Inflation(ists) vs. Deflation(ists) - Part II

I want to follow-up last week’s Inflation vs. Deflation post since the debate is of the utmost importance, financially, socially, and politically. Not that there are quick, microwavable answers. But I appreciate everyone's attempts so to all who contributed their opinions, be they intellectually-argued, divinely-inspired, dogmatically-held or viscerally-based, thank you.

This is admittedly a bitchy post. Gore Vidal bitchy. I don’t know why. Perhaps it is because when the camps are clearly drawn, caricatures and archetypes are easily derived. Yet we all fight against our biases, so bitchy as it is, I hope sensitive souls will take barbs and less-than flattering generalizations merely as a call to examine our biases and predispositions.

Here is what I've garnered from on and off-line comments after distilling them down;

1. Liquidationists - contrary to Hayek himself (tnx Sean!) - probably underestimate just how unpleasant and un-civic unfettered unwinding of current untethered debt-to-GDP ratios would be. I wouldn’t be surprised to discover that liquidationists are more predominant in "safe” jobs, or perhaps no jobs. They have a sense of moral outrage at [other] people gaming the system (which I share) that exceeds their moral outrage at the human cost of unemployment, chaos, lawlessness, and mob-rule (which I do not). But interestingly, amongst the ranks of the liquidationists are those that have themselves gamed the inflationist system, but like Mark Cuban, have abandoned the carousel and now wish to protect their gains against dilution so are pleased to maximum pain. They may call themselves deflationists, but they shouldn’t be confused with them since this lot has a parochial interest, be it morally-driven spitefulness or relative financial gain from finally being rewarded for their prudence and parsimony…provided the system doesn’t implode too too much.

2. Inflationists are buffeted by a determinism of actions and events; cause and effect - a sense of inevitability that is - I will posit - seductive like a Caribbean beach, Marx’s manifesto, or in hypothesizing a closed-form solution (without proving it) in having conjured logically plausible answers, but without (it seems to me), the intermediate-term lattice. “We ARE going to point "C" (Zimbabwe) from point "A-and-one-half" (where we are now) because of this and that, (always involving a moon-shot for Velocity) but point "B" is under-explored whether because it’s been assumed out of existence by adopting jump functions, or multiple paths that lead to the same place. But as an investor, first and foremost, I am terribly interested in point B which is actually more important [to me] than point-C, as many-a-hedge fund manager (and their investors!) with the long leveraged correlated complex of anti-dollar trades has learned in Q3 and Q4. Interestingly, many in this camp are NOT economists, which given the record of economists, I do not hold against them. But there is something admittedly cult-like about The Movement and its members. Not that it makes them wrong, or less likely to be right. It may make them more likely to be right for I may be confusing that thing which is akin to Mormon certitude, the tsk tsk tsk head-shaking by The Faithful at The Sinners, for what may be simple visionary-ism.

3. True deflationists, to some extent, have the easier path to defend since they will be right sooner or later, as even hyperinflation will "bust" eventually yielding to the very deflation authorities tried to avoid. Cheating (i.e. leaving the forecast period open) apart, deflationism CAN defensibly share reality with eventual inflation, though the hyperinflation feared by some is more difficult to reconcile with the “big-D”. But timing IS everything, and the shorter odds of the deflationists IMHO result from the inflationists might easily being off by a factor of several years - longer than one can continue to continuously post variation margin, longer than counterparties can remain solvent, and not before the assets expressing the pure and extreme view halve again (note: that is an alternative scenario – not a prediction). Which in almost any book, particularly a trading book, would make it wrong. They try to be agnostic (vs willfulness of liquidationists) this is not their true way. For most deflationists are, it must be pointed out, pessimists by nature. Maybe they are not perma-bears (not that there is anything wrong with that in Japan), but for many of the deflationists, have been waiting for this since 1987 .... and 1994.... and 1998....and 2002. You don’t even need to have the sound on when a deflationist comments for their body language gives away their inherent sense of worry. Their brows are more furrowed. Skin more pitted. They would never be caught dead in a bow-tie. And so one wonders: are they right in spite or because of themselves?

4. There are nuances. I am what [astute] reader-commentator (and unabashed inflationist) David Pearson terms "a deflationist overshooter". This is articulated or perhaps only implied in the original post, and reckons that: the weight of de-flation (de-leveraging, de-risking, precipitously de-clining core asset prices, de-capacitating financial system distress, de-employment shocks, secular de-consumption (savings) ratios, even demographics) trumps any triage, stitching or even bionic limb replacement conjured by central banks and Keynesian stimuli, by a large magnitude. And, this view conjectures, that by the time even the most interventionist authorities comprehend this, it will be too late for the inflationist "V" to ripen. AFTER that (two years?!? three?!?) when the majority of purge may be complete, and only then (year prior to re-election year 2012?) will the drastic measures be taken, which will be overkill and could very well/will lead to above trend inflation. Not hyperinflation. Above-trend inflation. It understands – as Jeremy Grantham suggested last weekend, that solutions will - like reducing greenhouse gases - likely require multiple types of adjustment including falls and write-downs in asset prices (particularly debt); debt-for-equity swaps, copled with some rise in nominal incomes and price indices. But like the deflationists, this view is predicated upon tinder being too wet to combust (again thanks David for the correct terminology), and authorities – in this new paradigm – having the impetus and fortitude to “do the right thing” in the heat of the moment, which, if recent history be the example is as likely or difficult as it is for one party living up to pre-coital promises in another universally-known heat-of-the-moment act.

5. Most comments have been yankee-centric - perhaps mirroring readers interests and geography. I can warm to risk appetites returning when Global ZIRP arrives and begins to push the mountains of cash investors hold, further out on the risk curve. And global fiscal packages diminish the nominal falls and begin - not necessarily to get traction - but just stabilize things. NOT intermediaries, or leveraged punters, but owners of capital whose initial forays will resemble a tug-o-war with the ongoing deleveragistas, happy to finally catch a bid in something. Don's comment was a good one. It highlights the historical assumption that the developed world would eventually close in on us, by rising to our level - not by dragging us down. But globalization is at least partially about convergence, and the leverage in the west papered over fundamental unsustainabilities about such rosy western convergence notions that must be confronted in the absence of cold-nuclear fusion, flux capacitors and unlimited resources.

We are between the proverbial rock and hard place; Scylla and Charybdis; or a fat arse and an cement park bench, and so there are no good solutions…only less bad, and probably more socially expensive ones.