November 12, 2008

Inflation. Then Deflation. Then Inflation. It hath been foretold.

After a lot of back and forth the past couple of years, HP'ers settled a while back on the Inflation/Deflation/Inflation scenario. And I think we nailed it. We felt we'd have:

Stage #1) A bout of wild inflation as Bernanke dropped rates too far too fast,

Stage #2) Followed by deflation as the reality of the bursting of the biggest financial bubble in human history set in,

Stage #3) Followed by inflation as dollars fall from the sky by the trillions, just as Bernanke told us he would do after we got to ZIRP (Read that speech folks. Read it twice. Then read it again.)

Well, I think most sane people would agree, we're in stage #2 right now. It could last for awhile, as everything, and I mean EVERYTHING, falls in price. Houses, gasoline, gold, iPods, Lamborghini's, corn, stocks, you name it. And here come the job losses, which makes it even worse.

And then, eventually, WHOOSH! The deflation bottoms out and currency debasement kicks in. An inflation holocaust according to Jim Rogers. And the funny thing? People will actually WANT inflation. They'll WANT the government to make prices go higher. You're about to see some really weird-ass sh*t.

Peter Schiff looks wrong today, dead wrong. He advised getting out of the dollar and into commodities and foreign currencies, which worked during stage #1, but has been disastrous during stage #2. Well, he'll be right when stage #3 kicks in. It's only a question of when.

The spectre of deflation

Until recently, the idea that deflation— the decline of most prices—was possible, let alone a potential economic danger, seemed outlandish. If anything, inflation was the threat. Led by rising oil and food prices, it was increasing in most countries.

But, in the past two months, deflation has suddenly become conceivable and, though still a long shot, it’s much more menacing than most people realize. The most urgent economic task for Barack Obama and other world leaders is to prevent the long shot from happening. A mild deflation—like a mild inflation—would be barely noticeable, and even pleasurable.

Who doesn’t like lower prices? But beyond a few percentage points, deflation can create economic havoc by forcing debtors to repay loans in more expensive money and causing consumers to postpone purchases. In the Great Depression, deflation reigned.

Consumer prices fell about a quarter from 1929 to 1933. Spending collapsed. Supply swamped demand, driving prices down. By 1933, manufacturing output had dropped 39% and joblessness had reached 25%.

It’s this history that makes deflation terrifying . Obama and his fellow leaders should worry. Since mid-September, economic conditions have deteriorated badly. In October, General Motors’ US sales were down 45% from a year earlier, Toyota’s 26%. Payroll employment dropped 2,40,000, the 10th straight month of decline. Abroad, signs of distress also abounded.


keith said...

I re-read that Bernanke helicopter speech one more time today (for probably the 20th time). It really is like reading Manias, Panics and Crashes - it tells you the future. It's all right there.

Here's one passage (among many) that caught my attention today:

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.

Anonymous said...

i missed the inflation part. i remember a spike in commodity prices, but no inflation in my book said...

The dollar devaluation is the last bullet.
I've used that speech to predict every step. No one believed anything until it actually happened.
They don't believe the dollar devaluation theory either. All my trades are set to take this possibility into account now. We are hedged against the dollars current rise but have very little direct dollar exposure.
I don't think people will even care when it happens.

Eric said...

We'll get high inflation when when the fed and treasury accept that banks just won't lend to unqualified borrowers any more. When this happens get ready for stimulus checks for $10,000+

keith said...

Everyone's wondering when's the time to buy (gold, stocks, houses, etc).

Well, the answer is quite simple

The moment the deflation ends and inflation begins

At that point, you'll want to spend your cash (especially dollars), and take out as much debt as you can safely handle

This is the most unstable market maybe in history. Wild inflation. Wild deflation. Then wild inflation.

The Fed's mandate is for price stability with optimal employment, while regulating the financial system.

0 for 3.


An epic failure.

But at least reading Bernanke's paper, you know what comes next. The "when" is the only question to be answered.

keith said...

