Inflation/deflation - The Big Debate

[Abrak]

It seems to me that the most important question you can get right in investing is whether, on a ten year view, expectation for inflation will decline or rise.

Debate is polarized.

But the bear case against USTs is not that obvious to me now.... here is the deflationary view spelled out....

http://www.hoisingtonmgt.com/pdf/HIM2009Q1NP.pdf

And here is the inflationary view by perhaps the world's leading expert on deflation.

http://en.wikipedia.org/wiki/Bernanke_Doctrine

I have always thought that the US will inflation the way out of their debt crisis but people like Krugman seem to be right (at the moment) that deflation is a more destructive and powerful problem than people have anticipated.

Any views? And to the extent you have one, what is the best play TIPS? TBT? Gold? etc.

[hhgz]

"Debate is polarized."

I think that why they call it a "debate".

"the US will inflation the way out of..."

"Inflation" as a verb? Excellent

[jesimps]

"Debate is polarized."

I think that why they call it a "debate".

"the US will inflation the way out of..."

"Inflation" as a verb? Excellent

Prat!

[CaptHaddock]

It seems to me that the most important question you can get right in investing is whether, on a ten year view, expectation for inflation will decline or rise.

Debate is polarized.

But the bear case against USTs is not that obvious to me now.... here is the deflationary view spelled out....

http://www.hoisingtonmgt.com/pdf/HIM2009Q1NP.pdf

And here is the inflationary view by perhaps the world's leading expert on deflation.

http://en.wikipedia.org/wiki/Bernanke_Doctrine

I have always thought that the US will inflation the way out of their debt crisis but people like Krugman seem to be right (at the moment) that deflation is a more destructive and powerful problem than people have anticipated.

Any views? And to the extent you have one, what is the best play TIPS? TBT? Gold? etc.

You are exactly right that deflation/inflation is the crucial issue of the day! I also read Hoisington & Hunt every quarter. They have had some good calls in the past few years. So far, I lean toward the deflationist camp for these reasons:

1. With US capacity utilization down to 67% and U-6 unemployment up to 15%, it is hard to see how an inflationary spiral can get started. High inflation, such as during the 70's (peaked at 18.5%), seems to require a wage/price spiral.

2. The scale of the losses so far vastly outweighs the govt intervention. Between houses and stocks alone, the US has lost $15 trillion or more. Obama's stimulus calls for spending $200 billion in 2009, half of which will be tax cuts that don't have much impact.

3. Japan both printed money (increase money supply by 1/3 during 2001 and 2002) and doubled its national debt in Keynesian spending. Inflation never happened. The money sat in vaults. You only get about 1.3% interest on a 10 year Japanese Treasury.

Also, all the generals fighting the last war expect inflation, which they know and fear. But deflation is unfamiliar. So, it will not be priced correctly. And deflation has arrived in any case: CPI for the trailing 12 months is slightly negative.

IMHO, the upshot from an investment/preservation of capital point of view is that the best buy now is bank/credit union CDs. You can still get 4% going out 5 or 7 years at some CUs. If deflation were to play out as it did in Japan during the 90's, you would be delighted to have a safe 4% when prevailing rates drop below 1%. On the other hand, if the call turns out to be wrong and inflation does return, you can get out of a CD without loss of principal at the cost of a few months interest. That can't be said for Treasury Bonds.

But some serious people, such as Rogoff and Blinder, do see a risk of high inflation. So, the situation bears careful attention.

[cloudhopper]

http://www.mi2g.com/cgi/mi2g/frameset.php?...ress/151108.php

[cloudhopper]

Here's a better primer

http://economicedge.blogspot.com/2009/02/i...ts-mystery.html

[cloudhopper]

It seems to me that the most important question you can get right in investing is whether, on a ten year view, expectation for inflation will decline or rise.

Debate is polarized.

But the bear case against USTs is not that obvious to me now.... here is the deflationary view spelled out....

http://www.hoisingtonmgt.com/pdf/HIM2009Q1NP.pdf

And here is the inflationary view by perhaps the world's leading expert on deflation.

http://en.wikipedia.org/wiki/Bernanke_Doctrine

I have always thought that the US will inflation the way out of their debt crisis but people like Krugman seem to be right (at the moment) that deflation is a more destructive and powerful problem than people have anticipated.

Any views? And to the extent you have one, what is the best play TIPS? TBT? Gold? etc.

Here's a rebuttal to Hoisington but IMO is incomplete as it ignores the huge debt overhang out there. I do agree with the author that the USD value will be a big indicator though...

http://www.financialsense.com/Market/wrapup.htm

[cloudhopper]

Here's one for the inflation camp-

http://www.financialarmageddon.com/2009/04...y-of-paper.html

but I still remain a deflationista for now in cash although I'm insuring against inflation with physical gold.

