Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Stock Market SEASONAL TREND and ELECTION CYCLE - 24th Nov 20
Amazon Black Friday - Karcher K7 FC Pressure Washer Assembly and 1st Use - Is it Any Good? - 24th Nov 20
I Dislike Shallow People And Shallow Market Pullbacks - 24th Nov 20
Small Traders vs. Large Traders vs. Commercials: Who Is Right Most Often? - 24th Nov 20
10 Reasons You Should Trade With a Regulated Broker In UK - 24th Nov 20
Stock Market Elliott Wave Analysis - 23rd Nov 20
Evolution of the Fed - 23rd Nov 20
Gold and Silver Now and Then - A Comparison - 23rd Nov 20
Nasdaq NQ Has Stalled Above a 1.382 Fibonacci Expansion Range Three Times - 23rd Nov 20
Learn How To Trade Forex Successfully - 23rd Nov 20
Market 2020 vs 2016 and 2012 - 22nd Nov 20
Gold & Silver - Adapting Dynamic Learning Shows Possible Upside Price Rally - 22nd Nov 20
Stock Market Short-term Correction - 22nd Nov 20
Stock Market SPY/SPX Island Setups Warn Of A Potential Reversal In This Uptrend - 21st Nov 20
Why Budgies Make Great Pets for Kids - 21st Nov 20
How To Find The Best Dry Dog Food For Your Furry Best Friend?  - 21st Nov 20
The Key to a Successful LGBT Relationship is Matching by Preferences - 21st Nov 20
Stock Market Dow Long-term Trend Analysis - 20th Nov 20
Margin: How Stock Market Investors Are "Reaching for the Stars" - 20th Nov 20
World’s Largest Free-Trade Pact Inspiration for Global Economic Recovery - 20th Nov 20
Dating Sites Break all the Stereotypes About Distance - 20th Nov 20
THE STOCK MARKET BIG PICTURE - Video - 19th Nov 20
Reasons why Bitcoin is Treading at it's Highest Level Since 2017 and a Warning - 19th Nov 20
Media Celebrates after Trump’s Pro-Gold Fed Nominee Gets Blocked - 19th Nov 20
DJIA Short-term Stock Market Technical Trend Analysis - 19th Nov 20
Demoncracy Ushers in the Flu World Order How to Survive and Profit From What Is Coming - 19th Nov 20
US Bond Market: "When Investors Should Worry" - 18th Nov 20
Gold Remains the Best Pandemic Insurance - 18th Nov 20
GPU Fan Not Spinning FIX - How to Easily Extend the Life of Your Gaming PC System - 18th Nov 20
Dow Jones E-Mini Futures Tag 30k Twice – Setting Up Stock Market Double Top - 18th Nov 20
Edge Computing Is Leading the Next Great Tech Revolution - 18th Nov 20
This Chart Signals When Gold Stocks Will Explode - 17th Nov 20
Gold Price Momentous ally From 2000 Compared To SPY Stock Market and Nasdaq - 17th Nov 20
Creating Marketing Campaigns Using the Freedom of Information Act - 17th Nov 20
ILLEGITIMATE PRESIDENT - 17th Nov 20
Stock Market Uptrend in Process - 17th Nov 20
How My Friend Made $128,000 Investing in Stocks Without Knowing It - 16th Nov 20
Free-spending Biden and/or continued Fed stimulus will hike Gold prices - 16th Nov 20
Top Cheap Budgie Toys - Every Budgie Owner Should Have These Safe Bird Toys! - 16th Nov 20
Line Up For Your Jab to get your Covaids Freedom Pass and a 5% Work From Home Tax - 16th Nov 20
You May Have Overlooked These “Sleeper” Precious Metals - 16th Nov 20
Demystifying interesting facts about online Casinos - 16th Nov 20
What's Ahead for the Gold Market? - 15th Nov 20
Gold’s Momentous Rally From 2000 Compared To Stock Market SPY & QQQ - 15th Nov 20
Overclockers UK Quality of Custom Gaming System Build - OEM Windows Sticker? - 15th Nov 20
UK GCSE Exams 2021 CANCELLED! Grades Based on Mock Exams and Teacher Assessments - 15th Nov 20
Global "Debt Mountain": Beware of This "New Peak" - 13th Nov 20
Overclocking Zen 3 Ryzen 5600x, 5800x, 5900x and 5950x to 4.7ghz All Cores Cinebench R20 Scores - 13th Nov 20
Is Silver Leading Bitcoin or is Bitcoin Leading Silver? - 13th Nov 20
How Elliott Waves Simplify Your Technical Analysis - 13th Nov 20
How to buy Bitcoins using debit/credit card? - 13th Nov 20
Will COVID Vaccine Kill Gold and Silver? - 12th Nov 20
Access to Critical Market Reports - 12th Nov 20
Stock Market Dow Futures Reach 30,000 on News of COVID-19 Vaccine Trials Success - 12th Nov 20
8 Terms & Conditions You Must Know Before Asking For Life Insurance Policy Quotes - 12th Nov 20
Gold Stocks Post 2020 US Election Outlook - 11th Nov 20
Champions’ League Group Stage Draw: All You Need To Know - 11th Nov 20
Stock Market Secular Trend - 11th Nov 20
Stock Market Correction Curtailed by US Election - 11th Nov 20
What Causes a Financial Bubble? - 11th Nov 20
Ryzen 9 5900X RTX 3080 - Scan.co.uk vs Overclockers.co.uk UK Custom PC System Builder Review - 10th Nov 20
Killing Driveway Weeds FAST with a Pressure Washer - Saving Block Paving from LOTS of WEEDs - 10th Nov 20
Trump Fired, Biden Hired, What Next?  - 10th Nov 20
Looking for a Personal Loan? Here Is What You Have To Know  - 10th Nov 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Are We Trending Towards Deflation or in It?

