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Five Things You Need to Know: Deflation is Here, What Next?


Ultimately, the question of where we are going is less an economic question than a philosophical one.


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

Secular Forces of Deflation... Explosion of Simulacra... The Crisis of the Real... The Precession of the Simulacra... What Next?

The long-term secular forces of debt revulsion and deflation continue to build and are showing up in social mood with increasing frequency. The question is what do these forces mean for our everyday lives, how will they manifest in popular culture and lifestyle?

In Tuesday's New York Times, in the Science section of all places, was an intriguing story asking the question, "Are Bad Times Healthy?"

"Most people are worried about the health of the economy. But does the economy also affect your health?"

On the one hand, economic growth can lead to both advances in medicine and treatment of disease as well as to improvement in a population's overall economic health. But what about long-term economic stagnation or economic declines? Do people get sicker if the economy fails? The conclusions the article reaches about these questions may seem surprising, but they fit squarely within the hypothesis that social mood drives social change, not vice versa, and underscore the psychological shift a darkening social mood brings in attitudes toward consumption, money and time.

""The value of time is higher during good economic times," said Grant Miller, an assistant professor of medicine at Stanford. "So people work more and do less of the things that are good for them, like cooking at home and exercising; and people experience more stress due to the rigors of hard work during booms."

""When coffee prices suddenly rise, people work harder on their coffee plots and spend less time doing things around the home, including things that are good for their children," he said."

This is a rather straightforward manifestation of how society copes with more challenging economic times; by seeking a positive outcome from less work and less consumption, and by challenging the boom hypothesis that hard work is both critical to economic success and something worth valuing above time spent at home with family and children.

Yet another social manifestation of debt revulsion and anti-consumption preceding the breakdown of a debt bubble is the conscious attempt to revolt against the explosion of simulacra that the fiat currency-based debt bubble inevitably produces; simulacra in finance, food, fashion, art and culture.

Explosion of Simulacra

Plato, in his dialogue, The Sophist, portrayed the distinction between two types of images; those that try to faithfully reproduce the original, and another, more insidious image that is intentionally distorted in a manner to make the reproduction itself appear real to those who see it.

"Theaetus: Stranger, can I describe an image except assomething fashioned in the likeness of the true?"

Plato presented two types of images; a faithful one, and a simulacra, or a distortion that was asserted to be reality. Later, Jean Baudrillard expanded upon the Platonic duality of images to assert four stages of imagery.

To understand where we are at this historic juncture in finance, it is helpful to see our currency system in terms of Baudrillard's imagery and precession of simulacra.

After all, currency is nothing but a representation of value, a paper dollar simply an image that is intended to mean something between two parties in order to execute a transaction.

The Crisis of the Real

A significant consequence of the massive debt bubble we have experienced is the inevitable explosion in simulacra, of which derivatives are a prime example; the dissection of financial assets into increasingly discrete objects, or instruments, that ultimately displace the reality of the underlying asset and assume their own reality that exists separate and apart from the very thing upon which they were based. Thanks, in part, to extreme leverage, this new reality supersedes the original in both importance, and also fragility, attaining the ability to actually destroy the very asset upon which the derivative was based.

We have reached the tipping point where that ability to destroy the original is now at hand. This tipping point is what I call "The Crisis of the Real."

To understand what this crisis entails, it is useful to look at what this precession of the simulacra entails as it was outlined by Jean Baudrillard in his prescient work, Simulacra and Simulation, published in 1981.

Simulacrum, for Baudrillard, is a copy of an original that displaces the original as a sign and becomes real in its own right.

The Precession of the Simulacra

The precession of simulacra that Baudrillard outlined is as follows:

1) Era of the Original
2) Era of the Counterfeit
3) Era of the Produced, Mechanical Copy
4) Era of the Third Order of Simulacra, where the reproduction displaces the original

In September 2006 I looked at how this precession of simulacra applies to pricing structure in securities markets.

At that time, I argued for the view that we are seeing the culmination phase in securities markets where pricing structure breaks, literally: "From the standpoint of the final phase of the image (price), we now witness securities markets that have no relation whatsoever to anything - they are solely existent as a pure simulacrum from which higher and lower are relations to something without meaning; in other words a hyperreal market."

We can see this progression in what Baudrillard formulated as the Successive Phases of the Image. After all, securities prices begin as nothing if not representations, images, signifiers of some "thing."

Successive Phases of the Image (with price relation in parentheses)
- the image is the reflection of a profound reality (price "means" something profound with respect to the security)
- the image masks and denatures a profound reality (price disguises a profound reality - the value investor's dream)
- it image masks the absence of a profound reality (2000 Dotcom Bubble. for example)
- it has no relation to any reality whatsoever; it is its own pure simulacrum, a copy without a model (the continuous supply of credit to market participants with no underlying attachment to any "thing" real, pure transaction that supersedes the act of exchange itself).

What Next?

This debt revulsion and structural deflation demands a readjustment that has profound consequences for society. What does a revolt against the displacement of the "real" entail?

First, from a consumption standpoint, it entails a shift in focus, a change in patterns of accumulation and the valuation of material objects. Going back to the New York Times article on "Are Bad Times Healthy?", it means the revaluation of time spent at home, or among friends, and an overall attitude involving less "doing" and more "being."

The proliferation of images, reproductions, the sheer volume and excess of signs, of choices, is itself deflationary, and this secular pattern is evident in everything from clothing and textiles to automobiles, home furnishings, technology and media.

This is the structural deflationary paradox where the excess of signs and choices, an inflation of everything, literally, actually creates the conditions for imposing limitations and regulations upon the chaos of apparent freedom.

Deflation is simply the market's attempt to unwind and dismantle the confiscatory dominance of the inflationary regime. Inflation, in the purest sense, confiscates money, purchasing power, control. In the philosophical and social sense, however, inflation confiscates something else that will increasingly be revalued among all other concepts and materials: Time away from production.

I understand there are those who disagree with structural deflation and who believe that central banks worldwide, in coordination with fiscal policy, will be able to intervene and resurrect banking and production. The outcome, it is asserted, will be inflation, or hyperinflation.

But again, if we see that "The Crisis of the Real" is really a crisis of reproduction, then we can also see that the very mechanisms of reproduction - fiat currency, fractional reserve banking, leverage - are broken, perhaps permanently so. In order for inflation or hyperinflation to displace this ongoing debt deflation, the mechanisms that facilitate reproduction and currency velocity must be intact. The last vestige of bull market hope is the hope, too, that the monetary velocity triggers are functional. They are not, and there is a significant probability that we may never again return to that place where they were.

Ultimately, the question of where we are going is less an economic question than a philosophical one. If you could ask the aggregate what this change might mean, the answer would probably be something along the lines of an "impossible to conceive" fear and dread. Indeed, it is very difficult to imagine such a profound change in the aggregate. However, I suspect that if you ask one individual at a time what it means, the answer would be filled with the certainty of purpose, dedication to survival and even optimism that something good will eventually emerge from this transition.

This morning Lila forwarded me a note and some pictures from one of her very best friends, a native of Colombia, who just yesterday formally became an American citizen. She wrote, "Today was a wonderful moment in my life; I feel very proud to be an American." No matter how dark things may seem right now, or how dark they may get, as long as there are people who feel that way about being an American, then I can truthfully say that I do too. This too shall pass.

No positions in stocks mentioned.

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