Some Would Still Deny Deflation’s Irresistible Power

[A subscriber sent me a report last week from a high-powered consulting firm that said odds of deflation were remote. It’s a curious time to be making this argument, given that Europe’s economic implosion has sucked up trillions in stimulus with no discernible effect. One of the reasons that deflation is so poorly understood is that those who should know better persist in characterizing it as a decrease in the money supply. That’s like saying war is a decrease in peace. Both statement are arguably correct, but neither says anything. Who even knows what constitutes money these days, let alone how much of it exists?  If you want to understand deflation better than the eggheads and pundits, you need only focus on its chief symptom: an increase in the real burden of debt.  At a personal level, you’d feel that burden most acutely if the value of your home were to decline. It would be still worse if you’d taken out a second mortgage to put your kids through college. Could something like that happen to millions, if not tens of millions, of Americans? If you answered yes — and you should have, since it actually happened in the U.S., less than a decade ago — then you have implicitly rejected the notion that deflation is only remotely possible.

To further stimulate your thinking about deflation, which I regard not only as inevitable, but as a precursor to any hyperinflationary epiphany of the dollar’s worthlessness, I am reprinting a commentary that appeared here more than a decade ago. The Great Financial Crash has since validated my thesis, although I could hardly have imagined at the time that the banksters would subsequently blow a far bigger bubble that is growing even as I write these words. I published the material below in the heat of an inflation-versus-deflation debate that ultimately grew too rancid for my taste. A well-known economist in the hyperinflationist camp who was in the thick of it later recanted in a private email to me. I won’t name names, but if he ever comes out of the closet it would add a persuasive voice to the deflationist camp. RA]

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I’ve long argued here that the enormous credit blowout begun in the early 1990s can end only in a ruinous global deflation. Although I’ve yet to encounter a serious rebuttal, a deeply flawed argument that keeps popping up hinges on the notion that the Fed will somehow succeed in inflating our debt problems away. This ignores two irrefutable facts: For one, only hyperinflation, which by definition is unsustainable, could effectively wipe out some $200+ trillion [How quaint!] of global debt; and for two, the very process would destroy savers — in this case, mainly bondholders and pensioners — as a class.

A recent note from a Rick’s Picks subscriber illustrates just how the inflationists can go awry. He takes the fallacy of an easy-money bailout a step further, suggesting not merely that inflation rather than deflation will do us in, but that inflation is about to make every American homeowner rich – infinitely rich, if I haven’t misinterpreted his argument. The subscriber writes as follows:

‘Inflation Is…’

“Inflation is defined as an increase in the supply of money. Period. A symptom of inflation is a rise in prices. Just which prices rise depends on many things. Currently it is house prices that are rising, along with commodities. You can have inflation with falling prices (i.e., M3 growth, but with computer prices falling), or vice versa.

“Too many people confuse inflation with the CPI. The CPI is just one measure of the symptoms of inflation. It is not inflation itself, just like rising prices is not inflation. Inflation is an increase in the supply of money. Deflation is a decrease in the supply of money. Over the last few years, M3 has exploded. That’s one reason why house prices have gone up so much (along with low interest rates). I don’t see that stopping. [Emphasis is mine.] Greenspan has stated on more than one occasion that he will inflate when necessary. And boy is he good at it!

“So how are we going to see deflation (i.e., a decrease in the supply of money)? Bear in mind, even in this sort of environment you can still have rising prices in certain items.”

I replied as follows:

An M3 Gusher

Others have used the same definitions for inflation and deflation that the subscriber has used, but they will no longer suffice to explain how the real world works. This was starting to become clear about ten years ago, when monetarists panicked after the Fed deployed an M3 gusher to get us out of the 1990-91 recession. M3 did indeed go bonkers at the time, but the inflationary spiral that they all expected to result never arrived. Or rather, it did — years later, in the form of a stock-market bubble. But few thought to call that inflation.

Mr. Greenspan himself described this accretion of vapors as wealth, and although the ostensible riches vanished along with the dot-com boom, this seems not to have unsettled the Fed chairman’s bizarre notions about how the economy works. In his mind, the “wealth” has simply shifted into real estate, there to remain until it is urgently needed to grow the nation’s stock of capital goods, as he evidently believes is happening now.

