Wednesday, January 28, 2009

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.


Anonymous said...

I'm in the deflationists camp.... for the next 2 to 3 years anyway. demand destruction will be too great. The only thing I can see rising is just more hot air from wall street.

Anonymous said...

I've got to chime in, though i'm no economist and own nothing. So i sit in the audience and watch the game unfold. This post by Cassandra lays out the field in such excellent manner that i'm starting to make a little sense on my own opinion.

My gut feeling has been, for more than a year, that it'll be hyperinflation. I never had any real forecast or guess on schedule, just this irrational (seeming) certainty. Any time i've tried to think through the issue, i only get to the stage of deflationist overshoot. After that, my logic fails. There are too many moving parts. And gut feelings that don't have some ladder of logic leading to the conclusion dont' seem that reliable to me. But now that Cassandra has set up the field and enumerated the players, it seems i can see a couple of steps further on the ladder towards hyperinflation.

Deflation, even with overshoot, doesn't look that bad. Return to reality for everyone: painful but inherently good. So why do i think it's not going to stop there? It is because the system is being run by those who depend on showing profit. That profit has been made with a logic that has totally broken down now. It is the leveraged punters who are running the show, and they can't afford to sit out through some dry seasons profitwise, like Buffett can. The leveraged punters will be fighting for their lives - like a drowning person they can end up pulling under the one who's trying to save them. And i don't think they can wait through, say, 2 years of deflation. As to the method, the howto of hyperinflation, i have no idea. I'd guess that the leverage jockeys keep demanding all kinds of actions, and as soon as they notice they're riding something that's not going to win, they will demand something new. And at some point there'll be something that will produce a little win, and the jockeys will start demanding that particular action more and more. And when there's a new game in town that seems to be winning, all will be desperate to join in.

Well, can't say that i have figured it out - just a little elaboration of that gut feeling. I would not be convinced myself if someone presented this as argument for hyperinflation. But we in the audience can afford to entertain these pet theories. I don't have to make profit on it ;)

Anonymous said...

I think the leveraged guys will accept 2-3 years of deflation to buy assets on the cheap. It usually takes that long to build up decent secret positions anyway. The secret cabal (eg. Goldman sachs) with support from Obama will then inflate just in time to take advantage of the next presidential cycle. This is how the rich get wealthly.

Anonymous said...

I'm in the post-coital promises camp. I'll call you in the morning.

Charles Butler said...


Interesting that both the liquidationist and inflationist camps are proceeding from a belief in the very appealling biblical event known as 'apocalypse'.

In the first case, the falling apart of the order would be a natural confirmation of the 'righteous inheriting the earth'. That is all well and good, but I'm sure most are resigned to it never happening.

The inflationists, on the other hand, seem to be working backwards from the assumption that the 'end' is inevitable and then backfilling the data to prove that the present is the immediate preamble to that. In terms of the structure of the argument made to back up the point, almost all proceed from evidence to conclusion rather than starting from the hypothesis. Note that this is the same method used by both kangaroo courts and Amway distributorship pitches (not to mention religions in general). Naturally, there is also a very marked tendency among adherents to not view doubts concerning the data backing the thesis as a threat to the belief itself. No surprise that one single solution, gold in this case, is seen as adequate.

Not immune to the construction of froot loop notions myself, my take is that we already had our rampant inflation, beginning at the bottom of the Volcker recession and ending right now. Artfully masked by both outsourcing and by the belief that the technological 'revolution' was delivering more for our money than it was costing (or, stated otherwise, that paying for its religiously believed-in benefits with future earnings was a win-win strategy by any measure), persistent and strong increases in the cost of living only showed up in the US savings rate - a curve that any non-believer would interpret as indicating rampant inflation.

For the very simple reason that deleveraging results in there being less money, I am firmly on the side of deflation, although I can imagine the opposite becoming politically and socially desirable at some point in the next decade.


In defense of the goldbugs, I love the metaphor (inadvertantly, I'm sure) embedded in images of 1920's Germans pushing wheelbarrows of money off to the bakery. Not particularly different from schlepping a wallet full of plastic to Circuit City to upgrade your Fox News delivery system, is it?



Unknown said...

"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."

Once US and UK workers realize how trade policy intentionally gives up more than it gets them personally, things will get interesting. Next time someone like Laura Tyson argues with someone like James Goldsmith on Charlie Rose, I imagine Rose will be a lot more skeptical of arguments made by the Tyson types.

I'm not in favor of liquidation. I am in favor of supporting firms useful to society to prevent them from going under. However, I am opposed to shareholders and creditors benefiting from the process, when the government bails out their firm; helping them encourages corruption, incompetence, and mindless index fund investing.

datadave said...

Deflation for the underclass, Inflation for the upper class. And then it (inflation) will trickle down. Lower wages, less jobs and eventually higher prices (after low prices for a while.) Look at where gasoline's going. But jobs are hard to come back.

All in all, pandagirl's opinion is mine...first deflation for a year or so then inflation. (not a good time to buy gold yet but??? that goldbug guy a year or so back might have been right.. esp. if bought two or three years ago...but now? Looks like nothing out there to invest in. ).

It really sucks to be poor or middle class in America doesn't it?

Anonymous said...

Nice summary.

