the moon if this was the 1930’s and we were a manufacturing/ producer/ creditor nation. And, paradoxically, glossing over the differences between today and the 1970s is also a big mistake. Mish’s deflationary real estate maxim is in play for the foreseeable future, and that card was not on the table during the 1970’s, and neither was our current insane level of debt and dependence on foreign creditors.

“Also, some will argue that future high interest rates will boost the dollar back up to the levels of the past decade — but remember that the dollar never returned to its pre-1970s level. Even after the Volcker era the dollar was dropped to a much lower ‘new normal’ and stayed there for about three decades as measured in gold. Sinclair is smart to predict the higher ‘new normal’ for gold.”

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  • Alex August 18, 2009, 3:02 pm

    You people that are arguing about the WHO will shell out for the $200 K 911 Porsche are still living in the 20 th Century. That was the US century. The Chinese billionaires and millionaires whose currency will most certainly not collapse will shell out for it. The Europeans that can still afford it will. All the people working in the Middle east for oil companies making huge bonuses for nothing more than large profits from a rising oil price – at least in dollars. The US will simply be priced out of the market for certain goods and services and other markets will take their place. China, Brazil, Russia, India and if the EU Central Bank doesn’t follow the path of the FED the European savers whose Euros won’t be buying half of what they used to like the USD holders – if their lucky. The Chinese government may take a huge loss on the US Debt but their is a new consumer economy being developed to replace the bankrupt US. The US is not the driver of the world economy anymore. It is now the Kabooz and ultimately the USD will no longer be the world reserve currency! Empires come and Empires fall. usually the same way, by debasement of their currencies and war.


    You missed my point, Alex, since there was no argument about who would shell out, only the prediction that those who had to pay for the Porsche with U.S. dollars would be more or less lost to Porsche’s market. That said, everything else you’ve written, I agree with (other than the financial position of Europeans, who, for reasons of overly generous socialism and a shrinking work force, are nearly as broke as we are). RA

  • ben August 18, 2009, 5:22 am

    CPI keeps showing declines in transportation and housing…but rises in every other category…including food, medical care, and education. Hardly looks like deflation to me. But I wouldn’t mind this deflation that I keep seeing touted here. I’ll go to sleep with a hundred thousand dollars under my pillow. Please wake me up when gasoline is 50 cents a gallon and I can pick up a mansion in the Hamptons for 50 grand.


    Best I can do will be that Central Park West co-op I mentioned a while back in my commentary for $250k. Incidentally, there is no way the price of education is rising, since colleges are no longer in a position to extort parents for HELA money. That game is over, and I’m predicting the Ivys will be cutting each other’s nuts off within five years trying to sell degrees online. $12,000 sounds about right to me for a home-study Harvard BA. RA

  • Richard August 15, 2009, 6:48 pm

    Every organism, whether biological or organizational has one over-riding mission: Survive!
    How will deflation in the form of declining prices (whether nominal or adjusted), declining money supply and credit, facilitate survival of everyday Americans, the banks and the various levels of government?
    Not one form of deflation is helpful to banks or governments. Declining prices and loans mean declining economic activity and therefore declining revenues for governments. The vicious cycle of decline ensures repetitive rounds of layoffs and bankruptcy, further revenue declines for government and failure for banks. If you think it is hard to issue bonds to foreigners now, just wait for 5 years of the above.
    Every banker and every public servant understands at some level that he/she is a well-intentioned parasite whose life is threatened by a decline in economic activity.
    The hidden tax on accumulated wealth, inflation, is the only prescription that will ensure that tax revenues are collected, that loans do not default as readily, that balance sheets can be restored, and most important of all to those that are incharge, that governments and banks can survive!
    I challenge the defationists to prove that the banks and governments as they exist today can survive deflation!


    In every discussion of this issue over the last ten years, I have tirelessly pointed out that an inflation serious enough to “cure” our debt problems would necessarily destroy savers as a class, along with all insitutional conduits of saving, most particularly the bond markets. You are the zillionth inflationist to weigh in without even touching on this concern, which is hardly trivial. RA

  • Corey August 15, 2009, 1:03 pm

    We all need to prepare.

