Tuesday, September 14, 2010

Deflation, Inflation or Hyperinflation?

I had a post yesterday regarding local real estate for you, but I have set it aside for now.

A couple of weeks ago, on August 24th, I made a post (which you can read here) on a theoretical framework for the arrival of hyperinflation. It was reprinted from the blog of Gonzalo Lira and Lira's thread went viral on the internet.

One of the reasons it garnered so much attention is because the issue cuts to the biggest and most confounding debate that's going on right now in all of finance: what will the final outcome of the Fed's market manipulative actions be?

Will the end result be deflation, inflation or hyperinflation (which is a distinctly different phenomenon from either of deflation or inflation).

Lira's post infuriated some hard core deflationists who continue to refuse to acknowledge the possibility that in its attempt to inspire inflation at all costs, the Fed may just push things beyond the tipping point of monetary imprudence.

Recently Mish Shedlock came out with a rebuttal to Lira in a podcast on Global Edge with Eric Townsend and Michael Hampton. In the podcast, Shedlock's conclusion was that Hyperinflation is the endgame, "so it is unlikely."

Mish followed this up with a post on his blog.

Yesterday Lira responded saying that Shedlock had turned the issue into a personal attack and that Mish had taken many of his points out of context (you can see a portion of Lira's response in yesterday's comments section). Lira has proposed an open debate with Mish on the topic. We will see if Mish accepts.

I bring all of this up because it triggered a comment in yesterday's comments section AND a whole whack of emails to my inbox.

As I said at the start of this post, this topic is THE biggest and most confounding debate that's going on right now in all of finance.

With that in mind I note that John Williams has come out with another bold statement today.

John Williams runs a website (www.shadowstats.com) on which he provides a stunning amount of real, unmanipulated government data.

Williams received an A.B. in Economics, cum laude, from Dartmouth College in 1971, and was awarded a M.B.A. from Dartmouth's Amos Tuck School of Business Administration in 1972, where he was named an Edward Tuck Scholar. For nearly 30 years he has been a private consulting economist specializing in government economic reporting.

His website, Shadow Stats, often paints a dramatically different picture of the state of the economy from the spin offered by government. Williams will, for example, offer you statistics on the Consumer Price Index as it existed prior to 2000. That was the year the formula for calculating inflation was changed. If you were to calculate inflation today using the same formula used before 2000, the rate is in excess of 6%!

Considering we are now force-fed statistics that pacify the masses by stating there is not inflation, that is significant.

Of course it's because the government has changed the way that figure is now calculated so - voila! - there is no inflation (even though you are feeling it in your pocketbook).

The impact of this cannot be understated. Inflation is just as present now as it was in the early 1970s. The only difference is the government now claims that many of those higher costs simply don't count (four legs good, two legs bad becomes four legs good, two legs better).

John Williams is yet another economist who has stated his firm believe that hyperinflation is in the offing. In 2009 he put out this analysis.

And today he has just released a note to clients in which he warns that hyperinflation may hit as soon as 6 to 9 months from today.

With so many established economists and pundits seeing nothing but deflation as far as the eye can see, and the US Federal Reserve doing all in its power to halt the deleveraging cycle, both in the open and shadow economies, what is Williams' argument?

Here, if you interested, is the statement from John Williams. I personally think it is important to read the likes of Lira, Shedlock and Williams to try and understand this important debate and make up your own mind on this critical economic issue.

Excerpts from statement from John Williams of the blog Shadow Stats
  • SUMMARY OUTLOOK: Systemic Turmoil is Unthinkable, Unacceptable but Unavoidable.

    Pardon the use of the Aerosmith lyrics in the opening headers, but the image of tap-dancing on a land mine pretty much describes what the Federal Reserve and the U.S. Government have been doing in order to prevent a systemic collapse in the last couple of years. Now, as business activity sinks anew, much expanded supportive measures will be needed to maintain short-term systemic stability. Such official actions, however, in combination with global perceptions of limited U.S. fiscal flexibility, likely will trigger massive flight from the U.S. dollar and force the Federal Reserve into heavy monetization of otherwise unwanted U.S. Treasury debt. When that land mine explodes — probably within the next six-to-nine months, the onset of a U.S. hyperinflation will be in place, with severe economic, social and political consequences that will follow. The Hyperinflation Special Report is referenced for broad background. The general outlook is not changed.

What does this mean for US financial markets?

  • In these circumstances, the financial markets likely will be highly unstable and volatile. Looking at the longer term, strategies aimed at preserving wealth and assets continue to make sense. For those who have their assets denominated in U.S. dollars, physical gold and silver remain primary hedges, as do stronger currencies such as the Canadian and Australian dollars and the Swiss franc. Holding assets outside the U.S. also may have some benefits.