I'm starting to think that Bernanke & much of anti-deflationary conventional wisdom are suffering from a kind of logic fallacy - that is, because we've learned from the mistakes of the great depression (Smoot-Hawley, letting the banks fail, remaining on the gold standard too long, trying to balance the federal budget, not growing the money supply fast enough, etc), we won't go down the same deflationary path.

Now I'm not saying we will go down the same deflationary path, either, but just because we're tweaking a bunch of macroenomic dials very differently doesn't guarantee against deflation (a caveat: I suppose the Fed does have a an all-out thermonuclear deflation war buttom that mobilizes the helicopter fleet to spectacularly debase the currency, but when/if the choice comes to THAT, I wouldn't be surprised if Dr. Ben chooses to keep the 'copters on the ground).

As noted, I'm wondering if the deflationary pressure of the massive deleveraging the US (and other developed markets) is facing is so overwhelming that even the optimal macroeconomic policy doesn't nothing more than slow the process down a very small amount.

Or not.

Anonymous said...

Nice summary.

I'm starting to think that Bernanke & much of anti-deflationary conventional wisdom are suffering from a kind of logic fallacy - that is, because we've learned from the mistakes of the great depression (Smoot-Hawley, letting the banks fail, remaining on the gold standard too long, trying to balance the federal budget, not growing the money supply fast enough, etc), we won't go down the same deflationary path.

Now I'm not saying we will go down the same deflationary path, either, but just because we're tweaking a bunch of macroenomic dials very differently doesn't guarantee against deflation (a caveat: I suppose the Fed does have a an all-out thermonuclear deflation war buttom that mobilizes the helicopter fleet to spectacularly debase the currency, but when/if the choice comes to THAT, I wouldn't be surprised if Dr. Ben chooses to keep the 'copters on the ground).

As noted, I'm wondering if the deflationary pressure of the massive deleveraging the US (and other developed markets) is facing is so overwhelming that even the optimal macroeconomic policy doesn't nothing more than slow the process down a very small amount.

Or not.

"Cassandra" said...

Bulls-eye Charles.

For those who're not familiar with Charles' ciber-lecturn, you will find him at at IBEX Salad.

Kristiina - after reading your comment, I was thinking about you, and whether your view from Finland amongst The Sensible Stoic People was nearer or farther from the so-called "epicentre" - you know, a resource-sensitive economy adjacent to implosion of emerging baltic and the caning of Russia (except on the tennis court). But the more I thought about it, there ISN'T an epicentre. Your interest in all this remains enigmatic to me...

Anarchus - the real question is who and/or what can return the debt-to-GDP ratios to sustainable levels?!?! The answer is (as MacroMan pointed out yesterday, is Time. Time coupled with some inflation. And "more-better" if one actively eliminates it through writedowns, debt-to-equity conversions.

One other question that's been nagging me about Grantham's Debt-to-GDP chart. IF so much debt is now discounted in the market place, and written off or wrtten-down or marked to market, then the actual present value has began to reasonably compress. But all the aforementioned things will happen. The scale and time-element however do seem to make the inflationist fears a distant worry.

Anonymous said...

I think the categorization lies along 2 fundamental questions
1) Can the actual Asset/GDP ratio be sustainable worldwide ?
If yes to 1), one can imagine a deflation "Japan-like" that drags along for years. Not gilded age, but a game of musical chairs where the ones that found a seat when the music stopped live quite well at the expense of the ones who didn't. (in Japan, think farmers and retirees in the first category, and young middle class workers in Tokyo for the second). As such situation requires strong social cohesion so that the "losers" accept their fate, I am not sure it can be extrapolated outside Japan.

If no to 1) the ratio has to come down. Then the question is to know which asset class must share the pain.
Only concentrating it on houses and shares is not enough IMO, so the bonds have to come down too when compared to GDP.
It can occur through default (Great Depression deflation) or through general elevation of price level without corresponding augmentation of yield (70's or post war's inflation). This is indeed a political decision, and it is difficult to predict the outcome.

Unknown said...

"It can occur through default (Great Depression deflation) or through general elevation of price level without corresponding augmentation of yield (70's or post war's inflation). This is indeed a political decision, and it is difficult to predict the outcome."

It cannot occur through general elevation of price level as long as there is global wage arbitrage, allowed by GATT, GATS, etc. Price elvation and stagnant (much less declining) wages lead to civil unrest, politicians getting voted out, etc.

K T Cat said...

What makes you think you have a choice? We've all enjoyed things that we haven't earned and now the debts have piled up to the point where we can't ignore them. Any way you twist and writhe, you're going to have to pay them off.

Anonymous said...

Dear Cassandra,
I have this perversion: watching us economy. I know normal people watch porn or sports on tv, but i find that incredibly boring. Whereas the intoxicating craziness of economy is endlessly entertainig for me. I know its not normal and most of the time i hide this interest. And i understand that i should not interfere when serious people try to figure out how to make money... But maybe you know how the flesh is weak. Or, i guess, in this case, mind. My mind wants to chew on things, preferably impossible things. And as to sensible stoic people: it sounds good but there's no such thing. We finns experience the world as a wood chip on high seas.

Anonymous said...

