'The Truth About Deflation' Janszen

[mosullivan]

I thought I would post this as I consider Eric Janszen to have a decent grasp of monetary policy. What I don't hear these people saying though is that inflation is an increase on the monetary aggregates with an expansionary business climate...We have neither today. Please comment and critique.

The truth about deflation

by Eric Janszen

With all of this panicking into dollars we get asked a lot about deflation. "Why don't you just admit that a 1930s style depression and deflation spiral has begun and soon there will be soup lines and we'll be buying cars for $2,000 and gold will trade at $100." The reason is that we are 100% certain that dollar appreciation that we call "Ka" as part of Ka-Poom Theory will not turn into a deflation spiral. Cars are not going to cost $2,000, although there will be plenty of cheap used cars for sale, and gold will not go to $200. Here's why.

The essence of Ka-Poom Theory is that after the phony credit-based boom ends, first the dollar rises and inflation falls before dollar repatriation and government reflation policies kick in. We don't think the transition from disinflation to inflation is trade-able because we expect it to be chaotic. But we don't blame readers for trying, or wanting to.

This ain't deflation

We're not nit picking terminology here. We’ll show you what a real deflation spiral looks like: nothing whatsoever like the deflation we are seeing today that we have long forecast and call disinflation to distinguish it from the run-away deflations that occurred under the gold standard in the pre Bretton Woods era.

Deflation was common back in the days when there was something for a currency to deflate against for more than a brief period of time before the government got involved: gold. Even then, governments often abandoned the gold to inflate the money supply to stop deflation, especially in times of war.



Note the early 1920s deflation reached -30% in some months and on and off for years at a time. Note also the massive inflations produced as the US government temporarily suspended gold convertibility and printed money to fund wars. Many forget that these huge swings occurred: 80% inflation during WWI and 100% inflation after WWII.

Governments can always produce inflation. Always.


The period of deflation that occurred in the early 1930s is the one that most people think about when they hear the word "deflation." What they really mean is a deflation spiral, with the money supply imploding, credit contacting, large scale bankruptcies, rising unemployment, and falling economic output. Note that there was not a single month of inflation from 1930 to 1933. Prices went down and down and down. For years.

The 1930s deflation spiral ended abruptly in 1934. Why? FDR took the US off the gold standard and devalued the dollar against gold which remained the international currency for trade transactions. And–this is key–there has never been another similar period of deflation since in any country. Ever.

Only one other government made the choice to stay on the gold standard at the time, Germany. Every other government got off the gold standard in the 1930s and inflated. Many, such as the US, resorted to currency depreciation, thus the impetus for Bretton Woods after the war; nations in a global depression that fight each other with competitive currency devaluations are soon fighting each other with guns.

There is a reason for that: since the 1930s no country has been on a national gold standard.



There were a very brief few months of deflation after WWII as the government attempted, Paul Volcker style, to wring inflation out of the post WWII economy. But note the deflation scale in this post-Bretton Woods period has now changed from the post-gold standard era. No more 30% deflations. On the rare short term periods when deflation happens it is less than -5% most months and only once since Bretton Woods exceeded 10% in one month.

Take-away: No gold standard, not deflation spirals. Ever again.



The first years of the 1960s were the golden era of monetary stability. In fact life was so good the US government decided to ruin it by starting a war, building the military industrial complex, and launching numerous entitlement programs that we are to this day still kidding ourselves into thinking we can pay for. Ran up a deficit, the Europeans figured we were cheating, called our bluff by demanding payment of debts in gold, so we defaulted. US to the world: Thanks for playing!



This was the ugly era of birth of the FIRE Economy. I won’t go into the details here but, clearly, deflation was not the problem. I will mention that this is when we came up with the dollar cartel to knock back OPEC and Nixon got to tell OPEC: "Thanks for playing!"


As the Volcker Fed raised interest rates, the US economy experienced a short spike of deflation around -5%. Since the technology stock bubble popped in 2000, the US has had several months of deflation like that in 2002, 2004, 2006, and 2007.

If you want to call today’s period of low inflation a "deflationary period" then you must also call 2002, 2004, 2006, and 2007 deflationary–actually more deflationary than today if you look at the graphs. Meanwhile oil increased from $20 to $147 over that period, which is not exactly a typical symptom of deflation.

Japan also has never experienced a deflation spiral. They could end their modest deflation, never exceeding -2% in a quarter off and on for more than a decade in short order, but the trade-off for them is a crashed yen– so they don't. I think we'll crash the dollar fighting off deflation.