[trogers]

Here's one for the inflation camp-

http://www.financialarmageddon.com/2009/04...y-of-paper.html

but I still remain a deflationista for now in cash although I'm insuring against inflation with physical gold.

Price of physical gold is already highly inflated - through much speculative trades. Try tulips.

[cloudhopper]

Here's one for the inflation camp-

http://www.financialarmageddon.com/2009/04...y-of-paper.html

but I still remain a deflationista for now in cash although I'm insuring against inflation with physical gold.

Price of physical gold is already highly inflated - through much speculative trades. Try tulips.

Could be. You know I really should have said I hold gold as insurance against financial chaos since it has been shown not to be a hedge against garden variety inflation. Chaos could take the form of hyperinflation, devaluation, default, capital controls, bizarre politics, war...I don't know. I also don't think any of those scenarios is really likely and my cash stash will probably buy increasingly bigger and better toys to amuse me in my declining years as deflation continues. But in the improbable and sudden event of a real OMFG calamity, insurance will be tough to get at any price.

[Abrak]

Here's a better primer

http://economicedge.blogspot.com/2009/02/i...ts-mystery.html

So which has been the best performing stockmarket this year? The answer Zimbabwe.

I cannot see this deflationary phase lasting longer than a year based on 1. Bernanke's doctrine of avoiding deflation at ALL costs and 2. the simple logic to inflate your way out of a debt bubble. He has talked about zero interests rates and 3 to 4% inflation in the past and it can only be good for aggregate demand and restoring wealth to debt ratios as well as consumer spending. The dollar will obviously suffer. I fail to see how a creditor strike in buying USTs will lead to high interest rates as the Fed will simply print.

The argument that monetary expansion has not had a noticeable effect on P so far is a very good one and is explained by the reintermediation of the shadow banking system into the regulatory one as well as a fall in V.

Ultimately I will put my faith in Bernanke (definitely one of the top 10 economists in the world). With signs of inflation consumer spending will rise (in preference to cash holdings and as debt evaporates) banks will be unwilling to lend so I will be depressed, G will do its stuff through printed money and nx will not suffer unduly due to the collapse of the dollar. That all adds to a highly inflationary environment.

I understand the arguments for deflation but they do amount to digging a bigger and bigger hole. Bernanke of all people wont let that happen. While the current numbers look deflationary 1. the stockmarket may have bottomed well above usual bear market valuation lows 2. the same may be happening in housing and 3, consumer spending remains incredibly robust indicating high MPC relative to MPS which presumably reflects expected inflation.

Edited May 3, 2009 by Abrak

[cloudhopper]

Here's a better primer

http://economicedge.blogspot.com/2009/02/i...ts-mystery.html

So which has been the best performing stockmarket this year? The answer Zimbabwe.

I cannot see this deflationary phase lasting longer than a year based on 1. Bernanke's doctrine of avoiding deflation at ALL costs and 2. the simple logic to inflate your way out of a debt bubble. He has talked about zero interests rates and 3 to 4% inflation in the past and it can only be good for aggregate demand and restoring wealth to debt ratios as well as consumer spending. The dollar will obviously suffer. I fail to see how a creditor strike in buying USTs will lead to high interest rates as the Fed will simply print.

The argument that monetary expansion has not had a noticeable effect on P so far is a very good one and is explained by the reintermediation of the shadow banking system into the regulatory one as well as a fall in V.

Ultimately I will put my faith in Bernanke (definitely one of the top 10 economists in the world). With signs of inflation consumer spending will rise (in preference to cash holdings and as debt evaporates) banks will be unwilling to lend so I will be depressed, G will do its stuff through printed money and nx will not suffer unduly due to the collapse of the dollar. That all adds to a highly inflationary environment.

I understand the arguments for deflation but they do amount to digging a bigger and bigger hole. Bernanke of all people wont let that happen. While the current numbers look deflationary 1. the stockmarket may have bottomed well above usual bear market valuation lows 2. the same may be happening in housing and 3, consumer spending remains incredibly robust indicating high MPC relative to MPS which presumably reflects expected inflation.

The Fed may soon have decreasing control over interest rates. I agree that the USD has to suffer (but maybe not against other fiat currencies!) Certainly anything imported will increase in price if the currency devalues. Another outcome could be stagflation like we had in the US in the 70s, but uglier as assets (especially the paper kind) continue to devalue while consumables prices increase. The (apparent) fact that total world debt exceeds money to repay it by a factor of ten or something seems very deflationary - fractional reserve lending is a bitch as it unwinds in a defaulting environment so Helicopter Ben has his work cut out for him as he attempts to re-inflate.

I don't personally trust any "current numbers", regardless of the source, anymore...

