Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Evergrande China's Lehman's Moment, Tip of the Ice Berg in Financial Crisis 2.0 - 21st Sep 21
The Fed Is Playing The Biggest Game Of Chicken In History - 21st Sep 21
Focus on Stock Market Short-term Cycle - 21st Sep 21
Lands End Cornwall In VR360 - UK Holidays, Staycations - 21st Sep 21
Stock Market FOMO Hits September CRASH Brick Wall - Dow Trend Forecast 2021 Review - 20th Sep 21
Two Huge, Overlooked Drains on Global Silver Supplies - 20th Sep 21
Gold gets hammered but Copper fails to seize the moment - 20th Sep 21
New arms race and nuclear risks could spell End to the Asian Century - 20th Sep 21
Stock Market FOMO Hits September Brick Wall - Dow Trend Forecast 2021 Review - 19th Sep 21
Dow Forecasting Neural Nets, Crossing the Rubicon With Three High Risk Chinese Tech Stocks - 18th Sep 21
If Post-1971 Monetary System Is Bad, Why Isn’t Gold Higher? - 18th Sep 21
Stock Market Shaking Off the Taper Blues - 18th Sep 21
So... This Happened! One Crypto Goes From "Little-Known" -to- "Top 10" in 6 Weeks - 18th Sep 21
Why a Financial Markets "Panic" May Be Just Around the Corner - 18th Sep 21
An Update on the End of College… and a New Way to Profit - 16th Sep 21
What Kind of Support and Services Can Your Accountant Provide? Your Main Questions Answered - 16th Sep 21
Consistent performance makes waste a good place to buy stocks - 16th Sep 21
Dow Stock Market Trend Forecasting Neural Nets Pattern Recognition - 15th Sep 21
Eurozone Impact on Gold: The ECB and the Phantom Taper - 15th Sep 21
Fed To Taper into Weakening Economy - 15th Sep 21
Gold Miners: Last of the Summer Wine - 15th Sep 21
How does product development affect a company’s market value? - 15th Sep 21
Types of Investment Property to Become Familiar with - 15th Sep 21
Is This the "Kiss of Death" for the Stocks Bull Market? - 14th Sep 21
Where Are the Stock Market Fireworks? - 14th Sep 21
Play-To-Earn Cryptocurrency Games Gain More and Is Set to Expand - 14th Sep 21
The CashFX TAP Platform - Catering to Bull Investors and Bear Investors Alike - 14th Sep 21
Why every serious investor should be focused on blockchain technology - 13th Sep 21
SPX Base Projection Reached – End of the Line? - 13th Sep 21
There are diverse ways to finance the purchase of a car - 13th Sep 21
6 Tips For Wise Investment - 13th Sep 21 - Mark_Adan
Gold Price Back Below $1,800! - 10th Sep 21
The Inflation/Deflation debate wears on… - 10th Sep 21
Silver Price seen tracking Copper prices higher - 10th Sep 21
The Pitfalls of Not Using a Solicitor for Your Divorce - 10th Sep 21
Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
This Boom-Bust Cycle in US Home Ownership Should Give Home Shoppers Pause - 9th Sep 21
Stock Market September Smackdown Coming Next? - 9th Sep 21 - Monica_Kingsley
Crazy Crypto Markets How to Buy Bitcoin, Litecoin for Half Market Price and Sell for TRIPLE! - 8th Sep 21
Sun Sea and Sand UK Holidays 2021, Scarborough in VR 180 3D! - 8th Sep 21
Bitcoin BTC Price Detailed Trend Forecast Into End 2021 - 8th Sep 21
Hyper Growth Stocks - This billionaire is now using one of our top strategies - 8th Sep 21
6 common trading mistakes to avoid at all costs - 8th Sep 21
US Dollar Upswing, S&P 500 and Nasdaq Outlook - 7th Sep 21
Dovish Assassins of the USD Index - 7th Sep 21
Weak August Payrolls: Why We Should Care - 7th Sep 21
A Mixed Stock Market - Still - 6th Sep 21
Energy Metals Build Momentum; Silver & Platinum May Follow - 6th Sep 21
What‘s Not to Love About Crypto Market Fireworks - 6th Sep 21
Surging US Home Prices and Gold – What’s the Link? - 6th Sep 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Debunking the Mainstream Economists Deflation Myths

Economics / Deflation Aug 03, 2010 - 03:05 AM GMT

By: Puru_Saxena

Economics

Best Financial Markets Analysis ArticleBIG PICTURE – Many prominent economists define deflation as a decline in the general price level within an economy.  To make matters worse, these academics use the establishment’s highly manipulated inflation data as their yardstick.  Therefore, when the heavily massaged Consumer Price Index (CPI) and Producer Price Index (PPI) show a moderate increase, these folks celebrate the ‘perfect scenario’ of moderate inflation and when the CPI and PPI contract, they worry about deflation.  Unfortunately, the vast majority of people blindly follow the views of the mainstream economists.  Consequently, they end up making costly mistakes with their capital. 