One thing I feel that's lost in the debate and ignored by the talking heads who lament the "worst economy/financial crisis/meltdown/etc since the Great Depression" is that we have a fiat currency regime. Past meltdowns, arguably even 73-74 meltdown, have been collateralized monetary regimes. Bernanke's October 2002 watershed speech explicitly espouses the printing press as an effective means to preempt deflation. I'm of the view of 1-3 years of credit deflation and then a structurally higher inflation rate, premium in asset prices, and fiat currency debasement against real assets, goods, services thereafter. Enjoy the dialogue here people

Anonymous said...

The nice thing about being a dastardly liquidationist is that, eventually, you get what you want anyway:

“An essential point in the social philosophy of interventionism is the existence of an inexhaustible fund which can be squeezed forever. The whole system of interventionism collapses when this fountain is drained off: The Santa Claus principle liquidates itself.”
-Ludwig von Mises

The good news, of course, is that it is not the Armageddon that Keynesians like Cassandra make it out to be.

Anonymous said...

Finland is a Eurozone member so I'd say Kristiina's interest should be more than cursory on the issue of deflation/hyperinflation in Europe.

I doubt that the ECB will drop rates below 1%, with 0.75% as an absolute bottom. We only have Japan as an example of ZIRP and I don't see the ECB as courageous/foolhardy enough to put 16 different economies through an empirical study of the practical effects of (near-)ZIRP. I guess that makes deflation somewhat more likely in Europe.

Jesse said...

I might be tempted to suggest that it strains the definitions to call the restructuring and reissuance of a currency after a hyperinflation as "deflation."

The 'camps' make the argument just silly, far from a reasoned discussion, with as your rightly observe people mostly talking their books and beliefs.

In a purely fiat currency regime, a sustained inflation or deflation is a policy decision.

Since few systems in this world are pure, one has to account for exogenous influences and lags.

But it remains, deflation or inflation are the result of policy decisions in a fiat regime. If one does not understand that, then there is no more than can be said, because there is a fundamental misunderstanding of how things work.

"Cassandra" said...

Anonymous said:
The good news, of course, is that it is not the Armageddon that Keynesians like Cassandra make it out to be.

Are you talking about liquidation with a little "l" or an upper-case "L"? What type of Economy and point in history are you speculating upon? Urban, suburban, agrarian, complex modernity or innocence of early industrial times?

While I admittedly have little factual support other than that surrounding the two major depressions ion in American economic history for my fears, so to do you in dismissing them. And "argageddon" was your hyperbole, not mine. I was suggesting however, that whatever it is, it IS underestimated by liquidationists. Benjamin Friedman articulates the positive externalities of growth better than I ever could. But perhaps one of your own also harboured the same fears, and a similar cost-benefit function in analysing State actions in reply to your nice von Mises quote, Hayek said in "Unemployment and Monetary" Policy, Cato 1979 (original IEA 1975)
“If I were today responsible for the monetary policy of a country, I would certainly try to prevent an impending deflation (that is an absolute decrease of the stream of incomes) by any suitable means, and would I announce I intend to do so.” P. 16 (thanks SC for that!)

Anonymous said...

a little point to remember about deflation/inflation is who is hurt and who benefits by either event. Inflation is the seizure of assets from the creditor class and distributed to the debtor class. Given that the creditor class controls the gvmt in most wealthy countries, it is hard to see why they would deliberately destroy their wealth. More likely they will allow that very smallest of inflation so that the debtor class still remains in debt, but is just now able to make her interest payments.

Jesse said...

It is not an idle point, by the way, to understand that in a fiat regime there is a significantly greater latitude in policy decision than otherwise.

That is the point. That is why central banks wish to maintain a fiat regime, and not to be encumbered by an external standard such as gold.

It is also important because once one realizes that it is a policy decision, one realizes that they are not discussing some deterministic outcome based on 'greater forces, but rather on a policy decision, what the governmance thinks "should" be done.

Granted the Fed does not have perfect latitude. There are the restraints of law and the Congress. However, the most legitimate, the hardest limitation in a fiat system is the value of the bond and the dollar. This is the tradeoff that the Fed and Treasury must make in weighing the outcome of their actions.

All this "dopey" backslapping and scoring of points between the 'camps' is particularly obtuse because this monetary chess match is most heatedly being argued about by people who think they are watching a game of tennis.

Yes we will likely see 'deflation' in the short term as the Fed fights the credit collapse, as we briefly saw deflation at the trough in 2002, depending on how one defines deflation. But, make no mistake, the Fed can print money and monetize Treasury debt until the cows come home. They will not do this, because they do not wish to trash the Bond and Dollar. Conversely, they could raise the short term rate to 30% and drain until the dollar was most precious.

Economic Luddites (aka deflatards)resort to imaginary restrictions on the Fed, such as 'they can't do this' or they can't do that. Well, why the hell not?

The Fed "only controls the monetary base" and "doesn't set interest rates."

Yeah the Fed is impotent all right.

The only limitation on the Fed and Treasury are the Congress and the acceptance of the dollar and the Bond in a fiat regime. Period.

And unless there is some greater conspiratorial policy reason, any net debtor that chooses deflation rather than inflation of the means of the repayment of the debt should have their head examined.

Jesse said...