[Hairy]

Very nicely stated, OP.

Any views? And to the extent you have one, what is the best play TIPS? TBT? Gold? etc.

TBT is doing really well right now. A statement by someone at the Fed (maybe Bernanke, not sure) said that they expect rates to remain between 2.5% to 4.5% -- which the market is taking as a sign that the Fed won't attempt to defend rates until they try to go above 4.5%. That should lead to a nice bull run on TBT over the next few weeks.

Gold would be good against inflation. I'd watch it carefully and scale in slowly, because if deflation becomes apparent, it will drop further.

As far as the current situation, I really didn't believe in the deflation fairy until pay cuts started to get announced all over the place. AMD was cutting wages 5% a few months ago, a lot of law firms are slashing the pay rate for new associates, and so on and so forth. Coupled with job losses, housing price declines, the massive decline in the stock market, and all the rest, I'm starting to be convinced that the deflation fairy really does exist.

Yes, Bernanke can destroy the U.S. dollar by "printing" if he really wants to force rates down, but so far he's been threatening more than actually doing. Those rates are rising despite his threats and acts. His one real attempt to push down rates via printing has failed; he got them to move from 3% to 2.5%, and now they're back up to 3.2% -- he bought less than a month of slightly lower rates.

Foreclosures are on the rise, now that the banks are ending their moratorium period, and job losses are continuing. There's some indication that a lot of the consumer spending increases have been because many people have given up on paying their mortgages; they figure their houses are "underwater" on their loan amounts anyway, and the banks will take a while to eject them because the banks don't want any more empty houses getting trashed. So, in the meantime, it's several months of free non-rent.

All in all, lots more pain coming down the pike, and there's no way Bernanke can print enough money to backstop it all, not without a fast and hard collapse in the value of the dollar, which would trigger hyperinflation and crush everyone. It's anyone's guess as to whether he's insane enough to do it.

Stay flexible, stay frosty.

[Hairy]

BTW, I believe the stock market has hit at least an interim top, and I expect it to fall over the next few weeks, probably to the mid-7K range. Reasoning: lots of bad news, such as the Chrysler bankruptcy, T rates rising, and various earnings misses. I've bought SDS in anticipation of a slide.

Longer term, the Chrysler bankruptcy will be a lot longer drawn-out than the government and company are pretending to believe it will be. They're saying 60 days, reality is more like 4-6 months. Given that Chrysler has shut down all of its factories for the duration, this is going to kill a lot of suppliers and machine shops. Expect much larger unemployment figures over the next few weeks as these shops give up. That will help push the market down. The uncertainty should also help push rates higher. So, SDS and TBT should both rise. No idea how gold will be affected; less buying power, but more economic uncertainty.

[Abrak]

All in all, lots more pain coming down the pike, and there's no way Bernanke can print enough money to backstop it all, not without a fast and hard collapse in the value of the dollar, which would trigger hyperinflation and crush everyone. It's anyone's guess as to whether he's insane enough to do it.

I have read quite a lot of Bernanke's work and it is very clear that he considers deflation to be the most destructive economic event. If you read his original address to the Fed (2002 Fed Reserve site) after he was appointed to the Board, he implicitly mentions that hyperinflation is a risk of an aggressive anti-deflation policy but he considers it very much a second worse scenario. Afterall with negative real interest rates and high inflation the stockmarket rises, so do house prices and real debt decreases.

The announcement of QE of US$300bn is simply a policy statement. Significant inflation and dollar depreciation will occur when US$300bn turns into US$3trillion. To Bernanke deflation is simply not a policy option.

Hyperinflation does not crush everyone it simply transfers wealth.

"The U.S. government has a technology, called a printing press, that allows it to produce as many dollars as it wishes at essentially no cost." Ben Bernanke.

[cloudhopper]

Another deflation sighting-

http://globaleconomicanalysis.blogspot.com...s-up-steam.html

[cloudhopper]

Deflation becoming apparent to MSM in U.S.

http://www.msnbc.msn.com/id/30751842/

[cloudhopper]

Another sign of global deflation

http://www.telegraph.co.uk/finance/finance...since-1948.html

[Naam]

Another sign of global deflation

http://www.telegraph.co.uk/finance/finance...since-1948.html

i beg to differ as the report focusses on Britain. no mentioning of "global". perhaps i need reading glasses?

[cloudhopper]

Another sign of global deflation

http://www.telegraph.co.uk/finance/finance...since-1948.html

i beg to differ as the report focusses on Britain. no mentioning of "global". perhaps i need reading glasses?

I am using the term global in the sense that we have now seen reports of deflation in China, Japan, the UK and the US. There are others too, but I would venture to say that these countries alone comprise a significant portion of the global economy, in both GDP and political/military terms.

