Tweet
 |
Oh, no! Not the Inflation vs Deflation debate again!
by Eric Janszen
The Fed’s greatest challenge is that the need to create an inflationary firebreak between crashing asset prices and the real economy has become so obvious that Wall Street money managers are starting to pile into the inflation bet en masse.
Among the items in my inbox this morning was a column by my friend Rick Ackerman. Published today under Rick’s Picks below the tag line – paradoxically, in light of the column that follows – “Phenomenally accurate forecasts” is the article “Reality-Check for Inflationists.”
The note was dropped as bait for me and others on the email list to enjoin the seemingly endless inflation versus deflation debate that I promised myself I’d not go back to after the last exchange with others in the same camp as Rick. Yet here I am biting like a Yellowstone trout on a curly tail grub. I just can’t help myself. Also on the mailing list was my friend Mike Shedlock, among other contrarian bloggers of various political persuasions, who are variously believers in either an imminent deflationary spiral or hyperinflation.
iTulip, it is worth mentioning, has for years tried to carve out a political position best labeled by one of our members as Libertarian Pragmatist. We are pro-entrepreneur and so libertarian leaning yet our views on free markets are informed by the historical fact that the concentration of wealth and power that develop in free market systems inexorably leads to conflicts of interest, market failure and crisis. If things get bad enough politicians are exhorted by voters to kill the entrepreneurial golden goose in the same shotgun blast that socialist policy aims to take out crony capitalist fat cats. The slaughter of both geese and cats may follow soon after November elections, depending on how much unemployment is created by the recession that is being produced by the credit excesses of the past seven years.
From my perspective as an entrepreneur, after running two venture capital backed companies and now the modest iTulip, Inc. empire, for a total of 20 years' start-up company experience, and also from three years on the money side of the table funding start-ups via venture capital, I conclude: the left needs to learn the critical importance of entrepreneurs in the economy and that the measure of any economy’s health and promise is the degree of accommodation its tax laws, financing environment, and financial markets offer entrepreneurs. After all, it is not government or large corporations that drive invention and economic growth, and it is always small business that pulls a nation out of recession; entrepreneurs take enough risk in the marketplace without taxes and other impediments thrown in their path by government.
The right, on the other hand, needs to learn the importance of respect for the poor, the uneducated, the folks not born on third base. I don’t mean coddling or hand-outs, I mean policies that convey respect and more effectively produce greater equality of opportunity without trying to produce equality of result. The epitome of what I don’t like about the attitude of the right toward the poor is summarized in Margaret Thatcher’s comment that any man who finds himself riding a bus to work at the age of 26 can count himself a failure. The man or woman competently attending Thatcher’s bed pan in her final days will not arrive at hospital in a Ferrari, and an optimist might hope that Thatcher in those final days have some appreciation for the orderly’s care, and if she is thinking clearly and honestly with some prodding may be able to make the philosophical leap to extend that appreciation to all working people, those who do their jobs – important and unglamorous – yet are not compensated well enough to buy a car.
Respect.
But I digress. Back to Rick’s latest deflation versus inflation fishing expedition. So far the fishing’s been catch-and-release. Let’s see if we can’t land this baby once and for all and have it for dinner.
If you are a subscriber you can read Rick’s column here. I’ll post the relevant bits.
A Reality-Check For Inflationists
Can you see the sky from where you are sitting right now? If not, go outside and look directly above you. Are there any $100 bills wafting your way? We didn’t think so. So much for the theory that “Helicopter Ben” would shower America with printing press money if something ever went seriously wrong with the economy. And no one could doubt right now that the economy is indeed in serious trouble -- so serious, apparently, that even the optimists are starting to admit that they see no end to falling real estate prices, one of our bigger problems.
So the question naturally arises, why is the Fed letting this happen? Haven’t we always been told that the central bank would never, ever let the economy collapse – that it would pull out all the stops to prevent it? Well, the fact is, the Fed has been pulling out all of the stops – most recently yesterday, when its chairman admitted that no policy other than more easing is being contemplated in an effort to reverse the country’s steepening plunge into recession.