You will recall that during the bottom of the previous bear-market, most of the pundits were shunning ‘risky assets’ (stocks and commodities) and they were advocating a heavy exposure to cash and fixed income assets.  Back then, the vast majority of strategists and their devotees were erroneously fretting about deflation.  According to these folks, deflation was a done deal due to the following reasons:

a. Contraction in private-sector debt – When the credit crisis arrived in the summer of 2008 and asset prices collapsed later that year, over-leveraged consumers and businesses started paying off their debt (Figure 1).  After all, this act of deleveraging was a logical reaction to the devastation caused by the most vicious bear-market since the 1930s.  So, when private-sector debt began to shrink, the proponents of deflation (deflationists) announced the death of inflation. “How could the global economy inflate when the private-sector was tightening its belt?” was their battle cry. 

Figure 1: Private-sector debt in the US

Source: St. Louis Fed

Although the deflationists had a point, their assessment was flawed because they totally ignored the borrowing capabilities of the governments.  Whilst it is true that from peak to trough, private-sector debt in the US contracted by roughly US$800 billion, this debt reduction was overwhelmed by the US government’s debt accumulation efforts.

Figure 2 shows that over the past two years, US federal debt has surged by a whopping US$3 trillion, thereby more than offsetting the deflationary impact of private-sector deleveraging.  If you have any doubts whatsoever, you will want to note that total debt in the US is now at a record high!

Figure 2: Explosion in US Federal Debt

Source: St. Louis Fed

It is interesting to observe that in response to the Great Recession, in addition to the US, most governments have taken on huge amounts of debt. And by doing so, they have managed to thwart the deflationary forces of private-sector debt repayment.

b. Excess capacity – The lack of aggregate demand and the excess capacity prevalent within the economy is another factor often cited by the deflationists. Let us explain:

You will recall that in the aftermath of the Lehman Brothers bust, the credit markets froze and the global economy came to a screeching halt.  Suddenly, worldwide consumption contracted and the world was left with idle factories, empty buildings and unwanted inventories.  Thus, the deflationists argued that with such a lack of aggregate demand and so much spare capacity, we could never experience inflation. 
Once again, the deflationists failed to understand that over-capacity has been a constant feature in our economic landscape and price increases (which they erroneously describe as inflation) have very little to do with capacity utilisation. 

It is interesting to observe that over the past 42 years, the US economy has never operated at full capacity (Figure 3).  Moreover, it is notable that even during the highly inflationary 1970s and the most recent inflationary boom (2003-2007), the US economy operated well below maximum capacity.  In case you are wondering, the same holds true for the global economy.  Therefore, the idea that inflation cannot occur in the face of excess capacity is ill-conceived and absurd.  

Figure 3: Chronic over-capacity in the US

Source: www.thechartstore.com

All the popular deflation myths aside, the reality is that inflation is an increase in the supply of money and debt within an economy.  Furthermore, the price increases often described as inflation are simply consequences of monetary inflation (euphemism for the dilution of the money stock). 

Look.  Whenever any central bank creates new money and whenever any entity (individual, business or government) takes on more debt, the outcome is inflation.  As Milton Friedman once said, “inflation is always and everywhere a monetary phenomenon”.

Today, under our fiat-money system, governments are willing borrowers and central banks are more than eager lenders (money creators).  Under these circumstances, a contraction in the supply of money and debt (deflation) is out of the question.  Conversely, given the short-sightedness of the politicians and their perpetual urge to ‘kick the can down the road’, the real risk facing the economy is extreme inflation or even hyperinflation. 

Given our grim outlook on inflation, we continue to favour hard assets and the fast-growing developing economies in Asia.  If our assessment is correct, our preferred sectors (energy, precious metals and industrials) and our favourite stock markets (China, India and Vietnam) are likely to generate spectacular long-term returns. 

Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets.  In addition to the monthly report, subscribers also receive “Weekly Updates” covering the recent market action. Money Matters is available by subscription from www.purusaxena.com

Puru Saxena

Website – www.purusaxena.com

Puru Saxena is the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients.  He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs.

Copyright © 2005-2010 Puru Saxena Limited.  All rights reserved.


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


Post Comment

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