[midas]

Another sign of global deflation

http://www.telegraph.co.uk/finance/finance...since-1948.html

i beg to differ as the report focusses on Britain. no mentioning of "global". perhaps i need reading glasses?

I am using the term global in the sense that we have now seen reports of deflation in China, Japan, the UK and the US. There are others too, but I would venture to say that these countries alone comprise a significant portion of the global economy, in both GDP and political/military terms.

And bearing in mind your world only seems to constitute what happens

in your own backyard- it is global

Thailand faces technical deflation : DBS Global Research

Data of inflation will be out later today and many analysts now expect Thailand to face a deflation rather than an inflation in the month of January for the first time in recent memory.

[Abrak]

While like another poster pointed out I am a 'deflationatist' who holds mostly cash but hedges is view with holdings of gold. Okay I readily admit that this simply means that I am confused. More to the point, I agree with another posters point that I have got lot lucky to the extent that gold prices have already done ok to the extent they reflect a degree of inflation that isnt obvious in the pricing of other assets.

When I invest I like the concept of win/win ideas or if I lose I dont lose too much. One particular thought is the idea of biflation - basic commodity prices will increase, while assets (particularly associated with too much debt in their accumulation) might continue to decrease. (By basic commodities I would not guess at say steel, where huge amounts of debt been taken on to create a worldwide surplus). More something like wheat, prices are very depressed, consumption does not go down even in a depression and it will probably do well in an inflationary period too.

Unfortunately I know precisely nothing about the economics of wheat, so I have no idea if the actual idea has any merit or even if the general idea is even thought provoking.

[cloudhopper]

Deflation spreads to EU

http://www.guardian.co.uk/business/feedarticle/8531286

[cloudhopper]

Good review at today's TAE

http://www.theautomaticearth.blogspot.com/

[Naam]

What about Hyperinflation??

nothing to worry about. hyperinflation will be compensated by deflation. dozens of gurus predict inflation, dozens of gurus predict deflation. logical result = neither nor. now waiting patiently for the next five dozen gurus to appear on the stage and predict stagflation and a new generation of voodoo priests who will scare the living bejesus out of naïve ignorants by forecasting hyperstagindeflation² (any time from now).

[signed Naam... who's striving to be the most hated poster on ThaiVisa ]

[lannarebirth]

What about Hyperinflation??

nothing to worry about. hyperinflation will be compensated by deflation. dozens of gurus predict inflation, dozens of gurus predict deflation. logical result = neither nor. now waiting patiently for the next five dozen gurus to appear on the stage and predict stagflation and a new generation of voodoo priests who will scare the living bejesus out of naïve ignorants by forecasting hyperstagindeflation² (any time from now).

[signed Naam... who's striving to be the most hated poster on ThaiVisa ]

More inflation/deflation blah blah:

http://www.investorsinsight.com/blogs/john...-one-right.aspx

[BEENTHEREDONETHAT]

What about Hyperinflation??

nothing to worry about. hyperinflation will be compensated by deflation. dozens of gurus predict inflation, dozens of gurus predict deflation. logical result = neither nor. now waiting patiently for the next five dozen gurus to appear on the stage and predict stagflation and a new generation of voodoo priests who will scare the living bejesus out of naïve ignorants by forecasting hyperstagindeflation² (any time from now).

[signed Naam... who's striving to be the most hated poster on ThaiVisa ]

It's just the doom and gloom guru's who don't think you play nice. You keep raining on their parade.

Biflation is just around the corner. That one you get to take your pick. Some stuff goes up some goes down and some stays the same.

[Naam]

What about Hyperinflation??

nothing to worry about. hyperinflation will be compensated by deflation. dozens of gurus predict inflation, dozens of gurus predict deflation. logical result = neither nor. now waiting patiently for the next five dozen gurus to appear on the stage and predict stagflation and a new generation of voodoo priests who will scare the living bejesus out of naïve ignorants by forecasting hyperstagindeflation² (any time from now).

[signed Naam... who's striving to be the most hated poster on ThaiVisa ]

It's just the doom and gloom guru's who don't think you play nice. You keep raining on their parade.

Biflation is just around the corner. That one you get to take your pick. Some stuff goes up some goes down and some stays the same.

when will triflation start?

[losworld]

I think we will begin entering the inflationary period early 2010 fueled by a fall in the U.S. dollar and strength in the Chinese currency. These two factors plus a possible surge in oil prices will create a bad situation in the U.S. that will spill over to the rest of the world.

[Naam]

I think we will begin entering the inflationary period early 2010 fueled by a fall in the U.S. dollar and strength in the Chinese currency. These two factors plus a possible surge in oil prices will create a bad situation in the U.S. that will spill over to the rest of the world.

please state your reasons why a strengthening CNY would lead to inflation