  • cameroni August 14, 2009, 9:31 pm

    The arguments for deflation are convincing at this point in time. The prospects of a hyper-inflation and the arguments in their favor seem equally persuasive too if certain events come to pass, like the actual release of existing and proposed stimulus funds into the economy. It reminds me of a religeous debate at times.

    I know one thing for sure from having lived in both severely depressed and hyper-inflationary countries. Both hyper-inflationary and depression outcomes result in shortages, both suck trust out of the financial system, both require a much more serious and focussed approach to building and holding wealth, not in financial institutions, but at home. And both result in widespread hoarding of hard assets and consumables. Both bring on security threats at home and unpredictable interventions by governments to contain the problem.

    No matter what happens you will want to do a few fairly straightforward things to protect yourself. Stock up on trade goods, consumables and food that stores well. (freeze-dried coffee and sugar for example keep indefinitely and are as good as cash in a crisis). Keep cash on hand (at home), reduce debts and take steps to properly secure your property. The reason a crisis is a crisis is because it comes on quickly. Nobody knows the date and time of the next big event but it is just prudent to be prepared during normal times if you really expect a serious economic disruption in the future.

    It does not matter if we hyper-deflate or hyper-inflate. The steps we need to take to protect our families and our homes against those events are in many cases exactly the same.

  • Paul August 14, 2009, 6:36 pm

    Glad to see the inflation / deflation debate continue.
    If I may be so bold, I believe that Senor Cuidado (and C.C.) are suggesting a mixture of inflation and deflation. As Rick shows, above, who in the USA is going to shell out for the $200k+ 911 (Besides some of those highly reimbursed Wall St traders)?
    As Rick likes to remind us, what will be the mechanism to fuel the monetary fires, besides the IRS / Gov’t adding zero’s to the end of our bank account amounts? How exactly is Helo pilot Ben going to get the $s in everyone’s drop-zone?
    To answer my own question, there already are mechanisms in place and being used: Welfare payments, food stamps, Medicare, Medicaid, SS, unemployment benefits. These current mechanisms probably keep most potential pitch-fork carriers out of the streets and away from Gov’t buildings and townhall meeting sites. But will these relatively small payments per person / family fuel the fires of inflation?
    I guess I can’t see how enough $s get into circulation to kick off the inflation. The bankers sure aren’t helping. They can barely keep their capital ratios from falling below requirements. The Gov’t and the Feds are in lifeguard-mode in some arenas other than banking (Government Motors), but, for the most part, the Gov’t seems content to only directly contribute to a food and water program for the masses.
    Best of luck to all.


    Great post, Paul. Thanks for the help. RA

  • C.C. August 14, 2009, 4:01 pm

    Both Rich and Dusty make good points. And they’re both onto something. So allow me a ‘broadside’…

    Step out of the box for a moment, and think of this in current social terms – i.e., social trends & social ‘norms’.

    A deflationary environment – albeit devastating, is somewhat ‘boring’ – and slow, over time. It’s a grind-down of say ~100 grit sandpaper spread out over 10 years or more. That could happen – per Mish’ expectations. Consider though, the socio-economic state of our ‘State’. Do we do ‘boring’? Does our political ‘leadership’ – and the electorate that repeatedly votes them in office, take on society’s ills with a reasoned, patient and measured approach?

    Or are we a (3) second, sound-bite oriented society, with the patience and temperament of a flea?

    And what about our ability to persevere – our ‘grit’ so to speak? Do we have any? Or, is it more like that at the first sense of trouble, we clamor for somebody (Namely: Government), to step in and ‘Do Something…’?

    You know the answer.

    Let that answer be your guide as to what the Government is prepared to – and Will do, to keep the Fat, unattentive and slovenly populace inebriated with anything and everything in their power to keep them in office for one more election cycle.

    Yes, it is ‘different’ this time. We have become Totally and Completely Politicized. It is Politics from top to bottom – from DC to Wall Street and all of their fawning followers in between. What ever can be done to protect the incumbant’s tenure will be done – even if it means totally destroying the currency in the process.

    We could very well have the ‘best of both worlds’ – High inflation in a deflationary environmnet. Given the time and circumstances we live in, it is not out of the realm of possibility.