Economics ‘Hall of Shame’

If Mr. Greenspan someday joins Prof. Irving Fischer in the economists’ Hall of Shame, it will be because he promoted crackpot ideas about “wealth” like that one. Until then, however, and most unfortunately, tens of millions of Americans living in homes whose prices have doubled or even tripled in recent years will continue to believe they are rich, just as the Fed chairman says. But to return to the point: Suppose the monetary M’s were going wild but there was no observable inflation in the consumer sector. Would economists and pundits still worry about inflation? The answer, as we saw in the early to mid-1990s, is yes, at least for a while. But if the symptoms were so insidiously seductive as a dot-com boom, or so politically incorrect as a rise in the price of gold, who in a policy-making position would deign to acknowledge that inflation even existed? Moreover, although calling an increase in the money supply “inflation” may be technically correct, who cares? It is only the severity of the symptoms that matters. So let’s put M3 aside and imbibe the more tangible dangers of the real world.

Greater Fool-Pool Dwindling?

Most perilous of all, of course, is the housing boom, and I vehemently disagree with your blank assertion that prices in this sector will continue to rise – I paraphrase here – forever. A significant portion of the inflation in real estate is being squandered on consumption, and that simply cannot go on. The supply of greater fools ultimately depends on a push from below, and I somehow doubt that the economy, such as it is, will enable Gen-Xers to push me into a $2 million home. The game is over, and even if a still-rosy statistical picture of the housing market makes this difficult to see, there are other indicators that suggest a credit deflation lies just around the bend.

Bear in mind that Mr. Greenspan’s ability to promote inflation has depended entirely on the eagerness and ability of Americans to keep borrowing. If you think this trend will continue more or less forever, and that it will wax sufficiently to create economic growth over and above the rate if inflation, then I would surmise that you are as out of touch with your friends, neighbors and business associates as Mr. Greenspan evidently is with the physical world.

The Quadrillion-Dollar Home

Make no mistake: K-wave winter has begun, and debt is about to shrink precipitously as forced saving increases commensurately. Anyone who wants to bet against this prediction need only trade up to a much bigger house. As those of us who are now beginning to hunker down would profess, it is still all too easy to do. Regarding your question of how the money supply will decrease, the answer is elemental: An epic wave of bankruptcies will cause zeroes to disappear from the global balance sheet much faster than the central banks can get us to borrow those zeroes back into existence. Or maybe I’m wrong, and my house will actually be “worth” $1,000,000,000,000,000 someday. After all, it’s happened before. Just not recently. Or here.

I heard back from the subscriber, Jonathan O., concerning the above. Here’s our final exchange, starting with his comments:

“OK, first we need to understand what inflation is. If you term it as rising prices and deflation as falling prices, then we will always be experiencing inflation and deflation simultaneously. Never just one or the other. There are always items which are falling in value and others which are rising. In 1990-1992 we experienced falling real estate values in the UK – I never heard of any talk of deflation. Electronic prices are always almost falling. Gasoline prices go up and down.

Real Estate vs. Gold

“I don’t think real estate is going to go up ad infinitum. I do not believe, though, that it is going to plummet. It will probably go sideways to slightly down. Steve Saville put it cleverly by saying that in nominal terms real estate will probably go sideways, but in terms of gold, it will plummet wildly, as the dollar loses much of its value over the next five to ten years.

“Another thing: Gold goes up when confidence in fiat money declines, which is often because of inflation. That’s exactly what has happened the last few years.

“Your comments re Greenspan’s inflating indefinitely being dependent on the U.S. consumer being willing to take credit does make sense. I like your argument here – lots of people are relying on the U.S. government to bail them out whenever necessary.

My reply:

$237 Trillion Implosion

Public, private and corporate debt in the U.S. currently total about $37 trillion, not including unfunded liabilities. In addition, aggregate notional borrowing via financial derivatives amounts to a little more than $200 trillion globally. These sums obviously dwarf whatever monetary nostrums policymakers may have in mind to keep the U.S. and world economies marginally afloat. While we may have some relatively piddling price increases in gypsum wallboard, cocoa beans, copper and such in the coming months, and although housing prices could eke out modest gains over that time, these last-gasp symptoms of price inflation will be as nothing in comparison to the irresistible power of $237 trillion worth of debt imploding.

To repeat yet again something the late C.V. Myers wrote in his 1977s book, The Coming Deflation: “Ultimately, every penny of every debt must be paid – if not by the borrower, then by the lender.” Considering the cosmic sums involved, nothing less than hyperinflation or full-blown deflation will suffice to discharge our debts. Whichever occurs, the hard lesson we will be forced to re-learn is that debt is not metaphysical, and neither is money.

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