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Minyan Mailbag: Trends in Inflation and Deflation


Putting a focus on prices is putting the cart before the horse.


Minyan "CB" writes:

When people mention oil, groceries, etc. why do you say that's not inflation raising prices, rather it's bad policy? Yet you're using falling house prices to back up deflation when they have been equally derived by poor policy choices and really bad lending standards.

I think it would be most fair to discuss inflation only in terms of falling or rising prices, both of which are obviously happening. If the prices go up, regardless of the reason, that is still inflation.

In general I agree that there is lots of evidence of downward pricing pressure and nothing left at the trough in terms of credit due to solvency to back additional spending but I don't think that's the only part to the equation, that's just the demand end, not the supply end

In a similar nature Minyan "TreeInForest" writes:

We are seeing BOTH inflation and deflation simultaneously. Those who see only deflation are kidding themselves. When a blue collar worker sees his fuel costs, food costs, housing costs and every other cost headed up and away, that is inflation, technical definitions notwithstanding. "TPTB" (the powers that be) are hoping for cancellation from the two counter trends. We'll see.

Thanks, CB and TIF.

Simultaneous Inflation and Deflation are Not Possible

TIF, in order to have a meaningful discussion, participants must agree with definitions.

According to Austrian economic theory, inflation is a net expansion of money and credit. Deflation is the opposite, a net contraction of money and credit. If one accepts those terms, then it is impossible to have inflation and deflation at the same time, in aggregate.

If one chooses to separate the components, then yes, we can have inflation in money supply and deflation in credit. In fact those are the exact conditions I expect to happen. That is also an extremely good environment for gold.

There is no way consumer debt loads can be paid back given falling asset prices, and rising unemployment. Increasing foreclosures and rising defaults on credit cards are proof. Debt that cannot be paid back will be defaulted on. That is deflationary.

It is important to note that credit dwarfs money supply. In deflation, credit will contract at a far greater rate than the Fed prints. This happened in Japan and this also happened in the Great Depression. I expect it to happen again.

Those who claim gold is signaling inflation are mistaken. Gold is signaling a destruction of fiat credit and a rise in the value of real money. Things That "Can't" Happen are about to. The Fed has no magic powers to stop deflation, in spite of what most think. For more on this point please see No Helicopter Drop For Failed Banks.

Very few have been bullish on gold, bullish on treasuries, and bearish on financials. I have been and remain in that camp. At some point, a massive unwind of leverage in hedge funds may cause a steep selloff in gold. I am not guessing when that might occur, but if it does I suspect gold will be among the first things to rebound.

One look at a chart of treasuries shows price action and credit conditions far removed from the stagflationary 70's and 80's. This is no 70's rerun. One look at any number of charts shows Money Supply Trends Are Deflationary.

Those who are looking at prices as a measure of inflation are simply barking up the wrong tree. I will explain why in great detail in my response to CB below.

Prices of Oil, Groceries, Etc.

CB, I never said falling home prices (or falling prices of any kind) constitutes deflation. However, I have said falling home prices are deflationary. Furthermore, we can be 100% sure why home prices are falling: Psychology of lenders and borrows changed dramatically and there is a mammoth supply of housing relative to demand.

Similarly, I have never stated exactly why oil prices are rising. However, I have pointed out some of the parts. A part of rising oil prices is peak oil. A part has to be geopolitical concerns. A part has to be the war in Iraq. A part is lagging effects of past monetary policy. A part is due to current monetary policy. Yet another part is due to economic policy of other central banks. Can you figure out the percentages? I can't. In fact, no one can.

Let's consider food prices. A part of food prices has to be misguided government policies, especially on ethanol. A part can be changing demand. A part can be drought, and a part can be practically anything if you think about it, including policies of China and expanding economies.

This is the problem with a focus on prices. Putting a focus on prices is putting the cart before the horse. Here is another way of looking at it:

What can the Fed do about...:

  • Drought
  • Famine
  • Hurricanes
  • Peak Oil
  • Changing consumer preferences
  • Rising standard of living in China
  • Economic policies in Japan, China, and emerging markets
  • Strikes
  • Pestilence
  • Lags in economic policy
  • Government policy decisions
  • Productivity improvements
  • Innovation

Feel free to add to that list. Every single one of the above influences prices. There is not a single one of the above the Fed can do anything about.

But wait. The problem gets worse. Not only is it impossible to state with any degree of accuracy why prices in general are rising, it is also impossible, in many cases to know if they are rising at all.

Consider median home prices, for example. How much of the rise (when things were going up) could be attributed to larger rooms, granite counter tops, incentives, etc. What about dual pane argon filled low-e windows? How does one compare historic prices to something that not too long ago was not readily available? What about improved safety features in cars? What are those worth?

About the only prices that can be accurately measured are commodity prices, energy prices, and food prices. Yet the Fed is concerned with consumer prices in general, not caring much about the few prices that can reasonably be measured.

But wait. The problem gets still worse. The one and only thing the Fed does not discuss that influences prices in general is the supply of money and credit. We have a Fed that sets interest rates yet never discusses money!

There is still one more factor influencing prices. That factor is the lagging effect of past Fed guessing about what interest rates should be.

Is the Fed a Private Institution?

I need to make a clarification to one thing I have said recently in referring to the Fed as a private institution. My statement was incorrect.

See Who owns the Federal Reserve? for this clarification: "The Federal Reserve System is not "owned" by anyone and is not a private, profit-making institution. Instead, it is an independent entity within the government, having both public purposes and private aspects."

That statement does not materially change arguments presented above or elsewhere about the powers of the Fed.


If you read carefully what I am saying I feel there is only one set of conclusions:

  • The Fed cannot properly measure prices.
  • The Fed does not know what interest rates should be even if it could measure prices.
  • Prices constitute neither inflation nor deflation.
  • Inflation and deflation are about expansion or contraction of money and credit.
  • The Fed has no idea what the lagging effects of its policy actions will be.
  • The Fed should not be an institution at all, private, quasi-private, or government.


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