    Peace –


  • D Graham August 14, 2009, 3:01 pm

    I think this debt destruction episode will be resolved by more of the same: (likely years) of creating fictitious dollars to replace factual lost dollars or equity. This can only result in decreasing the value of existing dollars. I think the other legs of this stool are U.S. consumer slowdown relieving pressure on demand, which will have a balancing effect on the devalued currency. I think $5 oil is a ridiculous notion. Just MHO. Maybe if you had $200 gold, but there are ratios which have stood all time and doubt they are going to make exceptions now. If we have 1600 dollar gold you can bank on 100 dollar + oil and 4 dollar copper. The US is no longer the driver of all demand. A lot, but certainly not all…and if we keep making China wealthy they will only increase their demand.
    The other consideration that no one is really discussing (because it 100% hyperbole) is that if we get into a commodity price battle you can guarantee war and that will only exacerbate prices.
    The other forces affecting prices will be taxation, peak oil, and the other 80% of the globe wanting our standard of living. The government can’t afford property prices to fall 90% and take property taxes with it. It would be untenable. Far better to keep the fiction going and rejigger the currency up to the point that asset values don’t get too low (stocks, too).
    Mish is probably right about deflation due to demand pressure leaving due to our debt binge and resultant collapse on the other side….but Uncle Ben hasn’t even pulled the copter out of the hangar. Toll Bro’ suggested a “cash for shacks” program to kick-start the housing market. It sounds crazy, but our leadership has such a disdain (probably ignorance more than disdain) for sound money that you have to think it is being kicked around. Hang on to that rental in Detroit!

    “I see bad things…….I see dead dollars everywhere”

    I think it is going to be very turbulent and the odds of us merely pulling out and getting back to normal soon are way, way, way remote. The post bust Nikkei is probably a reasonable guide. 2008=1987. Swap commodities for equities, though. Commodities fell down post 87, they rise post 2008. More due to currency devaluation than demand overwhelming supply…..

  • Rich I August 14, 2009, 2:57 pm

    WWIII Smackdown: It’s baaaaack.
    While we debated deflation inflation like so many angels on a pinhead market, we the Greatest Depression deepened. The weather market people looked out the window on Main Street and Wylie Coyote looked down. Yikes!
    Now the real fun begins with double sell stop shorts or inverse ETFs.
    Ok, here’s a dangerous thought about the future (aren’t they all):
    Since dollars are backed by debt and debt is defaulting, dollars may be scarcer and more valuable even if the ghost of FDR devaluation reappears. (A zero cost carry on the dollar is meaningless if only insolvent banks buy Fed Treasury IOUs as a form of self-flagellation.) In other words, backwardization, a strong dollar. Works for me and Mr Market, as dollar today rallies while bonds, notes, gold, silver and equities take a long-awaited merciless beating on consumer attitude and El Erian.
    Do we still have circuit breakers?
    Re gold and silver as legal tender, one thought is Uncle Sam may get Constitutional Religion again AFTER the deflation takes us back to Fifties prices…
    PS: Here’s a pleasant reminder why we’re here:

  • Bill August 14, 2009, 12:52 pm

    As a child I loved reading books about the American plains Indians. One of the story’s that stuck was how an Indian would ride a horse until it collapsed in exhaustion; then build a fire under it, forcing it to its feet and riding it until it’s heart gave out.
    We are collapsing in debt created money exhaustion. It has been taken to extremes that amaze even the Austrians. The “fire” will not come from debt based money but from “unearned” money. We are seeing the switch already in the Fed’s monetizing policy’s. When unearned paper money is unleashed to the public hyperinflation will begin. As Phil C points out above,we have seen this before.
    I would respectfully suggest we spend what little time we have left not in discussing the economic details of our impending demise, but in developing political ways of stopping it.

  • Kevin August 14, 2009, 12:51 pm

    Rich, I think you hit the nail on the head! No one knows for sure but I would definitely lean more towards inflation, not due to demand but rather because of a currency crisis/default.

    Due to fractional reserve lending, the banks must keep inflating or die. This means they will just keep the printing presses (and computers) running.

    Financial warfare is currently in play, once the loss of confidence occurs for the last time it will be game over IMO. The US is no longer in control of its destiny, its creditors are.

