[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.
Rick, the real estate is not going to collapse until the hyperinflation has run it’s course. Why do you think it will? It only has to collapse if the borrowers can’t pay their mortgage payment. But this is not the case in hyperinflation.
I remember, for instance that in USSR, the workers pay went up in price very fast during the hyperinflation, and so did the real estate. As soon as food prices started to rise, workers refused to show up for work. Once the workers pay started to rise, it was a matter of child’s play to pay the mortgage, even though the interest rates went up too. This is because you got paid so much more that you paid literally half of your debt from just one salary check!
People who sold property have lost everything, and people who bought it, ended up being able to pay it off in few paychecks. Sellers wealth went to buyers hands, because the deal was done in the inflating currency. If you have sold a house, just a week later you could not buy even a half of it back for the money you got. At the same time, the buyers were able to double the payment that same week later.
Same here, you have seen the politicians already promising to raise the minimum wage to $15 by some year ahead. Well, this is only the beginning. They gonna start raising that minimum wage faster and faster and to a greater and greater degree, and with it, the rest of the wage structure will start going up and up and up. I mean we don’t have to even guess, this much we can already see them promising us.
So, you will be able to pay your remaining say, two thirds of a mortgage in say five paychecks, and then you will own the house. No default, technically. It’s the sellers that are going to take a loss, but they will also be (likely) made whole by special programs from the government. No need to change to lease, as all those mortgages are written in dollar terms. And keep in mind, that the government would not even raise the rates in the beginning, until the inflation had eaten away so much of the government debt that with then current revenues the debt is a joke to pay. Then they will try to raise the rates. The home ownership curve will shot to the skies.
Inflation helps the debtor. This is why the US even has the inflation – oriented economics (with Keynes and all that gang), – because the US government is a world biggest debtor. This is true no matter what debtor it is, the government or the homeowner, the inflation is their friend. Fergusson too, says that Jews did very good because they understood this mechanics.
As soon as this is going to start happening, the dollar is going to lose it’s reserve currency status, so there goes that condition. Or the other way around, as soon as the dollar is refused internationally, “the Hy-I” will begin.
Also, look how many times the hyperinflation had happened in different countries. Every one had different conditions, – not all of them had exact Weimar situation with the labor and the government etc. And yet, it happened in all of them just the same.
We already have a super-massive collusion between the US government and the entire population. Is new creative accounting not a sign of collusion? Are bank bailouts not collusion? What about all the programs that help bad people to stay in their houses (they should have never bought in the first place), – not a collusion? The suspension of the contract law, where suddenly it started to matter that the signing party was either too stupid or even too lazy to even read the contract before signing into terms, – and the government allowed this to break the contract, was this not a collusion on a super-massive scale? So called “predatory lending”, where all of a sudden it’s a lender’s job to see that the debtor makes the right decision? Not a collusion? The entire market is in a state of collusion with the government already.
As for the plans of the government employees, when the massive crying starts they will be partially bailed out. They will not hold anywhere close to the promised purchasing value, but they will be partially helped. So, if the purchasing power of someone’s pension today is , say 500,000 dollars, they will have only 50,000 by the time all is said and done, but if the government didn’t bail them out, they would be more like 5000 or even 500 dollars. Of course, on the other side of inflation these 50,000 of purchasing power will still look like 800,000 or 8,000,000 nominally.
When the crying starts this will become much more feasible politically, because the question will become literally about the very survival of all these government-paid people.
Hyperinflation is a process where the lender pays large. Who is the lender? The working people, and they have always have been. They will pay thru the nose for the debts of every kind. They will be made naked in this process. Uncle Sam will simply keep borrowing and pay back in ever inflated dollars. The rich will do the same as Uncle Sam. The poor will acquire multiple zeroes but loose all purchasing power during this, paying the piper.
From a massive empire, the US will turn into a humble big country with lots of really madly angry people. It will loose everything internationally, but it will retain the complete, dictatorial control over it’s impoverished citizenry. The anger will never find a proper outlet, a proper explanation, and will never turn on the government. Instead, it will turn on those who somehow managed to do good during this.
This is assuming that the US will not be able to start a world war as an excuse for what had happened.
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Home ‘owners’ are not going to get the opportunity to pay off their mortgages with wallet money, Mava; nor will workers’ pay catch up with inflation, let alone with hyperinflation. RA