As an expat holding dollars while spending pounds, my big consideration is when to transfer out of the dollar and into pounds. Every day just gets better and better. I'm looking for 1.30's soon. That would be amazing.

It was at 2.10 just a few months ago for reference.

Meanwhile, having this abrupt and historic rise in the dollar in the past few weeks is going to put a world of hurt into US exporters - at the same time as overseas demand crashes.

Instability and the lack of trust is what is bringing down the whole system. It's almost impossible to preserve wealth.

Anonymous said...

I think that will be a matter of political will. If the admin. has any stones, it will follow a Volker lead and jack up interest rates to keep inflation at bay. They are going to be starting at near zero for the overnight rate and people have become so much more rate sensitive over the past few decades that a movement upward of just a few hundred basis points is all that will be needed to show a fight against inflation and hold the line on acceptable prices. O.M.G. it might also actually encourage personal savings again - what a concept (/;>}

Ross said...

I am eagerly anticipating after Christmas sales.

I hope this hyperinflation theory is proven false, if only by wise actions by our leadership, which seems like a remote possibility.

Anonymous said...

Our deflation has a long way to go at this point. It is about the same as the contestants on "The Biggest Loser". Each one has years and years of accumulated fat layers to work through.

Mr. Market is being resisted by Government policy but we all know who wins in the end in the inflation/deflation O.K. corral shoot'em'up.

Guv'mint can fight all it wants firing shots from its .38 Special but Mr. Market is going to come out on top. By fighting the way that they are, the fight is being dragged out for a longer period than it should. The consumer attitude is shifting away from debt fueled consumerism and more toward thrift and saving and cash purchases. The foreign hired gunfighters are going down to Mr. Market's blazing .44. Or, the smart ones are fleeing the corral as they sh*t their pants. It is in the air. You can feel it (and smell it). Human emotion is starting to show itself. Think Newton's third law. Attitude and fear - that is what guv'mint doesn't control (yet) and that is the silver bullet in Mr. Market's .44 magnum bear gun. Mr. Market had the initials "B.B." engraved on that bullet that he's saving.

Anonymous said...

The USA in 1920's is like China today (or last year).

There was a great boom, tons of manufacturing and capital investment (1920's) and then a massive depression.

But look what happened: all that investment in physical production, engineering and knoweldge, was *still there*, ready for 1941, and the USA emerged on top of the world.

Same will happen with China---those factories, knowledge and supply chains, aren't going anywhere.

Outside the USA, the 1930's Depression was Even Worse.

There were developed, rich, countries which NEVER recovered, to this day.

Like? Argentina. In 1900-1920's Argentina was a first world country, average living standards higher than many European nations.

So, are we the manufacturing behemoth of the USA 1920's again, ready to rise, or a dysfunctional political clusterfcuk, like Argentina?

China is definitely the first---it will come back like a hurricane.

The history of the USA in the Depression, as bad as it was, is actually one of being the luckiest and most successful.

Britain's honest standard of living probably didn't come back to its 1900's--1920's level (on top of the world, with Empire) until the mid 1990's.

Anonymous said...

We are repeating the financial troubles of the early 1970's without trying to make it look like we are doing that. Jobs were scarce, loans were scarce, Prime rates were 11 percentish or so, and the main difference was that there was no internet and many less people (average citizens) who watched the financial news or understood any of it. From 1975--on, prices especially in real estate and autos took off like rockets, and people, now getting plenty of credit, fell right in to it. So inflation will come quickly, especially with lending in the tank. We are repeating the early 70's while denying we are repeating the early 70's. This time the difference is that it is a National Topic that can be felt more quickly.

Mammoth said...

There seems to only be deflation in those things one doesn’t need; i.e, that one can live without.

Meanwhile, who here is seeing deflation in food prices, insurance, and medical bills?

:::crickets chirping:::

Batman said...

Karl Denninger seems to think we are already close to the wall with an 8% bid /cover ratio on the last auction

"What if we had a bond auction and nobody came?"

Anonymous said...

Gold did well during the depression.

Stuck in So Pa said...

Deflation will only bottom after the commodity that caused the whole mess, (housing) finally resets to where it should be.

You have the "sticky-ness" of the FB's while they chase zero, coupled with the government's throwing everything, including the kitchen sink, into the fray, to prop up housing prices. This deflationary trough could last a lot longer than the Great Depression's bottom.

Meanwhile, all of the experts, like that ancient king who tried to hold back the tide, continue to rebuke a couple laws of nature.

1.The market can stay irrational longer than you can remain solvent.

2.The market WILL clean up it's own mess (Whether you want it to, or not.)

The only thing that can interrupt the market's natural cleansing powers will be World War III.

Paul E. Math said...

Price stability should be the fed's only mandate.

Full employment should be addressed by state and federal government policy.

Regulation of financial institutions should be performed by an organization whose sole duty is to regulate financial institutions, creating and enforcing sound regulation.

The only problem with this is it's too simple and straightforward for the meddling 'intelligentsia' and the corrupt profiteers.

vanilla ice said...

So basically, I should take whatever credit is available on my credit cards and start buying gold and silver stocks and bullion? And what about companies who own reserves of oil and coal?

Anonymous said...

Welcome to George and Dicks New Depression.

Welcome to Hell.


keith said...

This crash is taking it to "despondency" right about now I'd say. Where people just give up.

It feels like the world is ending and it'll never recover.

In other words, it feels like a bottoming.

If the governments of the world announce a 'shock and awe' stimulus after the global meeting on the 15th, then we could see some interesting things.

I'm thinking somehwhere in the ballpark of $10 trillion in total world government stimulus.

That would shock me. Might get a heartbeat out of the patient, who's DOA right now.

Global depression is on the table. What will it be?

vanilla ice said...

"This crash is taking it to "despondency" right about now I'd say. Where people just give up."

Maybe they are right to feel like giving up. This is the beginning of a very long and painful smack down. We are all worse off.

Anonymous said...

If the governments of the world announce a 'shock and awe' stimulus after the global meeting on the 15th, then we could see some interesting things.

I'm thinking somehwhere in the ballpark of $10 trillion in total world government stimulus.

That would shock me. Might get a heartbeat out of the patient, who's DOA right now.

Global depression is on the table. What will it be?

Okay, I am all for this nightmare going away, but where is 10 trillion going to come from? China is going to build bridges and infrastructure, they will flood the market with treasuries and dollars to convert to yuan in order to proceed with their own stimulus. This happens at the same time that no one wants to purchase treasures at auction because the return is so tiny that it is just better to stay in cash with no risk (see Denninger today).

Where will this $10 trillion come from?

Did you know that we will not have toothpicks once China begins building bridges with their surplus? Or shoes, or levis, or gym clothes, or TV sets (good thing) or appliances, or baby formula (leaded), ad infinitum.

A country that can't make its own freakin toothpicks deserves to crash.

Anonymous said...

phase 3 may hit in the last 2 years of obama's reign. because of it he will be challenged in 2012 by hillary and a republican will be swept into office. Perhaps 2012 will the time for ron paul.

Lady Di said...

Schiff made one costly mistake in his economic collapse prediction: He thought that the world would decouple from the US. It hasn't.

I continue to follow Roubini's outlook (and Mish's): Roubini states: severe recession through 09Stock market down another 20-40%; commodities down another 20%; housing will continue to decline.

Yes, cash is king, but more important in this deflationary environment is keeping your job, staying out of debt and protecting your wealth.

Finally, I think gold will have its day of glory once inflation takes off. There will be consequences to the trillions in dollars that the Fed is throwing down a rathole. There always are.

Gold is the ultimate king in my book.

Lost Cause said...

Ben can't drop rates below 0%. How is that going to cause inflation?

(Side note -- a bank that charges 4% on money that they get at 1% has a 300% profit margin.)

vanilla ice said...