Like the inflationists, we have never doubted the Fed would attempt anything and everything in its power to prevent a financial disaster like the one that is currently unfolding. Where we long ago parted company with the inflationists was on the question of whether the central bank’s efforts would succeed. For as long as we can recall, the inflationists/monetarists have reassured us that the “Fed would never let it happen.” However, we became convinced more than a decade ago that debt had grown far too large to manage. That it appeared to be manageable until recently was due solely to the misplaced trust of both borrowers and lenders. Once that trust began to erode, we reasoned, no monetary stimulus short of hyperinflation could possibly reverse the trend. Nothing we’ve seen so far has changed our mind.
Evidence Accumulates
So, what Helicopter Ben appears to have achieved using measures that even we would concede are hyperinflationary is: nothing. The banks might be able to pass themselves off as solvent, provided the auditors are in on the con. But merely making the lenders appear not to be bankrupt has done absolutely nothing to achieve what the Fed had set out to do –i.e., re-kindle the housing boom. In fact, even though mortgage rates have trended lower, the lenders have been under great pressure to tighten their standards. The result is that, on balance, demand from home buyers has continued to fall.
A ‘Crushing’ 5% Mortgage?
We predicted here long ago that, at some point, a seemingly “low” 5% mortgage would become a crushing burden on borrowers. That day has arrived. For if the underlying asset itself –i.e., one’s house – is depreciating in value by as little as, say, 2% per year, that would subject the borrower to a real-rate burden of 7%. Even hedge funds aren’t returning that kind of money these days. Far from it. So just imagine what kind of burden tens of millions of homeowners face as they become suppliers -- to someone else -- of 7% yields.
For inflationists, it’s time to face the music: The Fed can no more reverse debt deflation than it can reverse global warming. As to the theory that a hyperinflation lies ahead, this crackpot idea is so absurd that we would not dignify it by taking the other side of the argument. For what it implies, after all, is that we – you and I, and our neighbors – will eventually get to pay off our $250k mortgages with the money we receive from selling our homes for quadrillions of dollars. Yeah, sure. But until it happens, the spurious logic of inflationists and monetarists deserves no claim on our attention. The notion that the Fed could somehow ameliorate the staggering burden we face in having to pay off tens of trillions of dollars of debt is proving to be one of the most dangerous ideas ever to gain sway over our economic lives.
That captures part of the argument. Again, I encourage readers to read the whole column here.Can you see the sky from where you are sitting right now? If not, go outside and look directly above you. Are there any $100 bills wafting your way? We didn’t think so. So much for the theory that “Helicopter Ben” would shower America with printing press money if something ever went seriously wrong with the economy. And no one could doubt right now that the economy is indeed in serious trouble -- so serious, apparently, that even the optimists are starting to admit that they see no end to falling real estate prices, one of our bigger problems.
So the question naturally arises, why is the Fed letting this happen? Haven’t we always been told that the central bank would never, ever let the economy collapse – that it would pull out all the stops to prevent it? Well, the fact is, the Fed has been pulling out all of the stops – most recently yesterday, when its chairman admitted that no policy other than more easing is being contemplated in an effort to reverse the country’s steepening plunge into recession.
Like the inflationists, we have never doubted the Fed would attempt anything and everything in its power to prevent a financial disaster like the one that is currently unfolding. Where we long ago parted company with the inflationists was on the question of whether the central bank’s efforts would succeed. For as long as we can recall, the inflationists/monetarists have reassured us that the “Fed would never let it happen.” However, we became convinced more than a decade ago that debt had grown far too large to manage. That it appeared to be manageable until recently was due solely to the misplaced trust of both borrowers and lenders. Once that trust began to erode, we reasoned, no monetary stimulus short of hyperinflation could possibly reverse the trend. Nothing we’ve seen so far has changed our mind.
Evidence Accumulates
So, what Helicopter Ben appears to have achieved using measures that even we would concede are hyperinflationary is: nothing. The banks might be able to pass themselves off as solvent, provided the auditors are in on the con. But merely making the lenders appear not to be bankrupt has done absolutely nothing to achieve what the Fed had set out to do –i.e., re-kindle the housing boom. In fact, even though mortgage rates have trended lower, the lenders have been under great pressure to tighten their standards. The result is that, on balance, demand from home buyers has continued to fall.
A ‘Crushing’ 5% Mortgage?
