Get Ready for the Return of Inflation, says Tim Congdon, in a Wall Street Journal op-ed.
The economists Milton Friedman and Anna Jacobson Schwartz demonstrated in “A Monetary History of the United States” that a collapse in the quantity of money was the main cause of the Great Depression. Hoping to avoid a repeat, the Federal Reserve in recent weeks has poured money into the economy at the fastest rate in the past 200 years. Unfortunately, this overreaction could turn out just as poorly; history suggests the U.S. will soon see an inflation boom.
Friedman and Schwartz used a broad definition of the quantity of money that included all bank deposits, and found that U.S. money stock shrank by 38% between October 1929 and April 1933. Some prominent economists—including Princeton’s Paul Krugman and Columbia’s Joseph Stiglitz—claim that money growth no longer matters much, but they’re wrong. After all, the 2007-09 recession showed that the ever-changing fortunes of the banking system have a significant effect on demand, output and employment. From 2010-18, growth rates of the quantity of money and nominal gross domestic product were virtually identical at 4% a year.
Policy makers have repeatedly called the battle against the novel coronavirus a war. As in wartime, federal expenditures are rising sharply while tax revenues are being hit by the lockdown. Both World War I and World War II—and, indeed, the Vietnam War—were followed by nasty bouts of inflation. If that happens again, policy makers today being cheered for their swift, decisive action will instead have to answer for their grave lack of foresight.
Inflation View is Wrong
The inflation view espoused above is widely held. Some even call for hyperinflation.
However, the collapse in demand, dwarfs supply shocks and monetary printing.
The Fed Will Soon Need to Stem Deflation
Economist Tim Duy thinks along the right lines. Duy says The Fed Will Soon Need to Stem Deflation.
It was common early in the crisis to view the viral outbreak as a supply shock because, from the U.S. perspective, it appeared to be largely impacting the flow of goods from China. This original view suggested an inflationary impact from the virus.
The demand-side impact, however, now clearly dominates the economic outlook. Shutting large portions of the economy resulted in a collapse in spending and surging unemployment.
Not only do we have a collapse in demand, but the eventual rebound in activity is likely to be anemic, too.
The result will be a protracted, substantial output gap that will weigh not only on inflation but inflation expectations as well. That shift in expectations will weigh on demand. For instance, a student recently asked me if I thought this was a crazy time to buy a car. I said it would be better to wait a few months for prices to come down instead.
What About Wage Pressures?
Duy cited this interesting point from the recent Fed Beige Book of economic conditions.
No District reported upward wage pressures. Most cited general wage softening and salary cuts except for high-demand sectors such as grocery stores that were awarding temporary “hardship” or “appreciation” pay increases.
Deflation Summation
- Demographics
- No wage pressures
- Falling demand
- Anemic rebound
- Eurozone basket case supports the dollar
I find it amusing that people get huge inflation worries out of that mix.
Inflation Targeting Silliness
But Duy misses the boat too on one point.
Still, watch for deflation concerns to eventually reveal themselves in increasingly strong language reinforcing the Fed’s commitment to a 2% inflation target followed by forward guidance to more strongly lock in expectations that the central bank will not reverse policy easing anytime soon.
Duy is on the right track, but he failed to blame the Fed.
Very Deflationary Outcome Has Begun
A Very Deflationary Outcome Has Begun: Blame the Fed
Economic Challenge to Keynesians
Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.
My Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.
BIS Deflation Study
The BIS did a historical study and found routine deflation was not any problem at all.
“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.
Deflationary Outcome
The existing bubbles ensure another deflationary outcome.
Deflation is not really about prices. It’s about the value of debt on the books of banks that cannot be paid back by zombie corporations and individuals.
That is what the Fed fears. It takes lower and lower yields to prevent a debt crash. But it is entirely counterproductive and it does not help the consumer, only the asset holders. Fed (global central bank) policy is to blame.
So prepare for another round of debt deflation, possibly accompanied by a lower CPI especially if one accurately includes home prices instead of rents in the CPI calculation.
For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?
Inflation targeting is one of the reasons why we are in such a mess for the third time in 20 years.