The critical take-away is that we are indeed experiencing short term deflation. We call it disinflation here in the context of Ka-Poom Theory to keep readers from confusing the process with the start of a deflation spiral–which cannot happen under a floating exchange rate, fiat money system. The only way it could is if governments around the world all got together and decided to crash the global economy. That strikes us as unlikely. More likely one or more will move to reflate using currency devaluation.

If the Fed so desired the US could have 100% inflation by the middle of 2009 as the US did in 1946. All that is needed is for Congress to borrow a few more trillion into existence to fund old and new liabilities and have the Fed print it because our government cannot borrow the money from overseas or raise taxes, or devalue the dollar, or both.

It’s just that simple. Wish it wasn’t so. Trust your government not to do it?

Neither do we.

[malleni]

...

The truth about deflation

by Eric Janszen

...
This ain't deflation.
...

We're not nit picking terminology here. We’ll show you what a real deflation spiral looks like: nothing whatsoever like the deflation we are seeing today that we have long forecast and call disinflation to distinguish it from the run-away deflations that occurred under the gold standard in the pre Bretton Woods era.
...

Deflation was common back in the days when there was something for a currency to deflate against for more than a brief period of time before the government got involved: gold.

...
Governments can always produce inflation. Always.
...

The 1930s deflation spiral ended abruptly in 1934. Why?
FDR took the US off the gold standard and devalued the dollar against gold which remained the international currency for trade transactions. And–this is key–there has never been another similar period of deflation since in any country. Ever.

Only one other government made the choice to stay on the gold standard at the time, Germany.
Every other government got off the gold standard in the 1930s and inflated.

Take-away: No gold standard, not deflation spirals. Ever again.



The first years of the 1960s were the golden era of monetary stability.
...
Ran up a deficit, the Europeans figured we were cheating, called our bluff by demanding payment of debts in gold, so we defaulted. US to the world: Thanks for playing!
...
I will mention that this is when we came up with the dollar cartel to knock back OPEC and Nixon got to tell OPEC: "Thanks for playing!"


As the Volcker Fed raised interest rates, the US economy experienced a short spike of deflation around -5%. Since the technology stock bubble popped in 2000, the US has had several months of deflation like that in 2002, 2004, 2006, and 2007.

If you want to call today’s period of low inflation a "deflationary period" then you must also call 2002, 2004, 2006, and 2007 deflationary–actually more deflationary than today if you look at the graphs. Meanwhile oil increased from $20 to $147 over that period, which is not exactly a typical symptom of deflation.

Japan also has never experienced a deflation spiral.
They could end their modest deflation, never exceeding -2% in a quarter off and on for more than a decade in short order, but the trade-off for them is a crashed yen– so they don't.
I think we'll crash the dollar fighting off deflation.
...
The critical take-away is that we are indeed experiencing short term deflation. We call it disinflation here in the context of Ka-Poom Theory to keep readers from confusing the process with the start of a deflation spiral–which cannot happen under a floating exchange rate, fiat money system.
The only way it could is if governments around the world all got together and decided to crash the global economy.
That strikes us as unlikely. More likely one or more will move to reflate using currency devaluation.

If the Fed so desired the US could have 100% inflation by the middle of 2009 as the US did in 1946.

All that is needed is for Congress to borrow a few more trillion into existence to fund old and new liabilities and have the Fed print it because our government cannot borrow the money from overseas or raise taxes, or devalue the dollar, or both.



....

mosullivan,
Excellent article.
I just took the most interesting parts, but of course completely article is real good with simple logical explanations.
("Explanations" of sort "I believe that somebody will find the way for bail out us..." - is really not funny at all, since those are not explanations. These are - wishes...)

As said, quite logic explanations too...
Which is extremely important, since I am not currency trader so - I cannot "believe my feelings".
Facts - not imaginations, "theories" and own perceptions of history is not exactly necessary. Those are too much on the net already.

Anyway, it would be interesting to see what deflation theorists saying as answer.

[StilesBC]

I have been a "deflationist" for a few years. I was previously a "inflationist". I am also a student of Austrian Economics. Generally, we believe the Dollar is unworkable in it's present form and from an ideological perspective, we despise the confiscatory nature of inflation that a fiat currency naturally perpetuates. We want a gold standard, and as a result we want the dollar to implode so our goal can be realized. Therfore, any notion of the dollar rising is typically rejected as nonesense to most of my colleagues - Mr. Janszen included.

Unfortunately, most Austrians (not all) share the myopic view that because the Fed and Treasury are growing certain areas of the supply of money and credit that it will have the same effect it did every other time they did the same thing. i.e. - the creation of another asset bubble, and a rise in general prices.