The "creditor class" lives in China and Japan and Saudi Arabia.

One might suspect that the domestically wealthy (note the distinction between that and 'creditor class') would like to channel the bulk of the inflationary effort into their own pockets and benefits for the bulk of the effort before it stops short of hyperinflation.

Hey, we're already there! Isn't it niceto see how things work?

Anonymous said...

Your view of the inflationists is, as you vaguely tip in your introductory paragraph, rather incomplete and Vidal/Wolcott -ian, the latter of which I love, BTW.

But there are the inflationists among us who have no particular religious zeal about it, but rather see it as a logical conclusion given what we perceive as the likely intermediate steps you claim we ignore or fail to elaborate on.

I view this conundrum as I view all decisions in life, investing and otherwise, as best approached by simply looking at a capacity-to-affect-things-weighted assessment of those people and incentives involved and trying to pick which is the highest probability for a chain of their actions and reactions.

In this case, the central problem the US faces is debt, and, as you ably illustrate in another post, not enough productive purposes for that debt. The second most important factor is that there are things that can be controlled and things that can't. And we can assume it's likely that the things we can control will be almost certainly overused in an effort to control the things we can't. In this case, what we can't control is the deleveraging, the collapse speed of the debt bubble pierce, and all the far-reaching micro and indeed macro ramifications of such. What we CAN control, however, is the supply of money that defines the true value of that dollar-denominated debt. Indeed, it appears to be the only tool that can even be deployed in any sort of timely and sufficiently saturated way as to have any effect, as we're already at ZIRP, and the Keynesian/Chicago debate combined with Obama's blessed but, in this case dangerous, desire to compromise seems to make any fiscal tool blunted into some amount of ineffectiveness before it's even swung. (And this latter point, I think, explains why Krugman is so vehement lately: he sees a) that the Mankiw/Chicago view of the world largely got us into this nightmare, b) so their arguments ring absolutely hollow now, and c) we have, because of political realities, probably one chance to get this right, so d) we'd better lay out the rather clear case about how foolish these people are before we go making dangerous compromises that risk making the whole endeavour futile).

Add into the mix a number of other intermediate but important factors such as a) A deflationary spiral is broadly considered to be the most destructive possible force in economics (and this is an easy case to make: a productive enterprises typically take years to build up, but days to crush. So let's do what we can to keep productive enterprises alive. b) We have a Fed chair, who has on any number of occasions come out as strongly against deflation as anyone, c) said Fed chair has his right hand on the printing presses and knows all too well how the controls work (read TAF, TALF....etc), c) an inflation is exactly what's called on to get people's behavior to move out the risk curve, and d) inflation largely passes the near-term costs onto those who are willing to fund this inflation at absurdly low returns, many of whom are seen (read China) as evildoers who manipulate their currency.

Those, to me, are some of the intermediate steps between the expectation of inflation and the reality that you point out we inflationists are too vehement to dig into. I arrive at my inflation conclusion ONLY from those points, which largely add up to, "Inflation? - Yes we can!!". It's a place where we have the power to do it (and if you doubt this, see Jim Hamilton), where the political winds blow in the right direction to do so, and where a number of substantive arguments indicate it's a good idea. Not to mention the core human flaw (and political reality) that we're simply not going to sit around and do nothing.

Anonymous said...

I would think that we will have mild deflation for some time. May be up to late 2011 and then inflation will pick up. The fed will be printing like mad but the banks will not lend this money but would hoard it. They would the start to lend it when the upswing starts in late 2010. Then the high to hyperinflation will kick in. Hope that everyone would have taken their precautions by then.

John Fischer said...

"be they intellectually-argued, divinely-inspired, dogmatically-held or viscerally-based"
I hope half-baked agnostic speculation is also welcome. Trying to understand what "B" might look like would benefit from better insight into the Mind of the Fed than mine. Nevertheless, I can imagine a mechanism for reflation which doesn't involve helicopters: current Fed policy should eventually produce supply curve shifts via capacity reduction, higher capital costs, and higher USD prices for raw materials and imports. This will result in higher prices and be understood as "inflation" by the public. Possible reactions include: wage pressure, anticipatory capital flows into riskier assets, and/or a pretext for the Fed to claim they see the whites of their eyes and chase assets out of the bond market by raising rates from zero to epsilon. Both higher money velocity and asset reflation seem possible on some scale, as do some really nasty social consequences depending on how much, how fast, and in what sequence.

Anonymous said...

Our economic lives are essentially fractal. Macro level assumes open-ended, push-pull actions with desired results-not happpening. The point at which leverage loses desired effect is where change will occur. Right now the dealer/broker model is dead from self-inflicted wounds even before legislative and judicial review. Interesting discussion about demise from a million paper cuts or a gunshot wound to the head-same result. What form and how dispersed will rebirth be? Banks through the Fed will fight hard to maintain gatekeeper status, but will eventually be public utilities like Talib suggests. So where will all the extra-bank financing come from. Time for some financial innovation right here, right now. Barter deals are springing-up to substitute cash. Will exchanges be finance centers? Money center banks are dinosaurs stuck in tarpits. They all need hospice care and the rest of us need to quickly get to work on making the deal that gets the resource to the oppurtunity asap. Can we avoid "turning Japanese, I really (don't) think so". But while the financial world unwinds, slow crashcade, everything else goes on. Cassandra, your discussion is germaine and it doesn't matter what we call it. If we name it, pigeon hole it, we can move on, but not so fast. Too much to do here. There is a growing realization it is a bad idea to reflate because we'll be right back here how do we jumpstart and redirect at the same time. Not with the same people and ideas that got us here. Preservation of capital is truly an ugly thing, self serving. The more capital the uglier. It must work, produce, and contribute just like the real economy. Goldbugs and central bankers are the same--hoarders. All that money needs to get off its lazy arse and get to work!

