Free Markets, Free People

deflation


No hyperinflation yet

One of the key worries about the Federal Reserve’s policy of Quantitative Easing has been the fear that it would result in hyperinflation at some point. But, Mike Shedlock, writing at Business Insider, asserts that inflation is not what we should be fearing: deflation is. Despite his rather self-centered, Ooh-look-what-a-cool-boy-I-am writing style, he makes an excellent point, and provides some valuable insight.

Shedlock actually has a rather different definition of inflation and deflation than most do, as he doesn’t concentrate primarily on the money supply or price levels, but rather the state of credit markets.

Inflation
Inflation is a net increase in money supply and credit, with credit marked-to-market.

Deflation
Deflation is a net decrease in money supply and credit, with credit marked-to-market.

Hyperinflation
Complete loss of faith in currency.

The first two definitions have nothing to do with prices per se, the third does (by implication of currency becoming worthless).

To determine whether we are currently experiencing inflation or deflation, he uses the following criterion:

Symptoms of Deflation

  1. Falling Credit Marked-to-Market
  2. Falling Treasury Yields
  3. Falling Home Prices
  4. Rising Corporate Bond Yields
  5. Rising Dollar
  6. Falling Commodity Prices
  7. Falling Consumer Prices
  8. Rising Unemployment
  9. Negative GDP
  10. Falling Stock Market
  11. Spiking Base Money Supply
  12. Banks Hoarding Cash
  13. Rising Savings Rate
  14. Purchasing Power of Gold Rises
  15. Rising Number of Bank Failures

He then goes through all 15 criteria and shows fairly persuasively that—according to his definition, at least—we are in the middle of a credit-led deflation, despite the fact that consumer prices are rising. certainly, asset prices are declining.

Which, I think just means we’re having stagflation, if today’s CPI numbers are to be beleived.

In any event, as I’ve been saying since 2008, the danger of our policy mix is not inflation in the short-term, but rather a recreation of the Japanese response to the currency crisis/deflation of 1992 that brought about the "Lost Decade". We’ve actually doubled down on the Japanese policy, and are experiencing the same economic result.

So, businesses and consumers are holding tight to their wallets, adjusting their balance sheets…and waiting.  Yes, there’s tons of cash sitting in banks right now that isn’t going anywhere, and as long as banks have a shortage of credit-worthy customers seeking loans, all of that cash is gonna keep sitting there are excess reserves.

Meanwhile, the one thing that has kept the dollar buoyed as the world’s reserve currency is that there’s really nowhere else to go. As attractive as the Euro might have seemed a couple of years ago, there’s a real chance that the Euro is on it’s way out, except perhaps as the joint currency of France and Germany.

What I would point out, though, is that Shedlock’s definition of hyperinflation is a state that exists as a result of a psychological event, not the result of something one can forecast via some predictive empirical  measurement. That’s unsettling, because you can never quite predict when a psychological breaking point in public trust is reached. No matter how deflationary credit might be at the moment, if we begin seeing a serious, sustained rise in price levels for consumer goods, I’d be a little worried. A steep fall of the dollar’s price in the FOREX market would be worrisome, too. If hyperinflation is the result of a psychological shock disconnected with any sort of statistical measurement, then I’d be careful finding too much comfort in statistics.

The numbers say that deflation is our biggest problem right now, though, and I’d say that’s generally right. If the economy picks up and those excess reserves begin to flow into the hands of consumers though, I’d be looking very hard at the Fed as the velocity of money picks up, to see how they plan to sterilize the excessive growth in the monetary base they’ve created.

~
Dale Franks
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Podcast for 31 May 09

In this podcast, Bruce, Michael, Billy, and Dale discuss the economy and the Sotomayor nomination.

The direct link to the podcast can be found here.

Observations

The intro and outro music is Vena Cava by 50 Foot Wave, and is available for free download here.

As a reminder, if you are an iTunes user, don’t forget to subscribe to the QandO podcast, Observations, through iTunes. For those of you who don’t have iTunes, you can subscribe at Podcast Alley. And, of course, for you newsreader subscriber types, our podcast RSS Feed is here. For podcasts from 2005 to 2007, they can be accessed through the RSS Archive Feed.


Juxtaposition

Compare and contrast this rehabilitation effort of Timothy Geitner:

After his hellish opening weeks, Treasury Secretary Timothy Geithner started inviting White House economic officials across the street to his conference room for hours-long working dinners that have helped get — and keep — the whole team on the same page.

[...]

Geithner, a former president of the New York Federal Reserve who once looked like he was floundering in one of the administration’s most scrutinized jobs, is emerging in a new position of strength with the media and the markets, just as he launches President Barack Obama’s high-stakes effort to re-regulate the nation’s financial markets.

[...]

The secretary’s advisers acknowledge that his newfound political standing is tied, in part, to the state of the economy, which is now showing early signs of improvement. But Treasury officials also have updated their playbook after his Feb. 10 speech on financial recovery, which was panned by the press and blamed for a 381-point slide in the stock market.

They decided to “let Tim be Tim” and accepted the fact that his strength wasn’t giving a speech in front of a bunch of flags. Rather, they let reporters see him in off-camera, pen-and-pad settings, where he fielded questions with the confidence that his staff saw behind the scenes. He aced an interview with PBS’s Charlie Rose, thriving in a relaxed setting where he could explain issues at length.

… with this bit of economic reality:

China has warned a top member of the US Federal Reserve that it is increasingly disturbed by the Fed’s direct purchase of US Treasury bonds.

Richard Fisher, president of the Dallas Federal Reserve Bank, said: “Senior officials of the Chinese government grilled me about whether or not we are going to monetise the actions of our legislature.”

“I must have been asked about that a hundred times in China. I was asked at every single meeting about our purchases of Treasuries. That seemed to be the principal preoccupation of those that were invested with their surpluses mostly in the United States,” he told the Wall Street Journal.

[...]

The Oxford-educated Mr Fisher, an outspoken free-marketer and believer in the Schumpeterian process of “creative destruction”, has been running a fervent campaign to alert Americans to the “very big hole” in unfunded pension and health-care liabilities built up by a careless political class over the years.

“We at the Dallas Fed believe the total is over $99 trillion,” he said in February.

“This situation is of your own creation. When you berate your representatives or senators or presidents for the mess we are in, you are really berating yourself. You elect them,” he said.

His warning comes amid growing fears that America could lose its AAA sovereign rating.

I guess since the media tried to talk down the economy for the previous eight years, they may as well try and talk it up now that their boy is in the White House. The shame of it is that as the economy worsens, a lot of people are going to be shocked.