In the long run, the inflationists are destined to win… but in the here and now, deflationary forces still have the upper hand.
The bulls and bears fight tooth and nail as they always have. But there is another battle royale still taking place – the fight between deflation and inflation. Or rather, the verbal sparring match between those who see one and those who see the other.
Both sides are firmly entrenched. The inflationists call their opponents blind to the enormous sums of money being printed. The deflationists retort that inflation is a rumor and an illusion, given what near-term prices and wages have to say.
The debate is further muddled by disagreement as to what “inflation” actually is. Some try to argue, with verve and force, that inflation is literally defined as an increase in the money supply, independent of what happens to prices.
The problem with this definition is that it does not match up with what’s in the dictionary. And it is less than helpful given that money printing activities can act on prices with a lag… sometimes a lag that lasts for years.
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Worse still for the “printing equals inflation” dogma, it overlooks the fact that sometimes credit and wage destruction happens on a larger scale than money supply reconstruction. That is to say, if an economy loses X dollars’ worth of money and credit in circulation as a result of fiscal collapse, but only 0.5X worth of money supply is injected back into the system, the result is still a net decline in spending and pricing power.
Expansion is always relative to contraction. Positive and negative forces can cancel each other out, and thus the only way to truly get a handle on the inflation/deflation debate is through the lens of monetary velocity. (For more on this important topic, see the Feb. 1 Taipan Daily piece, “Is Inflation Tied to the Money Supply?” You can also sign up to read my fellow editor Adam Lass’ latest investment commentary.)
CPI Not Much Better
Of course, those who point to the record low Consumer Price Index (CPI) and say “Look ma, no inflation!” do not have a leg to stand on either. The very idea of excluding food and energy from inflation calculations is something of a farce. Worse still, the government is intentionally manipulative and deceptive in the way it handles CPI inputs.
What’s more, those who key off the CPI – ignoring printing press activity completely – are essentially ignoring the dead tinder and hot, dry conditions of future inflation risk that exist all around them, as if all that mattered was the unburned patch of ground in front of their nose.
First Deflation, Then Inflation
As we have stated before in these pages, “first deflation, then inflation” still seems the likely order of things. Right now, the world is still dealing with strong deflationary pressures, as evidenced by the following:
Key commodity price gauges have all been stagnating or declining year to date. From both a daily chart and weekly chart perspective, important markets like crude oil and copper have stalled. Trends are somewhere between flat lined and heading south. The same is more or less true for natural gas, unleaded and various agricultural commodities.
The U.S. dollar is at 12-month highs. The world’s most important commodities are still priced and traded in dollars, all around the globe. That makes dollar strength a deflationary force. A strong $USD also threatens U.S. economic expansion by putting a crimp in export competitiveness for small- to medium-sized U.S. businesses, and further means large U.S. multinationals could see their international profits cut.
U.S. wages are still stick in the mud. In past episodes of heavy inflationary breakout (like the 1970s), rising wage demands were a powerful input. But there is very little (if any) pricing power for wage workers now, in both the United States and elsewhere.
Joblessness persists. Consumers without jobs do not borrow and spend with abandon. “New claims for state jobless benefits unexpectedly rose last week,” Reuters reports, “suggesting the labor market recovery may have hit a speed bump.” And then there’s this, from The New York Times:
The recession seems to have penetrated a profession long seen as recession-proof. Superintendents, education professors and people seeking work say teachers are facing the worst job market since the Great Depression. Amid state and local budget cuts, cash-poor urban districts like New York City and Los Angeles, which once hired thousands of young people every spring, have taken down the help-wanted signs.
A global tightening cycle is underway. China is being forced to deal harshly with inflationary pressures (lest civil unrest get out of hand). Europe is focused on belt-tightening austerity measures as the southern eurozone countries come to grips with their debt. New resource tax initiatives (kick-started by Australia) threaten to dampen economic activity in the countries that deploy them. Interest rates in the United States can only travel in one direction – upward – having already hit zero.
Struggling equity markets cancel out the “wealth effect.” As Ivy League economists like Professor Robert Shiller have pointed out, “perception is reality” when it comes to consumer spending and economic vibrancy. When the equity markets are strong, Americans feel more optimistic and thus looser with their wallets. When equity markets are volatile and frightening, however, that optimism is replaced with a sense of foreboding, causing wallets to snap shut.
Outright debt levels are still a huge problem. Western world consumers and Western world governments are still up to their eyeballs in debt. The “deleveraging” process is still a long-run necessity, regardless of temporary delays. The hemispheric overhang of all that debt is perhaps one of the largest pressure sources of all in respect to deflationary impacts.
Inflation as Endgame
In the longer term, the “inevitable inflation” case is still very solid. That is because, ultimately, only one of two things can happen from here:
Either we push our way through to genuine global recovery, in which case stagnant monetary velocity picks up and the “dead lake” of printed money becomes a raging river, or
The widespread deflation situation become so bad, and economic weakness so pervasive, that skyrocketing Western debt levels send investors into a panic, leading to an outright collapse of faith in the trust-based fiat money system that dominates the Western world.
Either outcome – and we have to get one or the other – could be hugely bullish for hard assets and other inflation-linked investments, while at the same time massively bearish for fiat currencies in general ($USD included) and U.S. Treasury bonds in particular.
But timing is everything when it comes to trading and investing decisions, and that’s why it’s important to recognize which side – the deflation side – has the upper hand in the here and now.
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