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How Deflation Threat Helps Policymakers Inflate


[Gary Tanashian writes a technical and macro-fundamental analysis blog, is the publisher of financial website Biiwii.com and the premium-content, market-analysis newsletter Notes From the Rabbit Hole. In the essay below he explains how the interplay between inflation and deflation is used as a monetary policy tool by the Fed and U.S. Treasury. For the record, Rick’s Picks has long predicted a deflationary depression, but with a precipitous and devastating hyperinflationary phase. RA]

I would like to thank Rick Ackerman for the opportunity to continue a conversation that began in 2005 with an email I sent to him in response to an article he wrote about deflation that I felt was beyond the usual boilerplate that keeps insisting that a deflationary depression will bring all asset prices down. In fact, Rick’s constructive view of gold hints that he is not a knee-jerk gold booster like so many gold bugs, but rather a realistic believer in the idea that not all assets are created equal, especially during times of great monetary stress.

The 100-month moving average is the deflationary "backbone" that has allowed the Fed and policymakers to expand the money supply on demand for decades

There are several notable deflationists who absolutely hate gold, which makes sense since they have been micromanaging its “price” demise since 2002.  While they may be right for limited periods during an ongoing secular deflation against which ever more exponential inflationary policy is brought forth, they will never be right about gold’s “value proposition” in relation to assets positively correlated to growing (or more accurately, contracting) economies, at least during the current secular trend.

The garden-variety deflationist preaches global depression and cash-as-king.  Well, he may be half right: cash is good for short-term liquidity and can play court jester, but gold is king of enduring value in the current system as policymakers fight the dreaded deflation beast ever-further off the macro balance sheets. More astute deflationists do not focus on asset prices, instead focusing on money supply, which by various aggregates is working on a plateau that makes the one leading into mini-Armageddon ‘08 look modest.

Excited Deflationists

Deflationists are, to say the least, excited by this. And when a deflationist becomes excited, he finds it hard to resist the urge to once again lecture the silly inflationists.  Those would be the people that tout ever-rising commodity and asset prices (in many cases conveniently offering preferred investment recommendations) amid the debasement of fiat currencies.  On the big picture, I tend to agree with them.  But the inflationists have a funny way of going all quiet each time deflationary destruction happens to pay a visit along the continuum of inflationary regime.

It is advisable to tune out the cartoon aspects of both sides of the debate and realize that deflation and inflation go together in the current system.  In fact, I believe that our heroic policymakers depend on periodic bouts of deflationary fears to boost the implied confidence that they need to continue — you got it — inflating; or at least trying to inflate.  I have little doubt the game will end very badly one day soon, and it is open for debate as to whether the resulting depression will be deflationary or inflationary.

On the deflation/inflation theme, the following is excerpted from this week’s newsletter:

Inflation Impulse?

You may have seen my 2005 conversation about deflation with Rick Ackerman noted on the blog recently.  That was probably about the time I came up with the term “deflation impulse”.  It was a way of illustrating the view that systematic and ongoing inflationary policies are periodically interrupted by the need of the economy, markets and financial system to purge themselves of the toxins routinely injected by policy makers on a Keynesian business-as-usual continuum of diminishing returns.

The diminishing returns are of course measured in our gold ratios like Dow/Gold, for example, in which the Dow has endured a sustained bear market in “real” terms.  Since the inflationary saturation point in 2000, the anchor to real money – gold – has acted as a light of truth shone upon the people who control “official” money and thereby attempt to control asset markets.  I think I once wrote an article comparing gold to the kid in fifth grade who used to sit in the front row, hand up and ready to give every answer – not to mention tattle on other kids for a few more brownie points.  That is gold’s role in the sordid world of modern money.

Not that it matters much to our analysis, but when reviewing the long-term monthly (see above) of the yield on the 30-year bond, it occurs to me that it is probably more appropriate to view our often-watched exponential moving average 100 as the deflationary “backbone” that has firmed up Greenspan, Bernanke, Summers and Geithner over decades of inflationary monetary policy on demand.

Prechter ‘Fright Mask’

Each time long-term interest rates have risen toward the EMA 100 – attended by bouts of rising inflation fears – they have been repelled (red arrows), as economies and/or markets have weakened and talk of deflation once again hits the media.  This is the “Prechter fright mask” theme I sometimes have fun with on the blog.  This dynamic is critical to policymakers’ ability to keep the game going.  No stable T-bond, no ability to monetize confidence in the bond.