We predicted here long ago that, at some point, a seemingly “low” 5% mortgage would become a crushing burden on borrowers. That day has arrived. For if the underlying asset itself –i.e., one’s house – is depreciating in value by as little as, say, 2% per year, that would subject the borrower to a real-rate burden of 7%. Even hedge funds aren’t returning that kind of money these days. Far from it. So just imagine what kind of burden tens of millions of homeowners face as they become suppliers -- to someone else -- of 7% yields.
For inflationists, it’s time to face the music: The Fed can no more reverse debt deflation than it can reverse global warming. As to the theory that a hyperinflation lies ahead, this crackpot idea is so absurd that we would not dignify it by taking the other side of the argument. For what it implies, after all, is that we – you and I, and our neighbors – will eventually get to pay off our $250k mortgages with the money we receive from selling our homes for quadrillions of dollars. Yeah, sure. But until it happens, the spurious logic of inflationists and monetarists deserves no claim on our attention. The notion that the Fed could somehow ameliorate the staggering burden we face in having to pay off tens of trillions of dollars of debt is proving to be one of the most dangerous ideas ever to gain sway over our economic lives.
Dear Rick,
The argument is not between your expectation of a deflation spiral resulting in negative CPI and falling all-goods prices, the standard definition of deflation, versus hyperinflation resulting in greater than 20% annual CPI and rapidly rising all-goods prices, the standard definition of hyperinflation. Framed that way, both sides will lose; neither outcome will come to pass.
We agree: the Fed cannot do anything to stop asset price deflation. As we forecast in Dec. 2005, housing prices will fall for another five to seven years.
We disagree: you are entirely focused on the relationship between demand for goods and the money supply. You are not considering the demand for money versus the supply of money. The Fed can manage and so far has managed the debt deflation by lowering the denominator in the equation that determines all-goods prices: the supply of money relative to demand.
With so much debt overhang, the iTulip forecast since 1999 (Ka-Poom Theory) is that after asset inflations eventually end with asset price deflation the Fed without the constraint of a gold standard is not going to throw the economy into a depression by doing what it did in the early 1930s under the gold standard: failing to supply enough money to meet demand in the so-called “real economy.” The Fed continues to manage the money supply to exceed demand even as both goods supply and demand are falling during this recession.
Why are they doing this? They have no choice but to follow policies that are now producing inflation. Perhaps the Fed hopes the recession will eventually produce enough unemployment and loss of pricing power by wage earners to prevent nascent wage inflation from closing the inflation loop, thus inflation pressures will abate. Pure speculation, of course, that gives the Fed far more credit for foresight than has been demonstrated in the recent past, not to mention that if the folks at the Fed in fact believe this they are nuts. The root of the inflation we are experiencing is a weak dollar and rising import prices, especially energy.
Energy demand has been declining in the US along with all OECD nations where prices are not subsidized by government as they are in China, India, and oil producing countries where demand is as a result rising. On net oil demand globally has since 2004 increased 2% per year yet prices have skyrocketed. An economist who believes that recession will reduce inflation in the face of ongoing dollar depreciation is at the disadvantage that no supporting evidence whatsoever exists to support the belief. He or she should instead take a look at the experience of every other indebted nation on earth that has ever attempted to use currency depreciation as a long term policy tool. The result is always the same: inflation.
You see, the Fed’s greatest challenge is that the need to create an inflationary firebreak between crashing asset prices and the real economy has become so obvious that Wall Street money managers are starting to pile into the inflation bet en masse. (See Shayne McGuire: The Early Innings of a Gold Boom.)
The Fed will continue to get lots of help in this firebreak effort from a depreciating dollar. Check it out: the dollar was pushing 73 today. Not that long ago 80 was the End of the World yet here we are, still standing, and the dollar is still falling.
This is the essence of the “Poom” argument, that all of the money needed to produce all-goods price inflation has already been printed and resides overseas in foreign government and private accounts. It’s the money we spent on the wars, entitlements, and everything else. A tidal wave of inflation is held back only by dollar demand created by co-dependent governments overseas. The surprise that I did not anticipate is that the “Ka” disinflation and “Poom” inflation are happening simultaneously.
How well have our respective forecasts held up since March last year when you and I debated?
At the time you and Mike were both calling for “deflation” by which at the time you said you meant all-goods price deflation. Housing prices will crash and haircuts and cars and so on will get cheaper. I see you’ve modified that somewhat and now refer to “debt deflation” versus CPI deflation but you need some help with the debt deflation term as well. Monetary inflation with loan restructuring is one of two possible forms of debt deflation, the other being monetary deflation, loan defaults and write-offs. Of course loan restructuring and loan defaults and write-offs can happen at once, but loans tend more to be rolled over during periods of inflation than they are written off.