Anonymous said...

Jesse said - "And unless there is some greater conspiratorial policy reason, any net debtor that chooses deflation rather than inflation of the means of the repayment of the debt should have their head examined."

Put me down for the greater conspiratorial reason ...

The system is not always being run by those who depend on showing profit. There are those among us who focus more on control. Profit equals plain old vanilla greed. Control equals a more pernicious destruction of all competition -- a vying for ‘full spectrum dominance’. That is what we are seeing. Domestic populations are fair game. Money is its regulation. It is useless to those who can not access it because of subterfuge in the regulation.

The system will deflate and inflate as needed to produce over time a neocon desired, middle class free, ruler and ruled world with a low brow law enforcement class as the new overseer.

It is all very intentional.

The field of discourse needs to be broadened well beyond the walls of finance.

All of life is political.

Deception is the strongest political force on the planet.

i on the ball patriot

Stevie b. said...

Unless I've missed something, it'd be nice to see something further in this debate from David Pearson, who's views I always appreciate seeing.

Stevie b. said...

...and Jesse, if you're still reading this, when you said on your blog on this subject - "they will monetize debt and 'print money' overtly and with abandon, because they do not wish to trash the Bond and Dollar, since this is the fuel of their machine", - isn't this contradictory?

Anonymous said...

In my opinion inflationists are too caught up with the abstraction of price, rates, debasing digital/paper currency, itself a product of printing and digitizing more of said currency, etc.

Instead, the focus should be on the Real, and in that I am talking about production, consumption, and distribution of real things effecting real people, people who work and consume and in doing so rely on an increasingly limited natural resource capacity.

Now . . . we have not only credit/debt oversupply, but also over production and over capacity to produce real things for which there is no longer the over capacity to consume. Simply put, for inflation to succeed in starving off deflation, then more must be consumed, meaning more people are back at work and making more income to pay for the increase in goods and services being consumed. This assumes also that profits are increasing, capital is expanding and investments in increased production is taking place, thus increasing costs of goods and services because demand is increasing, and because lending and borrowing are increasing.

Presumably, from the point of view of the inflationists, this will come about due to magic wand waving over abstractions such as mentioned above, that then bring about a reversal of over capacity, over production, and over consumption (in the West). International trade will be back to expanding as countries develop renewed capacity to export/import.

Now, in the great reversal, no longer is capital being destroyed, whether fictitious or not, but is again expanding, because more profits are being made because higher prices can be demand and gotten for goods and services sold, while at the same time the fictitious capital production machine of so-called securitization gallops anew. Incomes rise globally and then . . . believe it or not, we'll come full circle to worrying about overheating economies and uncontrollable inflation.


joebhed said...

All of the options are playing within the little MONOPOLY game known as the debt-money system.
The debt-money system is broke, we agree.
"How Debt Money Goes Broke"

Inflation-deflation-illiquidity-liquidity and hybrids.

We need a new money system.
A simple debt-free money system.
The suffering of the people in pursuing these unworkable solution to fix the debt-money system is unnecessary.

And we should not tolerate it.

Debt-free money.
Public credit.

Let banks go back to banking.
Deposits and lending.

Mencius Moldbug said...


While I agree with most of what you say, and I like the phrase "deflationist overshooter," I think there is a fundamental error in the terms you're using, which your logic has not corrected for.

An "inflationist" or "deflationist" is making a general statement about the aggregate direction of a huge number of logically independent prices. In a stable monetary system in which the EMH were true, such aggregate price correlations would not exist; for example, the Central Limit Theorem tells us very quickly that broad stock-market indexes should be flat.

Obviously, they are not. Our monetary system being unstable, prices do correlate. However, it is quite a step from this to say that all prices move in the same direction (surely untrue), and that all kinds of prices move in the same direction.

In particular, the last few years saw a general correlation between the prices of financial securities, the price of industrial commodities, and the price of precious metals. Will this correlation continue to hold, allowing us the mental luxury of being either "inflationists" or "deflationists"? I am not so sure.

Today's gold price, for example, is set at the margin primarily by "investment demand" - ie, the desire of savers to save in gold rather than official currencies. In 2008, the gold price remained steady and even increased slightly because, as jewelry demand from traditional markets dropped off, monetary demand replaced it.

What drives this demand? Two factors: (1) lousy returns from saving in official currencies; (2) expectations of the future gold price. Note that while (2) is circular and inherently unpredictable, (1) can be expected to exhibit inverse correlation with asset-price deflation - which is the D-word that seems to occupy most of your attention.

The logic of inflation in commodity (and hence consumer) prices is different, but similar. You will note that the benign effect of deflation - a lower cost of living - has not been strongly apparent. Among other things, nobody's debts have shrunk.