We are on a deflationary continuum against which monetary policy is eased in various ways and with varying degrees of intensity backed by the confidence implied by the EMA 100 backbone; there is implied confidence in the Treasury because each time there is a bout of deflationary activity, “investors” run en masse to U.S. Treasurys.  Early subscribers may remember the “Lyin’ Larry” theme that NFTRH came up with at the end of 2008 when Mr. Summers very publicly cajoled the fearful masses to buy the safety of U.S. Treasury bonds, right into the teeth of an oncoming inflationary impulse that brought the yield on the long bond all the way back to the EMA 100.  The fearful lemmings were summarily blown up as inflation players once again went full-tilt.

The Final Deflation?

So is this it, the final deflation?  If so, a world of assets is going to decline hard and opportunity is going to be present for the “D Boys” to finally buy all those assets from all those frightened and naive inflation believers.  Or are policy heroes preparing a mother of an inflation yet to come, with the recent decline in yield from the EMA 100 and the confidence (and mandate to inflate) that would come with a continued decline?  The chart tunes out the inflation/deflation debate and simply states that for now at least, it is business as usual.

Nothing has changed over decades – although the impulsiveness of the 2008 decline can be read as a warning that things may have become more unruly in the macro markets.  But even here, this begs the question of whether that was an initial downward thrust toward deflationary resolution or a harbinger of an equal and opposite inflationary reaction?

As has been the case since the “Hope ‘09” rebound got strongly under way, I am not going to read too much into either potentiality.  Rates have neither strongly declined nor busted our EMA 100 “back bone” or “inflationary line in the sand”.  Until one or the other occurs, we remain on the business-as-usual continuum, where implied confidence remains with our policymakers, and they can be expected to do as they have done throughout the continuum: They will sell Treasury bonds and monetize the debt in an attempt to keep business-as-usual intact.

Protecting Yourself

Smart investors stopped listening to Lyin’ Larry long ago and got off the modern financial Ponzi grid.  It is really so simple:  pay off debt, own insurance in the form of gold, have ample cash as long as confidence remains in fiat currency (don’t fool yourselves, this confidence remains embedded), become involved in productive endeavor whenever possible, and with an inner smile that comes from knowing you’ve done your best to get your house in order, go forth and speculate if you so choose.

To summarize the NFTRH stance, I would say that the structure of the macro situation is that of a deflationary continuum against which free license is given to policy makers to continue their regime of inflation on demand.  Every time there is stress in the system (i.e., the U.S. credit contraction in 2008, or the European one in 2010), inflation – in the form of debt-based money supply ramp up – is brought forth.  This cannot continue forever, but it takes a greater thinker than myself to be able to call it a wrap right here and right now.  Eliminate debt, own value and pursue productive endeavor.

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Comments on this entry are closed.

Pat Nicholson June 26, 2010, 7:33 pm

Rick, I spoke with you at Melinda’s last eve. I was the conservative screaming maniac. Still am. I constantly decry the lack of common sense these days. It is nice to see that it still exists on your site. Your posters have given me a mental inferiority complex, but I will continue to read none the less. My best to you and your lovely wife. Patrick

constman June 26, 2010, 1:57 am

Rick it has been awhile since I have commented. A while back, on some excellent advice, I decided to concentrate on my “productive endeavor”. Its been quite fruitful. I made huge cuts in my staff and got to the business at hand. Making money at what I do best, building things that people need. I decided that to be a victim of a bad economy was a worthless endeavor and I am much better at building than trading!!!

I have far fewer competitors today than 3 years ago, and as far as I know farmers are still farming, manufacturers are still manufacturing, people are still going to the grocery store to buy groceries etc…… Commerce is still occurring and has been for thousands of years. Be productive, eliminate debt and buy some gold sounds like sound, simple advice. Additionally I will add, be a man, take care of your family and your business and the things that need to be done today. Today has enough trouble of its own, so why burden yourself with tomorrow’s worries when you can only deal with today. You are not even guaranteed a tomorrow.

Rich June 25, 2010, 6:53 pm

Bot some GE…

Rich June 25, 2010, 6:47 pm

Bot some DIS…

Steve June 25, 2010, 4:41 pm


Thanks for keeping the conversations going.

gary leibowitz June 25, 2010, 3:22 pm

Were there bouts of inflation from the post-deflation era of the 30’s? This time around the world is struggling with huge debt and new government austerity programs. Without a gold standard, I don’t see it rising to the levels most anticipate. I also don’t see how we can have bouts of inflation thru all this.

My stubborn stance, like that of a lot of deflationists, has been wrong on Gold’s recent rise. I still think that once the world falls into a synchronized deflation, Gold will not be the safe-haven everyone thought it would be.