Remember a few months ago when everyone from the Bush administration was saying "The markets are fundamentally sound."

Saying something like "Market ... has for all practical purposes ground to a halt" would have been sacrilege, but that is exactly what H. Paulson said today.

I also read in the WSJ that now may be a good time to buy stocks. HA! A good time if you like losing money. People just don't get it yet.

We'er starting our crash down the cliff and the public thinks we've just been in fender bender. We're all going down in flames together inflation or not!

Lost Cause said...

Cash is king these days. Deflation=Recession. There is no "third alternative" in the business cyle, people. It is either inflation, or recession, or some balanced state in which the top teeters upright for a limited time. Also, anyone who in any kind of debt is screwed.

Lost Cause said...

Whenever you think about some crazy price that you paid for something a while ago, you are feeling the effects of deflation. I know that I have had that feeling alot lately. I think that certain sectors are affected before others, but the wave is washing over everything.

Anonymous said...

Paulsons Bail-outs were for the purpose of direct grants to prevent insolvency . The fact that Paulson changed the Tarp program and its objective shortly after he got the money is clear .Of course Paulson had to in effect lie to get the money because the American people would not accepted what the real purpose was . Really ,the Feds/Treasury have exceeded their function .
Did it ever say that the function of the Feds was to give direct grants to Lenders to prevent insolvency ? No way .

Anyway , I think the original intent was for the Feds and Treasury to transfer the bad loans to to books of Fred & Fannie ,and than pay off the loss by taxpayers funds . This way the banks that owned unregulated loan bundles that could not be contractually subjected to a loan modification could be paid off in full and than taken care of by the Feds .

Why do you think they raised the Freedie and Fannie loan limits in a declining market ?

Whenever you see a government body doing strange things it is because they have to contort themselves in order to look like they are within the guidelines of what their real authority is . Contort things so it can be within the guidelines of the authority that was granted by law .
If Pausons had presented the case for direct grants for solvency for Banks ,there were of been to many reason to deny that objective . Saying that they were freeing up credit markets would fall within the domain of Feds Authority or purpose . All those short term loans that the Feds were giving the Banks, based on bad loans, was just to keep it going until they could in fact get the money for direct grants .No way could the Lenders make those loans from the Feds good . The Fed and Treasury must of been pissed that they had to go through the motions to get the set up for the solvency direct grant plan . The whole thing was sneaky and better plans would of been more effective ,and even more importantly fair . The Paulson Plan is a direct Obstruction of Justice and a attempt to keep Banks and Investment firms solvent who would really be sued silly had they not been given those direct grants to obstruct their liability , that would lead to insolvency anyway .Perhaps the Government would end up being thrown in on lawsuits as well as CEO's like Paulson would be in the Banking divisions of Big Investments firms .

I have never seen someone in history get so much money (as in Paulson )that would come in to play so much as to prevent legal liability on what that person did when they were a CEO at Goldmans.In other words , you do not have to address Justice or liability if you get to pay off the people who would of sued you .

Anonymous said...

I followed Shiff on housing (which saved me money) but, regrettably, lost big by following him with his picks of gold and foreign market investing.

If the US dollar will tank, what will be the currency that benefits? It can't be the Euro or the pound can it? Aren't they in as much trouble as the US?

Anonymous said...

Inflation wave: housing, other assests and everything that false wealth inflated with it.

Deflation wave: housing and the other assests. But not health care, it's its own animal. Education will put up a fight as well but have to go down.

Inflation wave: Government will print like mad to "recover" that false sense of wealth we had from the last wave, but this time the currency evaporates.

Peahippo said...


I'm looking to buy a house for $5-$20 per square foot, and it's DEFLATION that's providing it. Of course, it would have been a lot better to NOT have had outrageous inflation and unemployment provide a huge crash that caused this deflation. But since I was wholly unable to stop the speculators and their associated CRONY CAPITALISTS, at least I can now enjoy their inevitable, bitter tears. The tears of a criminal-level speculator are SO SWEET. I'm going to greatly enjoy a cheap standard of living ... since I MUST, since they left little to no economy that I can prosperously participate in otherwise.


investorinpa said...