John Xenakis, Kevin Depew (http://www.minyanville.com), Mike Shedlock (http://globaleconomicanalysis.blogspot.com), and myself (http://futronomics.blogspot.com) all understand that the conditions in existence now are different from those in the past 80 years. For one, we have an aging boomer population that need to liquidate their assets for retirement. Second, we have a heavily indebted Gen-X and Gen-Y population that desperately need to save money, eliminate debt and spend less money overall. Third, we have banking institutions worldwide, whose balance sheets are so impaired, that they are not ABLE to lend money, even if they wanted to.

It takes two people to make a transaction. And just because there is someone (central banks) providing a nice cozy environment to make one, doesn't mean it will happen. Banks cannot lend. Consumers and businesses see no reason to borrow. That is, in essence, the argument for deflation. "You can lead a horse to water..."

If businesses and consumers rapidly started saving, slashing expenses and re-educated themselves in new lines of work. And if banks allowed for a far higher level of transparency into their balance sheets, marked all assets to market and reduced their leverage ratios - we could potentially see a mid-cycle hyperinflationary boom, that if allowed to grow out of control, would lead to the destruction of the dollar. But that is a lot of "ifs". And the destruction we would see along the way would be breathtaking.

It "should" have been done by now. Balance sheets of westerners "should" have been repaired after the dot-com bubble. Banks "should" have reduced leverage and improved their balance sheets in 2002. And responsible government officials "should" have told us to reduce consumption and debt. Society in general "should" have, at that point, retrenched and to put it bluntly - started making more babies. But we were told to do the opposite. And like good little sheeple, we obeyed. Now we are being forced to do all of the above from a far tougher starting point.

Essentially, we are making the same mistakes that were made in the 30's. We're trying to prevent asset prices from falling to where savers are willing to buy them (i.e. much lower). And we are depleting the pool of available savings now, by going further in debt to prop up these prices. This means that when the opportunity arises for a new technology or infrastructure project to be advanced - we won't be able to. We'll lose the opportunity to some other, more frugal nation. And the jobs that would 'normally' be created will cease to exist.

From 1932 to 1937 the Dow Jones rose nearly 500%. Yet very few people managed to participate in one of the greatest bull moves of all time because there were no savings. The employment rate barely budged during this time first because there were few legitimate business opportunities, and later because the skills of most workers became obsolete after years of underemployment. As a result, the economy died again in '37 and eventually led to America's reluctant participation in WWII.

There is simply no way to make this crisis go away as our central bankers have promised us they can do. And we certainly cannot simply 'go back' to the way it was. To me, it is very clear that what they are doing now will be to our severe detriment 5, 10 and potentially 80 years down the line. Whether they are doing this malicously with some ulterior motives (aspirations of the banking elite for a one-world government, justification for another war) or out of ideological ignorance is not a question anyone knows the answer to.

The outcome is already pre-determined. Asset prices will go far lower, many people will lose their jobs and there will be widespread civil strife. What is not pre-determined is the path we take to get there, and our relative position to emerge from the crisis stronger than other nations. Will we give our liberties away in favour of comforting reassurances from authoritarian leaders (like the Germans did for Hitler) or will we return to our roots? Will we have the courage to jump at new opportunities in efficiency technology and health care or will we retreat to the comfort of old and tired industries? Will we embrace diversity, new ideas and trade, or will we persecute, attack and protect?

Those are the real questions. Arguing about why the stock market went down yesterday and what it will do tomorrow are such miniscule issues in comparison, yet nobody is willing to address them. That unwillingness leads me to believe our society is so blinded by their own waning narcissistic materialism that they will be willing to sacrifice anything to get it back.

It's not coming back. And unless we come to realize that soon and embrace it's cleansing qualities, the only question remaing will be, "what form of tyranny will we accept under the guise of it's promised return?"

[John]

Dear Matt,

That's a great posting. You have an excellent expository style.
And it bothers me enormously, as it does you, how all this bailout
and capitulation crap is turning a disaster into an even worse
disaster.

Sincerely,

John

[mosullivan]

Dear Matt,

Thank you for your reply. I enjoy coming to this site becuase John and others (like yourself) are willing to look at things without "speaking to your holdings" or so it appears. I've experienced rath, hostility, been called an idiot and told I am clueless when asked 2 simple explanations to inflationists:

1) Doesn't inflation ooccur with and expanding monetary AND BUSINESS environment?

2) How can we have inflation when money (even worse fact is that money a la 1930 is now debt) is being purged much faster?

I make it clear that I am seeking to clarify and not in any way demean or mock however, I still don't have a well-reasoned reply. Is this perhaps why the name calling begins? I know the answer. Or when I ask how are going to experience "Weimar" when we are the worlds reserve currency. are indebted (unwinding)

Thanks again for taking the time as I have found this discussion a great learning experience.