I also think the most profitable vehicle in these times would be cash. Just as those who hoarded cash in the 1930s were able to buy real estate for a song.

BTW, it looks like the turn-date might actually be a temporary low. If we break below 1020 on the SPX I would expect a 2 week rebound. This is why using the fibonacci turn-dates can be very frustrating.


My point of view is closer to yours, Gary L., than to Gary Tanashian’s. I see deflationary forces as completely overwhelming whatever relatively puny, countervailing measures the central banks are politically capable of implementing. I say “politically capable” because a decision to ramp up inflation efforts to hyperinflationary levels would be tantamount to destroying savers and creditors (i.e., Goldman Sachs et al.) as a class.


Rich June 25, 2010, 4:21 pm

In gold some trust.
Gary brings up a good point re the 30s:
FDR did the bank holiday and confiscated gold in 1933 right after sworn in on 4 March 1933 (back then they were in less rush to assume the presidency.). Once he had the gold he devalued the dollar ~75% by raising the gold price from 20 and change to $35 poer his Keynesian economic advisers who, like today, thought a cheap dollar would stimulate the economy and trade.
It accomplished little then as now.
There was a brief filip of 7% CPI and that was it.
There was declining monetary velocity as now.
Demand declined during deflation as now. Hyperinflationistas may have it wrong.
More dollars may not matter anymore pushing on a string.
No demand, no price inflation.
Applies to houses, precious metals, stocks.
To increase demand to pay bills with a declining supply of dollars raises the price of the currency.
Per Cam the other day, austerity being the code word for deflation/depression. MacFrugal is back…


The most likely scenario for a hyperinflation begins with a very steep increase in Treasury-debt purchases by the Fed, triggering a panic out of dollars into gold first, and then into all else of real value. RA

Benjamin June 25, 2010, 7:10 pm

Mr. Leibowitz,

If you want to never be surprised by gold again, look again at that 30 year bond chart. When bond yields fall, price rises. Market panics cause interest to drop, yes, but over the past 30 years Treaury prices have been in a bull and it wasn’t all panic.

The answer as to why gold is so strong is for the same reason govt. debt falls in yield/rises in price. The central banks have been buying all these years, hedging against their own inevitable failure.

mario cavolo June 26, 2010, 6:39 am

Hi Gary “I also think the most profitable vehicle in these times would be cash. Just as those who hoarded cash in the 1930s were able to buy real estate for a song.”

The issue with this is the continuously declining purchasing power of that cash. Find me an asset to store asset value, whether it be a currency, gold, oil, corn, a building in a certain location, or peanut butter, which at least maintains its relative value and at best grows in relative value. I don’t think cash is it, seems so safe but in fact, a loser. Scary times.

Rich “Demand declined during deflation as now. Hyperinflationistas may have it wrong.”

The new circumstance relative to history in this regard is that the rich have become SO much richer worldwide; yes in the U.S. and most dramatically here in China; For example, imagine 5-7 years ago there were 400 million apts owned, worth US $30-40k with NO mortgages and now they are worth five to 10 times that. Add it up.

So then the influencing issue is whether they will hoard it or spend/invest it. If too much of it just sits there then we’re headed for a global version of Japan.

Cheers, M

Benjamin June 25, 2010, 12:23 pm

I don’t believe I’ve ever had the privilege of reading any other of Gary Tanashian’s work, but this was simply outstanding! Very thought provoking as well…

“I have little doubt the game will end very badly one day soon, and it is open for debate as to whether the resulting depression will be deflationary or inflationary. ”

Don’t we all wish we knew…

Rich June 25, 2010, 5:32 am

Brilliant model of what’s really going on within a general Jubilee Generation winter deflationary economic trend with lower long-term rates since 1981, punctuated by periodic quasi six month gestational neoKeynesian inflationary and deflationary spasms.
The last one in 2007 took gold up from 550 in August 2007 to 1033.90 in March 2008 to 681 in October 2008 to 1007.70 in Feb 2009 to 859.90 in May 2009 to 1226.40 in Dec 2009 to 1048 in Feb 2010 to wherever it tops around 1310 around August 2010.
Alan Greenspan used gold as a proxy for real interest rates to loosen and tighten the monetary base, currently having slowed at a -90% annual rate and signaling the next bout of deflation.
Must be fun to be a master of the universe playing with the world’s money supply to inflate, deflate and foreclose assets.
Gold, Bonds, Silver and Stocks may hit new lows this time around.
As Leviticus knew, usury does not end well for all…

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