If the Lira/Shedlock debate comes together, I'll let you know.


Email: village_whisperer@live.ca

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  1. If the stated value, of “Federal” Reserve notes, declines enough with respect to copper and nickel, the 1946-2010 U.S. Mint nickels, composed of cupronickel alloy, could become somewhat rare in mass circulation.

    The September 14th metal value of these nickels is “$0.0576057” or 115.21% of face value, according to the “United States Circulating Coinage Intrinsic Value Table” available at Coinflation.com.

  2. It's important to note what was actually said. I haven't listened to the Podcast so I can only quote Mish below from his blog:

    "Actually what I said is "Hyperinflation Ends The Game" NOT as Zero Hedge stated "Hyperinflation is the endgame". The difference between those phrases is enormous."

    IMHO, deflation is playing out in the near to intermediate term (next 3-5 years). If it could happen in Japan, it could also happen in the US, despite the low savings rate of the latter. Don't underestimate the amount of faith the rest of the world has in the US and its currency. I know, I know, I'm not a fan either, but the US still has the best fundamental potential to right the economic wrongs, compared with countries like the PIIGS and even the UK.
    I'll say the chance of seeing hyperinflation in the US is very low because of this: There are many more countries, especially in the developing world, with much poorer economic performance and political instability than the US, yet we are not seeing hyperinflation in those places aside from Zimbabwe. If the US goes into hyperinflation, then God help the rest of the world.

  3. The key to understanding a great deal of the gulf between the inflation scenario and how the deflationistas see it happening is the role of credit in the whole thing. If you ignore credit it is very easy to come up with an inflationist scenario that is plausible, logical, likely and even one that I agree portrays many day-day expense projections well. I certainly am NOT expecting deflation in daily living costs.
    Only if you start with the assumption that money and credit are essentially the same thing in a modern economy and that the rate of credit growth or contraction has profound effects on the economy does deflation start to make sense. Virtually all, at least 95% of our "money" is actually private or government credit. Even the Federal Reserve is actually a private entity, and in the worst case could be cast adrift by the US government.
    If that private credit growth in Canada ever slows down to a pace merely sufficient to keep up with GDP growth (sustainable), we take an immediate hit to GDP sufficient to drop us almost to depression territory, as defined by a 10% drop, plus the effect on the economy by that sudden drop will assuredly take us into deep depression. Household credit outstanding increased by $103 billion from July 2009-July 2010.
    Down a touch from the previous year, but still a heady rate of growth. About $3000 per person, babies and old folks included.
    About $5000 per employed person, or 11% of income.
    7.9% of GDP.
    All that does NOT include government deficits, this is just what individuals have taken on. If that credit growth ever slows down, stops os (gasp) goes into reverse, we are in deep trouble.
    Note: Basic mathematics prohibit credit growth from exceeding wages, GDP or any other intertwined figure indefinitely.

  4. We agree on the end result, but not on the interim. There will be significant inflation, but not until:

    1) Consumers can again be the catalyst driving money creation by taking out bank credit


    2) There is a complete repudiation of fiat currencies.

    We will get to #2 before we get to #1, but that's a ways off. I'd bet at least 2-5 years. Also remember that inflation at its core is a monetary phenomenon associated with the aggregate money supply and velocity of said money. It's not a rise in consumer prices, though it may manifest itself as such.
    Food prices can rise for a variety of reasons not related to true 'inflation' via currency depreciation and increased money supply: Supply constraints due to poor crop or new trade rules (a la Russia, which has driven the most recent bout of price increases)just to name a couple.

    I've posted about this on my blog.




  5. I don't generally find Mish worth reading as he makes even basic errors (such as referring to ZIRP as 'Keynesian') but there is so much crap on the internet regarding monetary theory, etc. that no wonder people are confused.

    Naked Capitalism, Pragcap and others have had excellent pieces on hyperinflation that have unfortunately been largely ignored. I suspect the case of hyperinflation is 'inflated' itself by goldbugs, ideologues and other reasons that have little to do with what's actually going on in the economy..



    What it boils down to though is really simple:

    The US issues debt IN IT'S OWN CURRENCY. In the previous examples of hyperinflation, the country undergoing the event was dependent on external sources for funding and the debt was owed in another currency (such as the Gold standard world of Weimar-era Germany, or the US Dollar ironically, for Zim). In addition, there is the need for a lack of productive capacity versus demand, which is certainly not a likely issue in the US!