Economics / Deflation Jul 13, 2010 - 05:19 AM GMT

By: Mike_Shedlock

Economics

Best Financial Markets Analysis ArticlePaul Krugman is worried we are Trending Toward Deflation.

Inflation has been falling, but how close are we to deflation? I found myself wondering that after observing John Makin’s combusting coiffure, his prediction that we might see deflation this year.


Here’s the thing: the usual way inflation is measured is by looking at the change from a year earlier. But if inflation is trending lower, that’s a lagging indicator — if prices have been falling for the past few months, but were rising before that, inflation over the past year will still be positive. On the other hand, monthly data are noisy. So what to do?

Well, a crude approach would be simply to fit a trend line through those noisy monthly numbers. Here’s what happens when you do this for the Cleveland Fed’s median consumer price inflation number. On the vertical axis is the monthly inflation at an annual rate, on the horizontal axis months with Jan. 2008=0:


...
What I take from this is that deflation isn’t some distant possibility — it’s already here by some measures, not far off by others. And of course there isn’t some magic boundary effect when you cross zero; falling inflation is raising real interest rates and making debt problems worse as we speak.

There is a second chart and further discussion in Krugman's article.

The Rising Threat of Deflation

The article Krugman referred to is The Rising Threat of Deflation. Here are a few snips highlighting Makin's and Krugman's concern over prices.

U.S. year-over-year core inflation has dropped to 0.9 percent—its lowest level in forty-four years. The six-month annualized core consumer price index inflation level has dropped even closer to zero, at 0.4 percent. Europe’s year-over-year core inflation rate has fallen to 0.8 percent—the lowest level ever reported in the series that began in 1991. Heavily indebted Spain’s year-over-year core inflation rate is down to 0.1 percent. Ireland’s deflation rate is 2.7 percent. As commodity prices slip, inflation will become deflation globally in short order.

Meanwhile in Japan, while analysts were touting Japan’s first-quarter real growth rate of 5 percent, few bothered to notice that over the past year Japan’s gross domestic product (GDP) deflator had fallen 2.8 percent, reflecting an accelerating pace of deflation in a country where the price level has been falling every year since 2004. As of May, Japan’s year-over-year core deflation rate stood at 1.6 percent.

Consumer Prices Least of Bernanke's Worries

Note the concern over the CPI by Krugman and Makin. Is that what Bernake is most worried about?

I doubt it.

Bernanke is far more likely to be worried about home prices and commercial real estate prices, neither of which are is in the CPI. Next up, Bernanke is seriously concerned over falling bank credit and marked-to-market valuations of debt on the balance sheets of banks. Those are not in the CPI either.

No doubt Bernanke is also very concerned over the falling yield curve which signals risk avoidance. Of course Bernanke is very concerned about jobs.

I do not know how to rank those concerns other than to say everyone of them is far more important to the Fed than whether the CPI drops an essentially meaningless point from here.

The CPI is meaningless because we are already back in deflation. I say "back" because we were in deflation in 2007 and 2008.