This applies as well to commodity producers, whose costs have not greatly decreased. Their prices have. Many producers are not viable at these prices. Therefore, we can expect a wave of supply destruction to lag the demand destruction, pulling prices back up. The prices we see now are the interaction of 2009 demand with 2007's plans for 2009 supply. I don't expect them to last.

You'll note that both these "inflationary" phenomena (PM inflation, commodity-price inflation) have no trouble existing in an environment of asset-price deflation. As, of course, was the case in the '70s.

Moreover, commodity-price inflation tends to drive consumer-price inflation, which is what most people mean by the I-word. So I'm not sure I'd short those TIPS just yet...

Anonymous said...

On a more practical note, what do you propose to do?

Deflation is a relatively minor concern, if you are all cash.

Sure, there will be collateral damage (massive unemployment, social unrest, etc.), which will stress the foundations of any society.

Jared Diamond of Guns, Germs & Steel reached a conclusion at his TED talk several years ago that civilizations begin to collapse when inequity reaches an apex. Deflation in my mind would only amplify this trend.

But to invert the situation, what if you are wrong? What if inflation gets out of control?

Holding cash would be a horribly poor decision in the latter case, but the two outcomes are so divergent and extreme that would it not be prudent in your mind to procure insurance to protect against the extremes?

The dilemma, in my case, is finding an adequate proxy.

One of the common suggestions (proposed by Grant's, Bronte Capital, etc.) is to short long-term treasuries. This may work, but what if we have a return to pre-1951 accord policies?

Insurance it seems will only pay if the actors respond conventionally to the problem.

As you said, very few traders would be willing to roll this for the next 4-5 years. And even fewer would accept being dismissed as "wrong" like everyone who was long CDS in 2005 waiting for the bubble to pop.

This is where Taleb's point about bleeding for several years for a large payoff becomes applicable.

Bernanke has said several times that he would target LT yields through intervention (if necessary), but in that scenario whether the trade works is largely dependent on the arbitrary level selected by the Fed (in WWII it was 0.375% for 90-day bills, which were rolled for several years).

Buying OTM calls on commodities & short dollar positions seem like the next logical set of hedges, but in an extreme scenario, would counter-parties pay? Would governments watch idly as the prudent game the system?

Have you reached the conclusion that "insurance is simply too difficult to procure"? Or are you now willing to flow with the stream?

We're all playing the same game, trying to stay one step ahead, but the system is staring into the abyss of time.

Anonymous said...

It seems to me that under-emphasized, if not entirely missing, from these discussions is that postponing the inevitable will make it worse. (You gotta love the Pfizer/Wyeth merger in which TARP money is used to destroy tens of thousands of jobs as well as future innovation.)

Also, it's not as though the only two options are willy nilly liquidation and blowing another bubble. It _is_ possible to actively manage the untangling to minimize damage in productive capacity while allowing (if not encouraging) the various and sundry toxic financial instruments to go bust.

The cost of ameliorating the pain of adjustment via a safety net of sorts seems like it would likely much lower than continuing the bubble blowing.

All of that said, if I've learned anything in recent years, it's that the adjustment will come when there simply is no other choice. I don't think we can know whether that is after the dollar has collapsed or when it becomes obvious that it's about to.

Mark said...

1) Who has the most control over whether we get inflation? The US government.
2) Who is the biggest debtor in the world? The US government.
3) Which outcome benefits debtors the most? Inflation.

Anonymous said...

oil depleting at 6.7% a yr (IEA). ag commodities lowest inventories for 50 years. are these facts relevant in this debate?

Anonymous said...

A couple of questions:

1) Is the Fed really likely to go off buying long-term treasuries to try to keep the yields down even as the Treasury embarks on a grotesque offering binge, or is the Fed trying to jawbone Treasury yields down a bit (or even just trying to slow the rise?) ?

2) Deflation is ugly and painful and costly and it almost killed us back in the 1930s. IF you believe (as I usually do) that humans generally make new mistakes in the opposite direction of the most notable colorful past mistakes, doesn't this make it pretty likely that ultimately we'll have a spectacular inflation of the fiat currency?

2a) In the short run, the U.S. is in a favorable position because our Fed can drop money from helicopters and the resulting decline in the currency value just makes paying off our stock of debt cheaper - except of course that the going forward cost of issuing new debt is likely to be having it denominated in currencies other than dollars (ROOSA Bonds, anyone?).

I was amazed at the price action today - given the egregious greasy pork filled behemoth "stimulus" package wending its way through Congress combined with the Fed talking about buying Treasuries to keep yields down, why didn't gold go vertical?

Kieran McCarthy said...

Excellent article, Cassandra. It's nuanced, snarky, insightful, and balls-on accurate. I've read everything I could find on this topic in the last six months, and this might be the best commentary I've seen yet.

Gentlemutt said...

Please help me understand: are the inflationists like the Underpants Gnomes? They drive me crazy.

Unknown said...

Unfortunately I think that deflation continues. I bought a house in 2005 with 20% down and a 30 year locked rate at 5.5%. That house now is obviously underwater. I don't plan to default nor am I asking for government assistance, hell I signed the mortgage and there was no gun to my head. However, with that said, my family has all but exited the discretionary part of the US economy.

It is just simply going to take time to repair our balance sheet (which we will do). I have to think that there is a large percent of the US population in that same boat, and the government must know that. This economy is going nowhere until household balance sheets are delevered and brought back into balance. That is going to take years or perhaps even a decade to work out. Because of this credit destruction, combined with credit rejection (by both banks and families), I see lower wages and prices for quite some time along with a stagnant at best economy.

The amount of credit being destroyed or rejected easily outnumbers the amount of money being created, that is deflationary.

Anonymous said...


Why do you believe that gold makes a better fundamental investment than stocks? Stocks essentially trade as private currencies. And as currencies, they are actually slightly harder than gold ( I calculated the dilution rate for the NASDAQ 100 one year, and it came out to -1%). And with Sarbox, supply of new public companies is pretty tightly constrained.

Stocks also pay dividends, have better tax treatment, are politically protected, get included in 401Ks, and have lots of marketing dollars behind them. The downside is that stocks have only traded as private currencies for about fifty years, while gold has traded as a currency for a couple of thousands of years. That's a very big downside, but I'm not sure if it's big enough to outweigh the other advantages.

Anonymous said...

Devin Finbarr-I don't think there are any good currencies in a fiat macroenvironment.

In a deflationary environment, the rare unleveraged public company with pricing power might do well; in a highly inflationary environment, a commodity-oriented company with fixed cost long-term debt should do well - but in no way has Sarbox limited the supply of stock sold. Lousy markets have done that - but don't think that the government intends to own preferred stock in banks forever - all that preferred is going to be refi'd with common someday far off in the future.

I'm not a gold bug by any stretch, though I do own a bit as a hedge. As far as stocks and gold being completely different animals, don't forget that the enormous new source of demand for gold has been from ETFs . . . .

Mencius Moldbug said...


White man ask good question. It is easy to construct an artificial currency with zero dilution, and corporate shares (although not as divisible as one would like) look exactly like such a thing.

The trouble is that they are not Schelling points. Rational savers all choose the same good to save in, making it appear considerably overvalued next to comparable nonmonetized goods. Money is the bubble that doesn't have to pop. There is always at least one.

The trouble is that if you and a bunch of other people choose to save in a good that does not end up as money, you are buying into a bubble that will pop. Which will it be - Intel, GM, Exxon? Guess wrong and you lose.

Gold wins not because its monetary qualities are perfect (ideally, as you note, there would be no gold mining), but because it acts as a Schelling point for those fleeing official currencies. This is solely due to cultural history. But cultural history is also the reason you meet your friend in Penn Station at 12 noon.

Of course the official currencies have every advantage, and if the dollar was managed as a hard currency everyone would end up in dollars. But those managing the dollar have other motivations, which more and more involve trashing their own product.

I am still not convinced that I see the Schelling-point effect in the present gold price. I will be more confident of this when I see non-Indian gold demand consuming most annual production. Western monetary demand has increased by leaps and bounds, but remains quite small by historical standards.

(Traditional consumers tend to buy gold when it is cheap and sell (or not buy) when it is expensive, making it behave more like a commodity and less like money. Western investors are more likely to buy it for momentum reasons - ie, its solid performance in the last five years. Oddly enough, if you buy my Schelling-point theory, it is the latter who are behaving more rationally.)

Anonymous said...

I would add that it is no mere social accident that gold has a monetary value. It is an element in limited supply (i.e. it can't be synthesized at will). It is chemically non-reactive, so it can't be destroyed. In other words, it is chemically permanent, and the supply is relatively constant. Through many years of monetary evolution it was selected (in the Darwinian sense) for these very reasons.

Sorry to hijack the thread with this tangent. This discussion was very, very informative. Thanks Cassandra for sponsoring this forum.

Anonymous said...

Wow. Great post and comments. I think that RN's formulation ("things we can control...") is right on, and needs closer inspection. Add to it Jesse's thought, which I would paraphrase, in Friedmanesque fashion, as, "inflation is always and everywhere a political phenomenon."

Assume governments are responsive. The only policy response with which to fight debt deflation is debasing the currency. Governments have the ability to debase the currency, and have shown that ability in virtually every instance of deflation (including 1934-1937). Therefore governments will choose that policy. If and when they back off from it, its only because they fear its effects.

Ah. We happen to have, as RN points out, a central bank with a particular theory -- lets even call it a paradigm -- about how inflation gets started. We can call it the "dry tinder" theory, or call it by its real name, the Phillips Curve. This theory argues that inflation occurs when an economy runs too "hot", and only then. An economy suffering from a debt recession, this theory holds, has almost no probability of sparking the wet tinder, of causing inflation. Therefore, they think, there's really no reason to fear the effects of money printing until the economy runs too hot. And I think we'd all agree that that is a problem they'd desperately love to have at this point. So only the solution to deflation -- a too-hot economy -- creates a problem of inflation. Fine, they say, we'll deal with that later -- be happy to deal with it later, actually. Quite happy.