Schiff's latest:

By offering to reduce mortgage payments to 38% of household income for homeowners who are 90 days delinquent, the mortgage program announced today will spark a new wave of delinquencies. In a classic case of unintended consequences, the plan will encourage homeowners to rearrange their finances to qualify for the benefit. Those who could conceivably economize to meet their existing obligations will now have a strong reason to forgo such sacrifices.

The intentional reduction of income is also a possibility. In many cases dual-income families may decide to eliminate one job altogether as reduced mortgage payments combined with lower child care and other work-related expenses will likely exceed the after-tax value of the lost paycheck.

It may also be tempting for some homeowners to temporarily quit high-paying jobs, or delay job searches, and accept low-paying jobs while the creditors consider their fate. Once their mortgage payments have been modified to fit their diminished incomes, these homeowners would then be free to pursue better-paying jobs. With mortgage payments reduced to a fraction of their prior payments, these workers will have much more employment flexibility than those foolishly struggling to meet non-modified mortgages.

Anonymous said...

Do you think Uncle Benny understand the Idiom "You can lead a horse to water but you can't make him drink."

Bubbles end when the costs of financing are too high to continue to prop up the inflated value of the assets.

Then a negative self-reinforcing cycle ensues, in which many things are tried in order to reflate the assets, but none succeed, because financing terms change.

Yield spreads widen dramatically, and often financing cannot be obtained at all. If a bubble is a type of “boom phase,” then its demise is a type of bust phase.

Often a bubble becomes a dominant part of economic activity for an economy, so the “bust phase” may involve the Central bank loosening rates to aid the economy as a whole.

The Fed loosening monetary policy only stimulates parts of the economy that can absorb more debt.

Those parts with high yield spreads because of the bust do not get any benefit.

But what if there are few or no areas of the economy that can absorb more debt, including the financial sector?

That is a depression.

Anonymous said...

For what it's worth, or not worth, Schiff was talking on the radio yesterday to a call-in talk show and a caller asked if the money lost in the stock markets just went, poof, disappearing forever, thusly affecting the deflation/inflation argument.

Since he ultimately is an inflationists, he said that all the money that went back to nowhereland is being replaced by the bail-outs. So, there can't be great depression-type deflation, it's only temporary, for now.

But....., always one of those, the last I looked the stock markets have lost maybe 9 or 10 trillion, so, like a couple-of other posters have said, is there a really BIG bailout coming that we don't know-of yet?

Kind-of an ultra-hyper-ponzi scheme coming soon to a world near you? As a way to keep the antiquated good-'ole-boy economic system going. If thats the case, I'd guess the human race has come to the end of it's natural life.

We've seen the new appointee whispering in Obama's ear, I can only hope Michelle is an angel whispering in the other, she doesn't give speeches like one, sooooooo....... it bye-bye time, humans?

Anonymous said...

The Stock market value was fake ,the housing market was fake . If you start from that premise your ahead of the game .

Add to that basic premise that the
people who created these false markets don't want the house of cards to fall ,expect that much money will be wasted to try to change who is holding the worthless bags . They will put themselves first ,and main street comes last.

The problem with putting Main Street last ,is that Main Street is the host ,you can't kill the host . They just don't get it do they?

Anonymous said...

The American retail sector is, and has been, way overbuilt for some time. Here in Phoenix you have hundreds of huge shopping centers, numerous auto malls with tens of dealers and enough restaurants to make your head spin.

There's no way the population of an area can support that many retail outlets on a long term basis.

I expect this holiday season will be a last stand for many retailers, and retail chains in the US. Look for a tsunami of bankruptcy annoucements in the first 3 months of 2009, followed by deflation in almost all areas of the retail sector.

Until the market reaches a stable supply (number of retailers)vs demand (number of consumers)condition prices will go down or stay flat.