  • rico August 14, 2009, 11:51 am

    The Fed has already shown their willingness to monetize. Even if there is no private demand for credit we have already seen the willingness even eagerness of Congress to to try to spend their way out of the current mess. As things get worse it will become politically untenable to do anything other than spend the country into oblivion with the Fed willingly feeding their habit.

  • Dusty August 14, 2009, 5:56 am

    The U.S. will be lucky if its economy fares as well as Iceland’s. But that’s not going to happen, it will be much worse. Iceland had its own financial crisis in 2008 when its banks collapsed. Inflation shot up but they are getting it under control by a 30% drop in gov’t spending and implementing higher interest rates of around 12%. The U.S. is doing the exact opposite of what it should be doing. It is keeping interest rates low to make cheap money available so more people can go out and borrow money they can’t pay back, and the gov’t is spending money as if it was toilet paper. They are blowing more air into the giant bubble making it even bigger. You really don’t want to be around when it bursts.

    To make matters worse, the gov’t has switched their debt load from 30 year bonds to 2 year treasuries. The gov’t can’t pay off its debt right now at these ridiculously low rates, then what will happen when interest rates start moving up? Who is going to buy their debt? Does anyone seriously think they can pay back their $10 trillion debt??? Of course not. They have to default on the debt which will cause the dollar to drop like a rock overnight. No one is going to get stuck holding the U.S. dollar. Inflation is a inevitable when the U.S. dollar becomes as worthless as the Icelandic currency.


  • Rich August 14, 2009, 3:11 am

    I don’t think anyone can rule out deflation or hyperinflation. I would think that the strong odds are that the printing presses will continue to run. If Bernanke who has been on a “I want my job for another term ” campaign wont live up to his moniker, “Helicopter Ben”, then I’m sure he could be replaced with a Larry Summers type that will certainly fit the bill.

    Commercial real estate, Citi on the edge of bankruptcy, FDIC coffers to fill, Health care, Social Security,Pensions, Two Wars…may be 3, 500 more bank failures minimum, Foreclosure collapse, and a host of other things will need to be funded. Are we not going to print trillions to fund these?

    Where are the fundamentals for the dollar here ? Can you rule out hyperinflation (a currency event) with the constant printing of money at a rate never seen before? A severe loss of confidence in the dollar has occurred. The fed is buying our own debt. And if one thinks hyperinflation is years away then I think people are giving themselves a lot of credit as soothsayers. Hyperinflation is a real possibility and with the high speed trading world we live in and momentum the dollar COULD be shorted to oblivion and it would not take years.

    If the dollar tanks, how will it buy more of ANYTHING? People will just board up the shops and go overseas. There will be a minimum of goods to buy driving prices even higher. An inflation due to currency debasement NOT an up-tic in the economy.

    The United States has added liquidity to the system orders of magnitude more than any other country. There are consequences for that. You say the money is stagnant. For now .

    This current stimulus bill has used only 10 percent of the money and it prompted the Administration to push for another immediate stimulus. Biden blatantly asked for one. If things get worse there will be stimulus packages that make the current one look small. And when the current one uses more of the funds at the end of this year , what banks won’t fund a government guaranteed loan for infrastructure, technology, and energy projects ?? Continued stimulus will be the vehicle for the velocity of money.You can cite Japan but anything done in the USA, will dwarf their efforts in size and speed.

    I will not guarantee it will happen but if I had to bet between hyperinflation and deflation it would be the former. How is the dollar going to buy more of anything?
    In deflation one must believe the currency will be strong. I cannot convince myself of that.


  • Phil C August 14, 2009, 12:37 am

    I understand your point but can you compare how different the situation of the USA is with that of Argentina in the early 2000s, Zimbabwe, and Germany of the 1920s and explain why the outcome will be different than any of those 3?

    I know that one big difference is that the US dollar has been used internationally as an exchange and reserve currency, but how sure this can be sustained and not flipped overnight with some behind the scene arrangement between major players?

    Also, if they let a total implosion, this will require massive TARP on steroids to allow Goldman Sachs et al (the suckers behind the FED) to survive. Politically, geopolitically, how will Wall street and Washington will see this option versus a constant artificial pumping (again on steroids) of the stock market or check rebates, or cash for clunkers programs to keep the system afloat.
    I would think they will see the latter as less dangerous and they could even think they could bring back the dead economy?

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