Best, MIOS

[Higgenbotham]

Dear Matt,

That's a great posting. You have an excellent expository style.
And it bothers me enormously, as it does you, how all this bailout
and capitulation crap is turning a disaster into an even worse
disaster.

Sincerely,

John

I agree. Thank you Matt for a great post. A voice of reason in the wilderness. The part about this affecting us "potentially 80 years down the line"--everyone is remembering back to 1929, but this situation may be shaping up like the 1340s collapse of the Florentine banks (Peruzzi, Bardi, etc.). It seems to me that the ignorance that is engulfing our civilization needs to be stopped soon in order to avoid a larger disaster than the 1930s.

[John]

> I agree. Thank you Matt for a great post. A voice of reason in
> the wilderness. The part about this affecting us "potentially 80
> years down the line"--everyone is remembering back to 1929, but
> this situation may be shaping up like the 1340s collapse of the
> Florentine banks (Peruzzi, Bardi, etc.). It seems to me that the
> ignorance that is engulfing our civilization needs to be stopped
> soon in order to avoid a larger disaster than the 1930s.

It seems counterintuitive that any previous collapse could be worse
than the one we're about to have. How would the 1340s collapse be
worse?

Sincerely,

John

[Higgenbotham]

> I agree. Thank you Matt for a great post. A voice of reason in
> the wilderness. The part about this affecting us "potentially 80
> years down the line"--everyone is remembering back to 1929, but
> this situation may be shaping up like the 1340s collapse of the
> Florentine banks (Peruzzi, Bardi, etc.). It seems to me that the
> ignorance that is engulfing our civilization needs to be stopped
> soon in order to avoid a larger disaster than the 1930s.

It seems counterintuitive that any previous collapse could be worse
than the one we're about to have. How would the 1340s collapse be
worse?

Sincerely,

John

The potentially common feature of the 1340s collapse is that the entire European banking system collapsed, as the Bardi and other large Florentine banks had offices across mainland Europe and even in London. My recollection is that the larger banks had swallowed up smaller banks with sound balance sheets in the 1330s (as happened in the 1990s) to expand the bubble, then swallowed up bankrupt competitiors, as is happening at the moment, until the entire banking system collapsed, with the Bardi collapsing last in 1346.

Once this occurred, the political order began to break down and the Mongols looted and destroyed many European cities (edit--looking into this further, I don't see any evidence that the Mongols were so much a problem at this time except for at the Siege of Kaffa where the successors to the Mongol hordes had been stricken with the Black Plague and apparently catapulted plague stricken corpses over the walls of Kaffa in 1346). From there, the worst episode of the Black Plague took hold sometime around 1348, culminating the loss of about 30% of the European population by 1351. And if I remember right, this collapse was global in nature, affecting areas beyond Europe.

It's difficult to find much information on this history from a purely economic standpoint, but I created a folder with references which link to google books and other sources and can dig them up if anyone was interested. I found the readings dense and difficult to interpret in today's context, but did note many similarities. There's also a book by Barbara Tuchmann (Guns of August author), A Distant Mirror, which describes the Fourteenth Century collapse generally and which I have not read but would appreciate any insight from anyone who has.

As far as the scale of collapse, it sems to me that perhaps the 1930s would qualify as being in a certain class, with the 14th Century collapse being in the next most severe category, then perhaps the Dark Ages being in a category beyond that. In the 14th Century nation-states did not exist in the sense that they do today and we have now gone so far as to use the financial resources of the nation-states to backstop the financial system. If that fails, it would seem to me that we will have impoverished the citizenry to a greater extent than would have been possible in the 14th Century. However, my understanding is that general conditions in the decades leading up to the collapse were much worse than they are today, with weather problems, sporadic famines and economic depressions.

I'm not an expert on this history but, like I said, have noticed many eerie parallels from an economic standpoint in casual reading. Any comments appreciated, pro or con, from those who might know better.

With regard to the subject of inflation and deflation, if we are entering something one degree greater in magnitude than the 1930s it may be a waste of time to debate this subject. My best recollection is that the prices of gold and silver fluctuated severely in the 1340s with no definite trend, as seems to be happening today, while the economy more or less imploded.

[StilesBC]

Thanks for the kind words, folks.

And that is amazing stuff on the Florentine/Bardi panic, Higgenbotham. I've gotta look into that one.

[StilesBC]

Great interview from Kevin Depew today on deflation, Japan and Greenspan. He talks alot about changing socioeconomic moods and why that makes this a far different situation than any other in the last 25 years. Listen here:

http://www.minyanville.com/articles/Gre ... ex/a/19754