Cassandra's right though. All that's about point "C", and we're still at "A". I think "B" is all about people being scared of deficit financing, because I've seen it time and time again in Latin America. There, the worse an economy gets, the higher the deficit forecasts, the higher the risk of financing that deficit, the higher long term rates, the worse the economy gets. Repeat. Eventually the forecast for debt interest expense becomes an exponential function, and velocity spikes as holders flee the currency in expectation that the Central Bank will forever be saddled with that cost.

Lucky for the U.S. that rates go DOWN as the economy worsens. Well, at least until this past week. Let's all hope that its just a correction from a trend, and not a new one.

Peripheral Visionary said...


Interesting post. I am hoping that the deflationists have it correct, but I fear that the inflationists are on to something.

In particular, the deflationists underestimate the level of panic at the Fed. "The Fed would never" take certain actions is not a statement that makes sense at this point. The Fed has already done things it had never conceived of doing in the past, and as far as I can tell, the sky is the limit on future efforts. As such, the printing press is simply not out of the question.

Of course, there is a strong sentiment against unsterilized printing of money among economists (not that the Fed cares what anyone thinks these days.) As such, any effort to print money will likely be channeled through a set of programs with obscure acronyms for names, inevitably positioned as a "temporary" measure, ostensibly to battle deflation (not to pay for government debts with new money, of course not!)

One such candidate would be the proposed program of purchase of long-term Treasuries with new money. It's ostensibly positioned as an attempt to bring rates in line; but what is the difference between an effort to adjust rates and shameless financing of the government with printed money? The only difference is the Fed's intent to unwind the transactions. Of course it will go into the program declaring that intent (just as it has declared its intent to unwind the vast array of new programs it has undertaken)--but all that is needed for an inflation scare would be for someone to raise the serious question of if the Fed actually has the ability to unwind such a program.

That may be the path from A to B for the inflationists. All that's needed for inflation to set in is for it to become apparent that the Fed has no intention of unwinding the programs which have created amounts of newe money (and has every intent of creating new programs as needed, even for the payment of government debt.) At that point, it would become clear that the dollar is being devalued, and the concomitant dumping of dollar-denominated assets would flood the markets with dollars and spike interest rates on all dollar-denominated debt. At this point, the only thing keeping that from happening is the thin hope that the government will honor both its debts and its commitment to not devalue the currency, and the lack of a safe haven currency.

I hope the deflationists are right and the inflationists wrong, but I'm just not sure of that.

Peripheral Visionary said...

P.S. Not sure how Mormons get singled out for "certitude" and "head-shaking".

Well . . . OK, there is admittedly this:

"And behold, the time cometh that he curseth your riches, that they become slippery, that ye cannot hold them; and in the days of your poverty ye cannot retain them."

I suppose that qualifies as certitude, although Samuel the Lamanite is admittedly vague on the inflation vs deflation issue.

Anonymous said...

Any idea where US M3 is these days ??

FED stopped publishing that in 2006, Europe I believe is still reporting it.

Not that one can believe any numbers LOL

Anonymous said...

I did find this

Anonymous said...

As good an argument as any that have thus far been commented here.

Anonymous said...

Dear Cassandra,

A new reader here.

Excellent blog and very interesting forum. I am only sad my late colleague and friend Tony Dye not around long enough to contribute and he would have added far more value than I shall be able to.

From my perspective there are two very fierce forces in opposition. The deflationary spiral initiated by the unwinding of the great credit bubble still appears to have some way to go not just because of declining supply of credit but also because of collapsing demand for credit. Those people/organisations that a "sensible" banker (such discussions are always full of implausible theoretical assumptions like "sensible" banker) might lend to are increasingly avoiding any form of credit. Set against this are, as many of your contributors have pointed out, Western Governments often with savings lite populations to whom inflation is the obvious policy both economically and politically.

I don't see inflation gaining traction anytime soon, but should it do so history suggests it could be explosive. One of the startling things in studying the German inflation of the 1920s is how fast events moved in a pre TV pre internet era.

Thanks to contributor "Charles" who made me think hard about new angles.

To those who see the Fed and Government as all powerful players please don't forget they don't exist! They are imaginary human constructs, what exists are groups of people. Such people are on average self interested power seekers otherwise they would not have achieved these position today. They tend to frame all decisions in terms of how it will affect their personal power and position in the structure with little focus on actual outcomes. Most of them lack the experience or the depth of study to make an evaluation of the outcomes anyway (Despite the commentary otherwise, Bernanke is more a politician than an academic otherwise he would still be an academic).
Dont forget none of them trust each other!

Anonymous said...

For the record, Bernanke got pulled out of cold storage at Princeton because he is supposedly an expert on depressions. Alas, Team Academia and their endless doctoral dissertions have proven to be nothing but a clever way to fulfill the academic requirements of their chosen degree program.

The Total Credit Market Debt as a % of GDP is at an all-time high and will skew higher as GDP falters. Inflation would be utter ruin to the creditors. That is why the dollar is getting stronger and will continue to do so for longer than anyone now believes possible.

And for those that think in terms of decoupling, it's time to face facts: like it or not, the USA effectively has everybody else by the balls. Everybody likes to talk about Russia as a collapsed empire, but I don't recall the ruble having ever been a reserve currency.

Cash for property said...

Unfortunately you were right. Even after 5 years of this writing, it still stands out to be truth. Deflation is at its peak.