Devil is in the Definition

Whether or not we are in deflation or trending towards it depends on how it is defined.

For example, monetary purists worried about money supply alone are under the preposterous notion that we are trending towards hyperinflation.

The problem with using money supply alone as a measure of inflation is it looks (and is) damn silly. Home prices have never fallen in hyperinflation and never will. Short-term yields have never been at 0% in hyperinflation and never will. The list does on and on.

Given that we have a fiat-based credit system, it is equally silly to discuss inflation/deflation without paying attention to credit. After all, the Fed can print but it cannot force banks to lend or consumers to spend.

Credit expansion is the key to inflation in a fiat-credit system. Those focused on prices or money supply alone, and those worried that Fed printing and excess reserves will soon spark inflation have missed the boat.

Please see Fictional Reserve Lending And The Myth Of Excess Reserves and also Fiat World Mathematical Model for a rebuttal to the notion that monetary printing will soon have the inflation genie flying out of the bottle.

Practical Definition of Inflation and Deflation

My definition of inflation is much more practical given that it incorporates credit and marked-to-market concerns that affect banks' willingness to extend credit.

I define inflation as a net expansion of money supply and credit, with credit marked-to-market. Deflation is a net contraction of money supply and credit, with credit marked-to-market.

Given that consumer credit is plunging at unprecedented rates, given that credit dwarfs money supply creation, and given that marked-to-market valuations of credit on the balance sheets of banks is again falling, I propose we are back again in deflation.

My model suggests part of 2007 and all of 2008 were deflationary years. Inflation returned in 2009, and the economy is back in deflation now.

Proof is in conditions one would expect to see in deflation.

Humpty Dumpty on Inflation

In Humpty Dumpty on Inflation I proposed a series of conditions one might expect to see in deflation. Let's take a look at the current state of those conditions.

  • Falling Treasury Yields - Yes
  • Falling Home Prices - Yes, as measured by Case-Shiller
  • Rising Corporate Bond Yields - Not substantially - Yet. However sovereign credit spreads are widening
  • Rising Dollar - Yes
  • Falling Commodity Prices - Yes as measured by the $CRB from the beginning of 2010
  • Falling Consumer Prices - Yes (or at least close) as measured by the CPI. My preferred measure would directly include home prices and that would/will tip the CPI negative soon enough. I consider housing (but not the land it sits on) a consumer good.
  • Rising Unemployment - It is high and essentially steady. My model suggests no improvement at best, and far more likely new highs above 11%
  • Falling Stock Market - Yes as measured since the start of the year
  • Falling Credit Marked to Market - Yes, most assuredly
  • Spiking Base Money supply as Fed fights Deflation - This depends on your timeframe, but charts sure show a spike - Another spike is likely
  • Banks Hoarding Cash - Falling consumer loans - Declining bank credit - Yes, Yes, Yes
  • Rising Savings Rate - Yes. The US savings rate rose to an 8-month high in May
  • Purchasing power of gold rising - Yes
  • Rising numbers of bank failures - Yes

Nearly every condition one would expect to see in deflation is happening, The few that aren't are close at hand and likely. If those are the things one would expect to see in deflation, and the scorecard is close to unanimous, I suggest that those who say this is not deflation have the wrong definition.

Note that I expect gold should wise in deflation. I say that on the basis that Gold is Money and gold in the senior currency has historically increased in value in deflationary times. Other deflationists, some very notable ones, definitely got this wrong.

Bernanke's Deflation Prevention Scorecard

In case no one is keeping track, Bernanke has now fired every bullet from his 2002 “helicopter drop” speech Deflation: Making Sure "It" Doesn't Happen Here.

Bernanke's Scorecard

Here is Bernanke’s roadmap, and a “point-by-point” list from that speech.