Bubbles are Inherently Deflationary
It’s asset asset bubble deflation that is damaging, not routine price deflation.
When asset bubbles burst, debt deflation results.
Here we go again as Hyperinflationists Come Out of the Woodwork Again.
Mike “Mish” Shedlock
Surely whether we get price deflation or price inflation will depend on which items we are talking about, and how good times were before we started this mess? What was our jumping-off point?
And there we find really bad news – record levels of consumer debt, for example.
So…………most people were already struggling to buy food, let alone new TVs.
Now let’s take a straw poll – who here thinks people with barely any money will buy TVs instead of food?
Quite.
You can talk about price deflation in discretionary purchases if you like, as long as we all recognise that there weren’t many of these anyway?
TVs can get as cheap as they like, but sausages are still going to the moon.
Of course your friendly government will quietly remove sausages from the inflation basket, and put those cheap TVs in there instead.
And then everyone will be taking about deflation, while we all starve.
I totally agree with Jim Grant, the illusion that inflation as he puts it, is “resting” has been propelled forward by the Fed’s policy of low-interest rates and easy money. This does not mean inflation will not awaken with a vengeance.
The hyperinflation that occurred during the Weimar Republic and the speed at which inflation suddenly destroyed the currency dovetails with some of my thoughts on currency trading today. It confirmed that inflation can stem from a growing lack of faith in a currency, or all currencies, rather than just a lack of available goods.
As inflation takes root the goods available for sale often contracts as sellers retreat from the market awaiting higher prices which creates a self-feeding loop. The speed at which this can happen and the fact it could occur across the globe is explored in the article below.
Not always, take housing as an example, low interest rates may in fact increase housing inflation. As the interest rates fall, it allows people actually qualify to spend more often purchasing a more expensive home than if interest were higher.
Interesting Jdog1
So the parasitic cost of interest is the cause of inflation. low interest = low inflation?
Hey Mish… what are your thoughts about the arguments outlined in this video? He makes the case that Peter Schiff is correct and lays out his arguments in great detail. I think it’d be interesting for you to provide a rebuttal to his points in this video…
IDK Mish, seems like the stage is set for stagflation to me. Maybe it’s deflation to start, but the Fed has been very clear that they will create as much money as necessary so I take them at their word….(but in stagflation, some prices go way down while others go way up, so there’s that I suppose)
i am in your camp. i do not think this money printing will create any significant monetary inflation.
The ignorance and stupidity surrounding this subject is truly sad.
Not one in a thousand people really understands how our economy works.
Our economy is fiat / credit based. Nearly every purchase is made using credit. The effect of that is that the purchase price of every item purchased on credit is inflated by the amount of interest paid on the purchase.
When an item is purchased on credit, the money for that purchased is created out of thin air (fiat) at the point of that purchase by the buyers promise to pay for that purchase at a later date. The cost of a $100 purchase on a 20% credit card and paid over a year is $120. You created $120 to purchase a $100 item.
Over decades this practice inflates assets faster that wages making the system unsustainable in the long run.
Default on debt destroys money. If you make a purchase on credit you create the money for the purchase. If you default on that debt the money disappears, but the item you purchased still exists.
If this happens on a large scale, the effect is to have a shrinking money supply, and an expanding supply of goods. This is deflation.
The shrinking supply of money makes the money more valuable in relation to the value of assets. The expanding supply of assets causes the value of assets to decline as forced sales require lowering prices.
People who talk about hyperinflation and money printing really do not understand the process. The Fed does not print money, it makes money available to be borrowed…. at interest. It does not matter how much money the Fed makes available if there is no market for new credit. That is why credit lending standards become stricter during recessions. If credit were made too available, and that credit was defaulted on, it only increases deflation because of the additions to the supply of goods, and no increase in money supply because the debt was defaulted on.
I hope this helps people understand.
In a free market, when debt devalues, bond prices falling, bond yields rise. Any business or new businesses wanting to raise money via bond issues to grow, would have to do so at higher yields to compete with the collapse of the secondary market bond prices. If they have to pay a higher yield (interest rate) they will only do so if they can make a profit. This will encourage them to raise their prices. Of course they will only want to raise new money if there is demand for their product, which in the early stages of a recession is unlikely. As demand picks up however they’d have to raise prices to make a profit over and above the higher borrowing costs.
However, it’s not a free market. The Fed is manipulating yields and interest rates lower than they’d otherwise be. They’ll keep issuing dollars and treasuries for as long as they can get away with it, which will be until confidence in the dollar vanishes.
“If you default on that debt the money disappears, but the item you purchased still exists.
If this happens on a large scale, the effect is to have a shrinking money supply, and an expanding supply of goods. This is deflation.”
This statement does not consider goods that are not durable. Food for example. Nor does it consider the effects of a breakdown in supply chains due to economic malaise…it’s why we had stagflation in the 70’s and I can’t see how we avoid it this time as well. Long term, it’s very clear that price levels have risen….even from the low’s of the 1930’s compared to 1960 and beyond.
Nobody is talking time frame….couldn’t it be deflation for 6 months to a year migrating to stagflation/inflation?
Again we need to return to basics. Because inflation comes from credit purchases at interest, we need to look at where the lions share of interest comes from.
It comes from the most highly leveraged purchases. Real Estate, Business loans, Stocks purchased on margin Heavy Machinery, Equipment, and other purchases which are purchased with relatively small up front money and a great deal of financing and therefore interest payments.
Now while inflation is increased with leverage which is what makes speculation so profitable. In a deflationary environment debt default on highly leveraged purchases causes that same effect in reverse. A leveraged purchase with 20K down can easily loose 200K. The assets which have experienced the most inflation over the past 50 years are the same assets which are vulnerable to the most deflation now that recession / depression is beginning.
“Because inflation comes from credit purchases at interest, we need to look at where the lions share of interest comes from.”
I’m seeing the need to differentiate between the expansion of the money supply(inflation), and rising prices(which ostensibly is a reaction to money supply increases).
Taking oil as an example, which is another somewhat non-durable good- I would argue the current low price is not a reflection of money supply shrinkage, but as noted in the article title, as a demand shock. (drastically reduced demand obviously)
So what happens 1 year from now? The excess inventory is consumed by then, many oil producers go out of business and those that don’t scale their production way back….assuming the Fed keeps it’s promise to expand the money supply what do you think happens to the price of oil 1 year from now? I think it goes waaaaayyyyy up. (more dollars chasing less oil)
That’s why I think time frames should be part of this discussion…and differentiation between money supply and pricing.
Could go either way. E.G. the Fed increases its balance sheet by $2.5 trillion as asset valuations fall by $2.5 trillion. To the ‘money supply’ there is no net change. The Fed is merely buying up dead money and replacing it with fake QE money. The problem is a shopping mall is real and represents real consumption of land, labor and capital. QE is an accounting artifice. If the mall has no ‘real value’ today artificially supporting its price by buying its residue at 100 cents on the dollar adds no real support to the economy.
Asset bubble isn’t bursting from what I can see. This isn’t 2008 or 2009. Household and other balance sheets were actually stronger before Covid-19 then before the asset bubble that was the real estate market in the 2000s. This is why this time isn’t the same. The rise of China money into the US also has helped. They love to spend cash in North America. This time there is more equity then there was last time so the asset bubble won’t burst. There may be a little deflation but it will be followed by inflation.
“Asset bubble isn’t bursting from what I can see. “
…
Just getting started. The credit defaults (which will lead to asset deflation) take time to worm thru the system.
…
“Household and other balance sheets were actually stronger before Covid-19 then before the asset bubble that was the real estate market in the 2000s.”
…
Nope.
From NYFRB report Q42019
“Aggregate household debt balances increased by $193 billion in the fourth quarter of 2019, a 1.4% increase, and now stand at $14.15 trillion. Balances have been steadily rising for five years and in aggregate are now $1.5 trillion higher, in nominal terms, than the previous peak (2008Q3) peak of $12.68 trillion”
If you are referring to net worth, assets are concentrated in the top 10%. The bottom 90% have little to none assets to offset increase in debt … which is concentrated in bottom 90%.
Typical household balance sheet worse off.
Yes but real estate is way better off. I’m not comparing classes. This is about aggregate equity of assets. Old debt will be written off and we will get a new debt cycle at the lowest interest rates America has ever seen.
Good stuff!
Any comments on the gold market especially the last 3-4 days? Looks like my EKG well sort of. Guess its just a normal market nothing going on there!
How long can one keep saying ‘the idiots at the FED’… It seems more likely to me that they know exactly what they’re doing.
@Democritus
100% agree
There is no question that there is wage pressure. If you try to hire someone, I doubt you will get any applicants at all. People on unemployment collect about $20/hr for nothing, and the requirement that they look for work. Thus, if you have a job that pays $12/hr, you will have to hope you find someone looking long term who realizes that the rich unemployment checks may eventually come to an end.
Meanwhile, there is also a strange market out there, with some items in high demand and short supply (hand sanitizer, food, toilet paper, gaming laptops, etc), where prices are rising, and others where there is way too little demand (e.g. gasoline, used cars), and prices should be falling. In time things will come back into balance, but in the meantime things will get interesting.
I suspect that Mish is right that on the whole prices will fall, but in the middle of that, some prices may well rise sharply, and some items may become very difficult to get.
I second your wage pressure observation; exactly the same situation in my area. Making me wonder if the bonus unemployment pay from the Federal Government wasn’t a backdoor path to force minimum wage higher. The idea that small businesses with low skill employees are going to easily reopen in this environment is laughable. Business will be slower than normal and the employees will not want to come back to work for less than $20/hr.
Your post almost reads like a line from from Dire Straits song ” …Money is for nothing and the Chicks for free..
The pandemic is a perfect opportunity for them to make up for never having “learned to play the guitar” or “learned to play them drums”.
This! (stagflation)
“Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.”
The other side of falling prices has been the loss of some 60,000 American factories and the good paying jobs that went with them. What has happened to people in the industrial heartland?
What has happened to them, is rising prices. Not falling.
Rising prices for land, factory rents, housing rent for workers, interest on loans (in absolute money, not nominal rates), insurance, legal bills, non-production payroll, taxes etc., etc.
IOW, rising prices for everything factory owners and workers have to pay to deadweight, rent seeking leeches who add no value at all, to what the factory is producing.
Resulting in the factory no longer having enough left to pay workers what workers need to live, so they close down and/or move to areas where the share going to completely useless, negative value add leeches are still a bit lower.
If you want them back, get rid of the ability of FIRE and “legal” and other leeches to rob them.
Tell that to anyone employed in the oil and gas business.
Price deflation for sure at the ground level. It’s not like a significant portion of that Federal fairy dust will ever hit the ground near you. Deflation at the upper levels via unpaid loans is going to get much worse.
Don’t know about deflation. Ad prices, at least are still high, see results from Big Tech stocks.
Production is somewhat automated. Consumption is not. Maybe we’ll end up like that old Sci Fi story, The Midas Plague.
I lean towards inflation even as demand is going to remain weak, but then there are many items that have already doubled, tripled, or gone just hog wild, like the $5.99 I paid for less than 2 ounces of hand sanitizer the other day.
My reasons for thinking inflation over deflation are pretty simple: The Fed’s balance sheet, as a percentage of the GDP, is in uncharted territory this year.
But, I am not religiously committed to the position, I recognize that Mish has a better chance of being correct than I do, but one thing we know for sure is it will be one or the other. The economy is not going to magically reopen at the same price levels we are used to.
Part of me wants the deflation because I am on a fixed income. Part of me wants the inflation because I just bought a house and would hate to face a future with no equity. But, I am happy I no longer am on the sucky bad landlord treadmill either.
I agree. Unless someone muzzles the Fed, inflation is still more likely.
Can we assume that all turned out well with your logistical issues going from OR to FL? If so, whew, congrats! 🙂
Thank you Felix, it was not all as smooth as I would have liked literally and figuratively. United cancelled my flight back to Oregon to get my car so I had to rent a car carrier for an extra grand and tow it. Our roads are just not in good enough shape for non professional drivers to be driving what amounts to a smaller version of a big rig with such a load.
Phoenix, El Paso, San Antonio, Houston were all deep into multi year rebuilds of their infrastructure that is apparently timed to complete about the same year I die. But by far the worst was Louisiana. Their roads are so horrific there were places where the I swear the car carrier lost contact with the ground, ang my car is 5,000 pounds with a full tank of gas.
I think one of the worst things was trying to eat with everything closed. Seven of the eight days was Domino’s pizza. Their shares should do well as they expand sales. There are a few other hitches like not being able to register my car, possibly for months. And Duke power got my billing address right, but then input my service address as being WEST rather than EAST so they came on moving day while I was out closing on the house and shut off the electricity. I called to ask why they shut the power off and they said I had service, they said they would send someone out, but by 4 P.M. I still had no power and nobody had come. I called again and they said they sent someone at 11 in the morning and spoke to me, there was power at the address. That was when I realized they had made the address error, I did not get juice till almost 11 that night. All they did was cut the power here and put that other address’s meter in my name so that guy was using electricity I was paying for. Then the next morning when I went to shower there was no water. I had been told I was in the district served by the Homosassa Special Water District, but it is the County water so that took half a day and an extra emergency turn on fee to get sorted. That is what moving is like and the pandemic only made it worse since they are handling all such problems by phone.
Otherwise I love the house, it is so quiet at night though I get spooked, paranoid. Leave some lights on. I switched out all 12 of the bulbs in the coach lights out front to LED so I can keep them on all night.
Glad to hear you are in your new home Herkie
Thanks Marg54.
Japan has been doing this beat for decades. Sure the stock market has never reached previous heights, but they’ve managed to stave off debt deflation, and it’s unclear when somebody is ever going to prick that bubble.
We can do the same.
Very good point. Even in the midst of demand collapses/societal impacts like Fukushima…
There are different aspects and its not an apples to apples comparison. Like self funding debt internally via savers, nationalizing the banking system, etc. The US is funded externally…10X+ the next closest nation (France).
But because you have a good track record of walking the tightrope over Niagra Falls..doesn’t mean every country is a Jean-Francois Gravelet (aka Charles Blondin). Nor does the risk of deflationary collapse go way…so get a bigger wheelbarrow to load up on debt…kick the can another 8 to 10 years down the road…see how long the cable will hold. Also realize there is never a moment of rest to get off the cable…interest never sleeps.
I am in the supply shock and M1 shock and awe camp to cause buying power reduction before the real deflation occurs, 4-5 years from now. My suspicion is more small businesses will close in the next 6-12 months than expected, across all industries. Banks / governments will be left holding the bag. Loss reserves stacking up on bank balance sheets. Massive individual unemployment checks will continue well beyond expectations.
“Fed (global central bank) policy is to blame.”
If it’s their ‘policy’ that is to blame (for deflation), what should their policy be other than to dissolve themselves?
“what should their policy be other than to dissolve themselves?”
…
Nothing … other than provide liquidity in times of crisis.
Get out of the setting interest rate and QE business. Let free markets decide price of assets and interest rates. Of course, getting from here to there would entail a hard recession … and make a lot of rich people poorer. So be it.
I’d call that a non-policy rather than a (bad) policy.
But the Fed could at least clear interstate checks.
“…other than provide liquidity in times of crisis.”
Just to make sure the leeches can always drum up another “crisis” warranting the Fed robbing everyone else on their behalf again…… Nothing like newspeak for excusing crass theft.
In reality, even the most minimal and restricted central bank possible, is the single worst thing which can possibly befall a country. Relegating complete and utter nuclear annihilation to, at most, runner up status.
“what should their policy be other than to dissolve themselves?”
Absolutely nothing at all.
Ten reasons why a ‘Greater Depression’ for the 2020s is inevitable
A fourth (related) factor will be currency debasement. As central banks try to fight deflation and head off the risk of surging interest rates (following from the massive debt build-up), monetary policies will become even more unconventional and far-reaching. In the short run, governments will need to run monetised fiscal deficits to avoid depression and deflation. Yet, over time, the permanent negative supply shocks from accelerated de-globalisation and renewed protectionism will make stagflation all but inevitable. link to theguardian.com
“So prepare for another round of debt deflation, possibly accompanied by a lower CPI”
…
Absolutely
Massive debt overhang trumps EVERYTHING.
Until dealt with via write down / write off / pay down disinflation (deflation) will be the path. No sustainable inflation. Period.
Yep…that can has been kicked down the road for decades and expanding in size and scope in the process. From national to state to county to city to HOA to families to individuals…debt has never been higher.
Either need free money (absolutely no debt strings attached – i.e. trading personal debt for national debt or any variation of such theme isn’t free nor does it work) or a Jubilee.
But I personally don’t see that happening. Federal Reserve (private banks w/ private shareholders) is busy expanding their balance sheet (taking ownership). The cost for buying everything up (from junk bonds to mortgages)….cost of putting 1’s and 0’s into a computer. People cry about what they are buying…but at near zero cost…would you care? I wouldn’t…I’d buy everything.
Things keep up they can cut out all the minion banks and deal directly with debtors. I’ve seen that strategy become public here in the past couple of months. Things like buying loans and leaving 5% with member banks while they own 95%.
The long awaited conclusion to the plan put in place in 1913. Its taken several generations but all those assets have gone from owned to encumbered with liens. Look at all the land given to people via land grants and homestead acts…now all indebted and owned by banks…again at what cost? Create the money against the IOU on the asset. Beauty of fractional lending…and now (as of March 26, 2020) the reserve require is zero.
So do you think the monkey will let go of the rice to get his hand out of the coconut??? Considering that this is the culmination of a 100 year plan set in place in 1913…
What do you think it will take in order for that to happen?
“What do you think it will take in order for that to happen?”
What it will take, is indoctrinated American dunces growing up sufficiently to realize that, yes, Taliban Afghanistan is indeed a much, much, much superior country than what’s left of once-was America. Then act on their newfound enlightenment.
“Taliban Afghanistan is indeed a much, much, much superior country”
Is it for Women?
Yes. 8, or 14 depending on how you count, to 1.8 or thereabouts, kids running their errands.
Well I don’t know much about it to be honest, but you only have to do a little googling to realise life for women under Taliban Rule wasn’t very rosey. So maybe it’s not a “much,much,much superior country”, at least in this regard after all.
This is one link I found.
Depends who the monkey is, finance taking “ownership” (because that is a small minority that is in no position to truly enforce that position if it comes down to it – hence it is one of show… “follow me, I have a handful of rice here”), or the population invested in whatever via finance, that could only be sold in sum at a loss (” I’m still well off because I have a handful of rice…as long as I don’t let go”).
Monkey is Fed Reserve private shareholders.
Money can buy force. Pretty good historical precedent for that.
And then there is the possession is 9/10th of the law…so if people refuse to play…I suppose that comes back to the force equation. Certainly going to be an interesting play…and to see the closing scenes…
…or dollar auctions, but I think those would be too quaint for a modern setting. Probably people will end up selling their freedom for protection from their own failure.
Anywhere they can enforce inflation they will. This will destroy demand even faster. They will need a brownshirt army to force us to shop. Good luck with that. As they attempt to punish the remaining producers, real shortages will be setting in. These will not be easy to dispel. Then things will get political. Then the meteor comes.
People are shopping…just the nature of what they are shopping for has changed dramatically. Try buying (or even finding) vegetable seeds, ammunition, guns, etc…several hundred % increase in sales and slightly less increase in prices as demand outraces supply.
Not even diving into TP, soap, etc.
Money is going into financial markets not into hot pockets. We will see sky high financial assets but hey at least QLVD TVs or whatever you call them will go down in price.
Inflation is necessary for Zombie companies and the US to continue to service their debt in a highly leveraged, 0% rate environment absent demand growth. When you can’t cut rates any further, you need inflation to avoid insolvency.
King Dollar (no inflation) going nowhere anytime soon.
Way too much emerging market debt priced in $US … as demand collapses the scramble for $US to service debt will ensue.
There’s this thing called default. If everybody out there defaults on their dollar debt, what will the US do? Send troops overseas?
They’ll be more pressure like this in the coming months and years. The USD’s dominance is set to decline in my view.
this is interesting too
I don’t worry about inflation as long as my chimichangas and burritos don’t go up in price.