I tried to explain to you then that from a monetary management standpoint asset prices within the FIRE Economy and all-goods prices within the Production/Consumption Economy are from a monetary management standpoint managed separately by the Fed. We learned this last year from an economist named Dr. Michael Hudson. (We did a follow-up interview with Dr. Hudson recently, published tomorrow.) Now I get the distinct impression that his opinion has been discounted in economics blog circles, largely libertarian, because Hudson’s policy solutions are anathema to fans of small government. I don’t agree with a lot of Dr. Hudson’s prescriptions but no one is better qualified to explain how the monetary system and economy actually work. You don’t have to buy into the big government solutions to appreciate the depth of his experience and understanding. Figure his political economic model into the models we’ve been talking about on iTulip for years and you can develop a highly tuned forecast of future economic developments.
I don’t see a hyperinflation happening in the US as in Argentina in the 1990s. Again, that’s a false choice: deflation or hyperinflation. Unlike the Argentine peso, the US dollar is a reserve currency and US debts are denominated in dollars. If you think of the dollar as a common share of USA, Inc. – James Sinclair over at JS Mineset came up with that analogy years ago – think of the dollar decline process as major shareholders in China, Japan, and oil producing countries slowly selling out their positions rather than engaging in panic selling leading to a price crash.
As long as long term interest rates remain below the rate of inflation, commodity prices will continue to rise until the debt deflation runs its course. You point to 5% mortgage rates. There you have the impetus for the commodity price increases: you’re losing money on bonds earning 5% when true CPI inflation, versus the phony numbers, is over 5%. This is why so much money is flowing into commodities. How will this end? Do you see a Paul Volcker standing by ready to crank rates above 6% or whatever the CPI really is as real estate, stocks and bonds get pulled down by asset price deflation? What, you don’t think the Fed learned it’s lesson from the 1930s or Japan in the early 1990s? Short rates are going to zero and long rates, driven by liquidity, will continue to fall. As long as they do inflation and commodity prices will continue to rise.
Which reminds me, April 9, 2008 I’ll be on a panel at a wealth management services event at the New York Athletic Club with Barry Ritholtz of The Big Picture and Henry Blodget of Silicon Alley Insider. With blog title entries like Boneless Bernanke: Why Ben Has to B.S. Congress and Ben Bernanke and Arthur Burns: Separated at Birth something tells me Henry and I are going to being agreeing more than arguing.
A year ago in our debate I told you that asset prices – specifically real estate, mortgage bonds, corporate bonds and stocks – were going to fall and that as a consequence of the Fed’s response to falling asset prices we’d see commodity price inflation take off.
To your credit you told your readers to not buy gold because in a commodity price deflation gold prices fall. Not that this was particularly profitable advice but at least it’s consistent with your expectation of falling all-goods prices. Mike on the other hand also expects falling goods prices but for some reason at the same time recommends gold. Very odd.
So here are the facts: Since our debate a year ago the market for funny mortgages blew up, housing prices are collapsing, unemployment is rising in 48 states, and the US economy is by any serious account in recession, all in line with what you and I agreed on at the time. But... also when we talked, silver, gold, platinum, and oil were trading at $13, $650, $1040, and $70 respectively. Now they are trading at $19, $960, $2130, and $100. (Wish I’d bought more silver and platinum!)
Now for that lure you dangled in front of us: Here we are a year later with deflating asset prices and inflating commodity prices and you're declaring victory?
Let’s face it. Your forecast of CPI price deflation a year ago was incorrect, defective, erroneous, misguided, and wrong.
Consider this deflation fish caught, gutted, poached and eaten. Wonder what the other guys are going to say?
iTulip Select: The Investment Thesis for the Next Cycle™
__________________________________________________
For the safest, lowest cost way to buy and trade gold, see The Bullionvault
To receive the iTulip Newsletter or iTulip Alerts, Join our FREE Email Mailing List
Copyright © iTulip, Inc. 1998 - 2007 All Rights Reserved
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Nothing appearing on this website should be considered a recommendation to buy or to sell any security or related financial instrument. iTulip, Inc. is not liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. Full Disclaimer
Comment