Deflation, really?

Posted on: by .

While the media focuses on ISIS or is it ISIL and the massive Alibaba IPO, what I believe will have the broader impact to the market and may even be trend setting, at least through the mid-term elections, is the Fed monetary position and “how” one reads into the FOMC statement. We will get word later today.


Deflation, really?

I much as I find actual deflation absurd (with a fiat currency), if one were to actually measure the rate of inflation vs. using a “cost of living” model (like the CPI), there is NO DOUBT that a stronger dollar will certainly impact pricing and commodity prices.

As I had pointed out a week ago when the European Central Bank (ECB) dropped their interest rates to almost zero and launched their own money-printing-asset-buying program the mirrors our own QE, that it would rally the dollar and push down commodity prices. All of which will translate to deflationary pressures (or in real terms – far lower real inflation).

The Fed and Keynesians have brained wash our nation from high school economics to College PhD courses, which we are repeatedly indoctrinated in case you slept through school on NPR and the mainstream media that DEFLATION is a horrific economic condition, rivaling only a Nuclear Dystopia. What actually is “Deflation” and who does it hurt and how does it impact our economy and most importantly WHY are Keynesians so horrified by it?


The word Deflation!

The word “Deflation” became tainted during the Great Depression, which is ground zero for economic despair for all those that measure. To keep it simple and not to bore you with long detailed economic babble that put you to sleep in school; it is just a very simple Supply vs. Demand equation. In the Great Depression the Supply of dollars was limited, severely limited. Because dollars were in such limited supply and the demand for dollars was extreme, its buying power rocketed. People that did NOT have dollars turned to bartering. Those with dollars could buy huge amounts of anything. Stories of Rolls Royce’s selling for $1 dollar and entire buildings in New York selling for just $1000 dollars at the height of the Great Depression crisis became common. The dollars were in demand and there was so little in circulation.


Lord Maynard Keynes courtesy of wikipedia

The birth of Keynesian economics during the initial aftermath of the Great Depression came as Socialism (the New Deal) needed a government controlled economic model. Government systems need to be married with a like-minded economic theory to make them work. Socialism and all forms of collectivisms needs are economic engine that allows for government interventionism and control. The New Deal and collectivism needs fuel for them to run, which a combination of fiscal and monetary policies. The actual true “Free Market” and “Capitalism” were stripped down and a government leash was added. I have no doubt it was based on the best of intentions at the time, as the government wanted to get the economy roaring again, but through these radical changes and processes, we altered the role of government forever. It would now be a direct participant in the economy and have ever more control.


Keynesians Know Best!

The vast majority of U.S. universities teach only Keynesian economics, for no other reason is that it is what our nation has adopted since the Great Depression and is considered the right model and of course our government says so. Keynesian economics starts with studying the Great Depression, for that is what gave it birth. Ironically Keynesian economics does not consider history beyond the Great Depression, as if there is no economic history to come before it. It is a rather arrogant approach and while I certainly understand the how and why Keynesian theory came to be, out of a destitute situation, one would think that they should consider economic history. One key problem that Keynesian theory believes to have solved was the problem of “Deflation” that plagued the Great Depression. The could NOW control the Supply & Demand and avoid any future horror of Deflation. The Fed does this by a combination of printing (issuing) money and credit into the system, along with controlling interest rates. As their mandate dictates, “price stability”.


courtesy of wikipedia


Rome did it first!

As I pointed out, Keynesian theory myopically study the Great Depression as a base line and what to do as to never repeat it again. Yet, if one studies history one quickly realizes that Keynesian Economic theory is nothing new at all, in fact it is just a rebirth of a controlled economic model that has been tried before and more than once. The Roman Republic and later the Roman Empire adopted a Keynesian model to try to control economies and we know how that ended. A great book on the history of Rome and economic theory repetition is Haskell’s book New Deal in Old Rome (available also for free in PDF and EPUB).


Courtesy of mises.org

One massive difference between the Great Depression and today is that we were on a gold standard (although FDR temporarily suspended it). It is important to understand the gold standard did not cause the Great Depression, but it was a contributing factor to the “deflation” problem. Gold was finite and thus the money supply was finite as it was tied to the available gold. Keynesian didn’t toss out the gold standard, but instead tried a radical pseudo gold-standard adopted under the Bretton Woods agreement. There was no way that a pseudo-gold standard would work. They wanted the backing of gold to give the dollar value, but they also wanted to print MORE money than they had gold, to avoid the “Deflation” of the Great Depression. The idea was ridiculous by any objective measure, yet when you get into a room of like-minded individuals all drinking the same Kool-Aid, objectivity is never part of the equitation. We all know what happened, the bluff of a pseudo-gold standard was called and the U.S. was forced off the gold-standard because we were printing far more money than we had gold. The Keynesian currency model under the Breton Woods agreement failed, yet you will never learn that in school.


The Bogeyman!


courtesy of wikipedia

Yet, the bogeyman called Deflation and the Great Depression continue to rue the day, to such an extent that our greatest Keynesian theoretical minds still believe they can control the laws of Supply and Demand, much like the Romans. Bernanke is one of the great authorities on the Great Depression and his greatest nightmare is the threat of “Deflation”. It has become a rather interesting and silly bogyman, for no other reason in that it was one of the issues during the Great Depression, which we never want to repeat. Yet, as I pointed out – it is simply the law of supply and demand. Nothing more and nothing less. As much as we wish to try, we can’t control the law of supply and demand.

The Romans tried to control the laws of supply and demand as well, and much like today their bogeyman was deflation. They too tried to inflate their way out of debts. They began clipping coins (reducing the amount of precious metals in a coin), then they made coins out of cheaper metal, eventually coins were made out of iron slugs. Inflation ran rapid and the Roman Empire collapsed, it could no longer afford an army to defend themselves, taxes were at 70-90% in some city-states, and they could no longer afford the welfare reliant large city-centers. They tried to control the free market and the laws of Supply and Demand, they lost – much like other civilization in history that has adopted the same Keynesian approach and used an inflated fiat currency.

Inflation and deflation is driven by supply and demand, nothing more or less. The channels that drive inflation can come from currency as easily as it can come from the supply of goods. The dollar strength is NOT coming from a limited supply of dollars or any monetary policy the Fed has set. It has come because our trading partners, our allies (Japan and ECB); have created MORE supply of their currency (QE – printing money, buying assets, and lowering interest rates). Our dollar becomes stronger (has more buying power) because of the over-supply of Yen and Euros. The central banks are artificially creating over-supply into the system to spur inflation.

Keynesians are so scared of “Deflation”, to levels beyond reason and into the realms of fantasy – because of their myopically over-critical focus of the horrid deflation from the Great Depression, they can’t even think straight. Our own Fed has printed TRILLIONS of dollars, bought TRILLIONS off assets, and running ZERO interest rates for years because they are so scared of that ancient bogeyman from the 1930s. Their diametrically opposed belief between deflation and inflation is so extreme, that they have embrace inflation as a savior as something being good, something we should strive for.

Yet, deflation is a good thing for savers and consumers. Look at the Great Depression again, those that SAVED money and avoided or limited their debt, were able to buy more and expand their wealth. I am not talking solely of those evil Robber Barons, but I am talking the minority of middle class that were raised to save money, pay off debt, and plan for the future. I am not advocating for another Great Depression or to have extreme levels of deflation, but deflation is not bad any more than inflation is good. It is simply the laws of supply and demand.

We are currently feeling the forces of deflationary pressure since the ECB’s recent action. Commodity prices have come down or not rising as fast and that means a consumer’s dollar buys a little more. Perhaps a little more gas in the tank, a little more food, or a little more goods and services. A strong dollar gives consumer buying power. Frankly, if you have money saved you want deflation pressure because you can now buy MORE. If you have money saved, the last thing you want is inflation because it means your savings buys less.


CPI declines, oh my!

The Labor Department reported the Consumer Price Index (CPI) this morning, which is the government’s measure of inflation. You should know by now it does NOT measure inflation, but rather the Cost of Living (which is not synonymous). Yet, it is still the guide that Fed and politicians use and we the sheople have been told it is the “official measure”, so whether it is actually measuring inflation or not –it is what everyone uses as a guide.

The CPI declined .2% last month, the first drop in over a year and now running at an annual rate of 1.7%. This comes as a slight surprised for those economists that expected it would remain flat. As I continued to point out that ECB action that created the recent dollar rally is going to create deflationary pressure, which would show up in the CPI.

This recent decline in the CPI comes in direct conflict with the current Fed policy which is TRYING to create inflation, not the horrors of deflation. We have printed trillions, bought trillions, and running zero interest rates and we still can’t create inflation! Talk about frustrating, what to do?

The reality is that we are in a currency war against Japan and Europe, all of which are trying to inflate (devalue) their way to prosperity. As our QE is winding down and there is talk about raising rates, Japan and Europe are in full Keynesian printing mode, which is pushing up the US dollar as the Euro and Yen sink.


Are people blind?

I am still surprised that the likes of Steve Liesman (CNBC Keynesian Economics Reporter) believes that QE is going to end and that they are going to raise rates sooner rather than later. Yesterday I discussed the silliness of monitoring adjectives in the FOMC text, since the Fed has not acted in years. Now with deflation, as measured by the CPI, is now real – the Fed has an excuse to remain accommodative in their language. In fact they could even take action and reduce, slow, or halt the taper in the short-term. That would send the market rocketing and again push up inflation.

I am in the minority; I continue to believe that the tone and policy of the Fed remains extremely accommodative and dovish. Those that believe they are now all of a sudden Hawks, especially before the mid-term election and now in the face of a currency war, with CPI reporting deflation and the dollar rallying are living in some fantasy world.


courtesy of wikipedia

Fed expectations:

1. They certainly won’t raise rates or increase taper.
2. Odds are they will NOT change the language to a more Hawkish tone.
3. The only possibility of action is to become more accommodative, not less.


Support & Resistance

INDU 17,000
The market yesterday seems to read a more accommodative Fed and rallied. The CPI shows the Fed will not be taking a more Hawkish tone.

NDX 4050
The NDX took a U-turn and the tone changed from concern about the Fed becoming Hawkish to realizing those thoughts were foolish.

SPX 2000
What a difference a day makes. The market is not expecting any hawkish tone from the Fed. VIX is coming off as well.

RUT 1160
We could get back above 1160 and start building some support, heading into the Fed’s accommodative meeting.


Fed Hawkish? please…

The Fed Hawkish – are you kidding me? Stop listening to Steve Liesman and other economists that are trying to read into a Fed stimulated economy as improving and translating that into the Fed will stop their Dovish tone and start raising rates.

The market knee jerks because the media and the likes of Steve Liesman can give the market second thoughts. “Wait, perhaps Steve is right. Perhaps the economy is roaring along like he said; 4% GDP, unemployment is really at 6%, and inflation is well below 2%! The Fed is going to raise rates sooner and completely end all accommodative programs! OMG, time to sell and get out of the market!” The market comes under pressure.

Then reality sets in the next day; “Oh, yeah – it’s Yellen running the Fed and President Obama appointed governors that are all extremely Keynesian and Doves. What was I thinking, time to buy stocks.” The market rallies.

The 10-year bonds are not going back to 3% anytime soon. The dollar is not going to continue rally. The CPI will not continue to head lower. Interest rates are not going up. The Feds are NOT Hawks. Just keep repeating that and stop listening to those that are reading the tea-leafs.

If Yellen becomes a Hawk and raises rates this meeting or the October meeting, I will quit writing this preview and shut-up once and for all.

2 Responses to “Deflation, really?”

  1. Jason Hoppe says:

    You rock. Please start a college to teach people reality of economics. I’d join the class right away, but I likely couldn’t afford it in this economy.