1. Reduce nominal interest rate to zero. Check. That didn’t work...
2. Increase the number of dollars in circulation, or credibly threaten to do so. Check. That didn’t work...
3. Expand the scale of asset purchases or, possibly, expand the menu of assets it buys. Check & check. That didn’t work...
4. Make low-interest-rate loans to banks. Check. That didn’t work...
5. Cooperate with fiscal authorities to inject more money. Check. That didn’t work...
6. Lower rates further out along the Treasury term structure. Check. That didn’t work...
7. Commit to holding the overnight rate at zero for some specified period. Check. That didn’t work...
8. Begin announcing explicit ceilings for yields on longer-maturity Treasury debt (bonds maturing within the next two years); enforce interest-rate ceilings by committing to make unlimited purchases of securities at prices consistent with the targeted yields. Check, and check. That didn’t work...
9. If that proves insufficient, cap yields of Treasury securities at still longer maturities, say three to six years. Check (they’re buying out to 7 years right now.) That didn’t work...
10. Use its existing authority to operate in the markets for agency debt. Check (in fact, they “own” the agency debt market!) That didn’t work...
11. Influence yields on privately issued securities. (Note: the Fed used to be restricted in doing that, but not anymore.) Check. That didn’t work...
12. Offer fixed-term loans to banks at low or zero interest, with a wide range of private assets deemed eligible as collateral (…Well, I’m still waiting for them to accept bellybutton lint & Beanie Babies, but I’m sure my patience will be rewarded. Besides their “mark-to-maturity” offers will be more than enticing!) Anyway… Check. That didn’t work...
13. Buy foreign government debt (and although Ben didn’t specifically mention it, let’s not forget those dollar swaps with foreign nations.) Check. That didn’t work...

Bernanke has failed. "It" has happened.

Now What?

I wrote about Bernanke's Deflation Prevention Scorecard in April 2009.

Regarding points 8 and 9 above: the Fed did purchase treasuries and agencies, but admittedly without an explicit ceiling.

The Fed has stopped those purchases but is likely to start again.

Would Flattening the Curve Help?

Many propose that the Fed is likely to flatten the yield curve by setting explicit yield targets on the high end. Will that help? How?

I see no credible reason it would cause banks to go on a lending spree or consumers to go on a buying spree. Indeed, I do not see how forcing down the yield curve with massive treasury purchases will do much of anything but making a bigger exit problem for the Fed at some point down the road.

Moreover, it looks like the yield curve is falling nicely on its own accord!

Consumer Credit Inflection Point

The key problem for Bernanke is we have reached the Consumption Inflection Point - No One Wants Credit; Consumer Spending Plans Plunge

Keynesian Policies Fail

Keynesian stimulus measures have failed and will continue to fail. Please see Three Mish Segments on Tech Ticker, on Stimulus, Retail Sales, the Markets, Alternatives for details and an online interview.

We have wasted $2 trillion fighting deflation. It has not produced any jobs.

The correct way to spur growth is by fostering an economy that supports economic growth. For details, please see Bleak Outlook for Small Businesses and Job Creation; Where Obama Went Wrong, and What to do About It.

Keynesian Cures Worse than the Disease

Krugman has the wrong definition and the wrong worry. However, he is correct in his call for deflation. Unfortunately, this will lead to a bunch of "I told you so" kinds of posts from Krugman, in spite of the fact his cures are worse than the disease.

Indeed, Keynesian "cures" are one of the reasons this economy is in the mess it is in.

The final analysis shows that the real threat is not of deflation, but of absurd Keynesian and Monetarist attempts to prevent it. The Greenspan-Bernanke housing bubble (and subsequent crash), and decades of futility in Japan should be proof enough.

By Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

© 2010 Mike Shedlock, All Rights Reserved.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

dincer
13 Jul 10, 08:32
I don't believe in deflation in terms of US dollar

Mr. Shedlock, I respect you so much and I generally agree with your opinions except "deflation in terms of US dollars". (indeed you should say overtly "deflation in terms of gold" and let me warn you that you are unintentionally serving the interests of banking cartels) Fiat money regimes depend on inflation, if they deflate they collapse. And fiat money regimes have excessive entropy and chaos, and they are backed by confidence in government. If everything gets worse, the deficits of the federal government will soar, because its tax base will collapse, but expenditures at best will remain same.

So, will you personally want to own the currency of a bankrupt government whose currency will no longer be the reserve currency of the world? If government says "OK I am bankrupt and I cannot pay off my debt", then it will lose all its credibility (if there is any!). It is a two edge sword. You compare the situation with Japan's case, but you forgot that Japan has structural trade surplus, a savings ratio much higher than US' and Yen is not a reserve currency. Did you ever think about what happens when American people lose all their confidence in US Dollar? What will they use as a medium of exchange?

I assume you knew the fact that US Dollar was redeemable to gold at a fixed rate ($20.67/ounce) until 1933 and US people treated the dollar as the equivalent of gold. In 1948 US Treasury possessed 35% of world gold stocks, today this ratio is under 5% (I assume FED's declarations of gold possession are true). It is a pity that US government consumed real wealth of Americans to maintain the value of a paper money!


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules