Deflation: Rising & Surprising

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Wikipedia

“The US Congress established three key objectives for monetary policy in the Federal Reserve Act:  1) Maximum employment; 2) stable prices; and 3) moderate long-term interest rates.”

These three objectives are often conflicting and must usually be balanced rather than blindly pursued.

However, at least one of the objectives (“stable prices”) has never been pursued. Instead, the historical evidence indicates that real objective has always been rising, rather than stable, prices.  That’s inflation—intentional, long-term, institutionalized inflation.  For example,

1)  For my first job in A.D. 1959, I was paid 85 cents per hour. I swept floors in Blau Motors—a local garage. Today, the federal minimum wage is $7.25—apparently, almost 9 times higher.

2)  Back about A.D. 1965, I can remember gasoline selling for 25 cents per gallon. Today, even after the recent, fantastic fall in the price of crude oil, today’s price of gasoline is about 8 times higher than it was when I was a kid.

3)  In A.D. 1967, the price of a moderately-expensive new car was about $3,500. Today, prices for moderately expensive new cars are roughly 10 times higher.

4)  In A.D. 1970, the price of gold was about $30/ounce. Today, it’s about $1,300.  That’s a price increase of 43 times in 44 years.

These examples illustrate that the Federal Reserve hasn’t simply failed to perform its legal obligation to “maintain stable prices”—it hasn’t even tried.

Instead, judging by changes in nominal prices for wages, goods, commodities, etc., it appears that the Federal Reserve has opted to cause price instability by means of persistently higher prices (inflation) throughout most of my lifetime.  During the last 40-odd years, inflation seemed apparent and predominant; the fiat dollar lost purchasing power consistent with the rising prices I’ve just mentioned.

However, over the past 8 months, the purchasing power of the fiat dollar—as measured on the US Dollar Index—has increased from about 79 last May to 94, today.  That change indicates that the purchasing power of the fiat dollar—at least on the international level—has increased by 19% in just 8 months. That’s evidence of deflation.

Our apparent foray into deflation is surprising because:

1)  Inflation (the opposite of deflation) subsidizes borrowers and debtors since they can repay their debts with “cheaper dollars”. The US government is the world’s biggest debtor. Therefore, it’s in the government interest to cause inflation and thereby reduce the purchasing power and real value of the national debt.  We can expect the government to cause inflation simply to serve its own best interests.  Conversely, it should be surprising if government allowed or caused deflation, since deflation should effectively increase the size of the national debt and push the government that much closer to a time when it should be forced to default on its debts.

2)  Deflation is usually a symptom, cause, or harbinger of economic depression. Government and the Fed should work to prevent deflation in order to prevent an economic depression.  It would be surprising if government allowed or caused our economy to slip into deflation and economic depression.

3)  Since the onset of the A.D. 2008 “Great Recession,” our government and Federal Reserve have worked mightily through Quantitative Easing to cause inflation. We’ve been told repeatedly that inflation would “stimulate” the economy and rescue us from the grips of the Great Recession.  It would be surprising if the government reversed policy, abandoned its push for inflation and allowed deflation to become predominant.

4)  Throughout most of the 69 years since WWII, the government’s and Federal Reserve’s monetary policy has been to cause inflation in order to “stimulate” the economy. Again, it would be surprising if government had changed monetary policy to allow deflation which should slow the economy and push us toward economic depression.

5)  It’s widely believed that our stock markets, commodity markets, the prices of gold and silver and silver, and the perceived value of the fiat dollar have been intentionally manipulated by the government, Federal Reserve, Powers That Be, somebody, for at least the past 15 years. If that conspiracy theory is true, it implies that the government et al now want  I.e., if the government et al are really in control of our market indices and economic indicators, we shouldn’t be able to see evidence of inflation unless, surprisingly, the government wanted us to see it.

6)  There is a teeter-totter relationship in the relative values of fiat dollars and fiat yen, and fiat dollars and fiat euros. When the dollar inflates, the yen and euro tend to deflate and the Japanese and European Union economies tend to stagnate.  When the dollar deflates, the yen and euro tend to inflate and the thereby stimulate the Japanese and European economies.  Insofar as the US government is allowing the dollar to deflate, it is working to stimulate the economies of Japan and Europe and sacrificing the US economy to deflation. Surprisingly, our government appears to be working for the best interests of foreign countries rather than our own.

Therefore, the appearance of dollar deflation implies that government and the Fed have either:

1) Lost control of the economy and can no longer cause inflation/prevent deflation;

2) Decided to reverse nearly 70 years of pro-inflation policy and not only allow deflation but even allow another economic depression; or,

3) Decided to temporarily allow apparent deflation in order to trick the American people and/or the world into believing deflation is predominant and thereby cause Americans and/or the world to act in ways that our government will later exploit.

Every one of those three possibilities seems surprising.

•  Less than a year ago, virtually no one talked about “deflation”. No one expected to see deflation anytime soon.  The concept of deflation was barely understood.

Today, talk of “deflation” is common.  Some Americans are beginning to grasp its meaning, significance and likely consequences.  Deflation’s most important consequence is that it causes the currency to grow in value and forces debtors to repay their debts with “more expensive” dollars.   The extra burden imposed by deflation drives many debtors into insolvency and bankruptcy.  Deflation is death on debtors.

The biggest debtor in the world is the US government.

We have a debt-based monetary system.

You don’t need a PhD in economics to suspect that rising deflation (which is death on debtors) should have a debilitating effect on both the US government’s ability to repay the national debt, provide for Social Security and government pensions, and insure the financial system against economic collapse.  It should also have a debilitating effect on any debt-based currency—and that includes all modern, fiat currencies.

If deflation becomes predominant in the US and global economies, it should be about as welcome as the Black Plague.

•  Currently, there’s argument as to whether we’re really in an era of deflation, or if we’re still locked into our 69 year-long march to inflation. The evidence is mixed.  On the one hand, until just recently, we’ve seen many prices continue to rise (inflation).  On the other, we now some prices falling (crude oil) and the purchasing power of the dollar rising (deflation).

There’s nothing unusual in that “mix”.  At every stage in any economy we see some evidence of inflation and other evidence of deflation.

The question is Which is predominant at any given moment—inflation or deflation?

•  Jim Rickards is a regular commentator on finance and author of the bestseller Currency Wars: The Making of the Next Global Crisis, as well as The Death of Money. In a recent interview, Rickards described our current economic situation as being balanced “on knife’s edge” between inflation and deflation.  It could go either way.  We might slide into predominant inflation and an economic “recovery”.  We might slip into predominant deflation and an economic depression.

I basically agree with Rickards.  It could go either way.  Maybe we could go back to obvious and predominant inflation.  Maybe we could go into obvious and predominant deflation.

But, clearly, the current momentum is with deflation.  In just a few months, we’ve gone from a nation that barely mentioned the word “deflation” to a nation where talk of deflation is almost as American as baseball, motherhood and apple pie.  Deflation that seemed unthinkable just months ago, has become probable, almost undeniable, today.

•  Nobel Prize-winning economist Paul Krugman appears to agree. MoneyNews.com recently quoted Krugman (“Krugman: Swiss Currency Move Shows ‘Just How Hard it Is to Fight Deflation”) as saying that there’s a lesson to be derived from the Swiss National Bank’s recent decision to unpeg the Swiss franc from the euro:

“What’s important is the demonstration of just how hard it is to fight the deflationary forces that are now afflicting much of the world.”

If there was any remaining doubt as to whether “deflation” is a live issue or not, Mr. Krugman’s comments verified that deflation is real and poses a significant threat to the entire global economy.  If he’s right, the whole world is teetering on the edge of a global economic depression.

Asked about other economists who believe that the Federal Reserve should raise interest rates now, Krugman replied:

“But why?  There’s no sign of accelerating inflation in the actual data, and market indicators of expected inflation are plunging, suggesting that investors see deflationary risk even if the Fed doesn’t.”

Again, Krugman indicates that the forces of deflation are significant or even predominant.  Given that rising interest rates should inspire people to save rather than spend, rising interest rates should slow the economy and contribute to more deflation (and perhaps, economic depression) rather than inflation.  Krugman is saying that there’s no reason to raise interest rates, since doing so will only make deflation worse.

Given that Krugman has a PhD in economics and a Nobel Prize, there’s good reason to agree with his assessment of the move to raise interest rates.

Given my education and lack of a Nobel Prize (so far; there may still be some faint hope), there’s good reason to disagree with my opinions on economics.

Still, I disagree with Krugman’s assessment to a degree.  In a world of digital currency and the internet, currency can circle the globe at the speed of light.  That means that currency will instantly flow to any nation that raises the interest rates it pays.

So, while it’s true that rising interest rates should tend to slow the economy by causing Americans to save more and spend less (and perhaps precipitate an economic depression), it’s also true that rising interest rates should cause foreign-held currency to flow into the US economy in search of those higher rates of return.  As foreign-held dollars and foreign currencies flow into the US economy, they should increase our domestic money supply.  An increase in the domestic money supply should cause inflation rather than deflation.

Thus, to me (not to Mr. Krugman), raising interest rates should tend to both:

1) increase domestic savings, slow the economy and push us deeper into deflation; and

2) invite the influx of foreign currency, increase the domestic money supply, and thereby promote inflation.

Mr. Krugman implies that the single, possible result from raising interest rates will be increased deflation.  He’s probably right.

Even so, I have no doubt that raising interest rates will have two, contrary effects—deflation and inflation.  I’m probably wrong.  I might even be silly.  But if raising interest rates can increase the forces of both deflation and inflation, the question becomes “How much is each force increased?”  What’s the balance between the two, contradictory forces?

I don’t know.

However, I can see that if our interest rates were raised and thereby tended to slow the domestic economy by 4% while a simultaneous increase in the domestic money supply caused our economy to grow by 1%, then raising interest rates might cause a net economic slowdown of 3% (in broad strokes, 4% deflation – 1% inflation = 3% net deflation).  That net slowdown would contribute to economic depression.  Presumably, economic depression is bad.

In theory, the “balance” between the forces of deflation and of inflation caused by raising interest rates could be 9:1.  Maybe, raising interest rates would cause deflation to increase by 9% and inflation to rise by a mere 1% leaving a net deflation of 8% and revealing my ponderings on the inflationary impact of rising interest rates to be moot or silly.

But, what if the Fed raised domestic interest rates high enough to cause: 1) a significant influx of foreign capital; 2) a significant increase in the domestic money supply; and therefore, 3) a significant increase in the forces of inflation?  What if the resulting “balance” between the forces of deflation and inflation was 1:3?  What if interest rates were raised enough to cause a 1% increase in deflation and a 3% increase in inflation?  The net change would be 2% inflation. Wouldn’t that “stimulate” our economy?

The world seems convinced that interest rates must absolutely be suppressed in order to cause inflation and resist deflation.  So, we won’t even dare to raise interest rates for fear of causing more deflation.

I may be wrong, but I’m not convinced that the “world” is right.  We’ve had Zero Interest Rate Policy (ZIRP)—or at least “near” ZIRP—since A.D. 2008.  Since then, our economy has not been “stimulated” into a “recovery”.  Isn’t it possible that ZIRP drives currency out of domestic economy and thus slows the economy?  Isn’t it at least conceivable that the net effect of ZIRP may be deflationary?  Isn’t it possible that by abandoning ZIRP and raising interest rates we might (surprisingly?) attract enough foreign currency to increase the money supply, cause inflation, and thereby “stimulate” the economy back into a real recovery?

•  You might think that all of my ponderings resemble the Medieval debates over how many angels can dance on the head of a pin. I’d agree with you.

Still, it bothers me that rising interest rates can release both deflationary and inflationary forces and no one seems to be considering, weighing and balancing those forces.  Instead, the world seems determined to agree with Nobel Laureate Paul Krugman, that rising interest rates can have only one effect: deflation.

Well, Krugman’s probably right and I’m probably silly.  Still, I can’t understand why no one seems willing to consider the potentially inflationary effects that might result from raising interest rates, attracting foreign capital, increasing the domestic money supply, and thereby stimulating inflation.

I’ll admit that those inflationary forces are unlikely or will be, at most, insignificant.  But as I’ve written, it seems obvious to me that increasing the interest rates should tend to increase the influx of foreign capital, which should increase the domestic money supply, which should increase the domestic forces of inflation, which should “stimulate” our economy.

But no one else seems willing to consider and explore that possibility.  Why not?

•  I’m, therefore, left to ponder another question: Are the forces of deflation rising by accident or intent?

However unlikely, it strikes me that a thorough study of the deflationary and inflationary effects of raising interest rates might reveal that the net effect was inflationary.  If so, rising interest rates might actually result in inflation, economic stimulation, and a reduced chance of slipping into an overt depression.  That would be a good thing, right?

Insofar as deflationary forces appear to be rising without much “official” resistance, and insofar as no one seems to be considering the possible inflationary impact of raising interest rates, I’m left to wonder if the Powers That Be want deflation to become predominant and therefore want an economic depression.

•  Again, my previous speculation may be silly. Maybe I just need to get out more and stop thinking so much. But according to MoneyNews.com,

“A US deflationary trend already may have begun. The government reported Friday that consumer prices fell 0.4 percent in December, the biggest drop in six years. That put the gain [inflation] for all of 2014 at just 0.8 percent, the smallest 12-month advance since October 2009.

“The Wall Street Journal’s survey of 66 economists produced an average forecast for only 0.5 percent consumer price inflation in the 12 months through June, with 25 percent of the economists expecting deflation during that period.”

To me, it seems undeniable that:

1) deflation is present in our economy;

2) the forces of deflation are growing;

3) if the forces of deflation are, so far secondary, they could nevertheless become predominant within the next month or two; and

4) no one in the Federal Reserve or national government is making a significant attempt to thwart the growing forces of deflation.

I’m not surprised by the first three items in the previous list.  But the fourth item—no one in government or the Fed is making a significant effort to stop deflation—is more than surprising.  It is, for now, seemingly incomprehensible.

Either government recognizes that it’s incapable of fighting deflation, or government has chosen to allow or even cause deflation.  If either of those possibilities is true, rising deflation carries the surprising implication that we’re in or approaching a global depression.

Y’all best buckle up.