Monday, December 14, 2009

Response to Robert Murphy

Robert Murphy of the Mises Institute had a good article out this morning titled, "A Case For The Inflation Camp." He talks about why he expects consumer prices to continue to rise. I recommend my readers have a glance over this.

As my readers know, I have a different take on matters. Below is the brief response I left in the comments section of Murphy's post. Feel free to weigh in with your own take.

The primary arguments in favour of deflation look less at consumer prices and more at asset prices, bank lending, debt/income or debt servicing ratios, demographics and social revulsion of excesses.

Many things can contribute to consumer price changes. This year we had a very large drop in inventories and capacity utilization which eased downward pricing pressures significantly in spite of falling consumer demand and reduced credit availability. We also had commodity prices rising from leveraged speculative bets by hedge funds.

The first two are like bullets in a six shooter. They can only be used once. I suppose the commodity speculation could be considered the very early beginnings of a "crack-up-boom," but other than gold, there seems to be little panic buying in the more "emotional" of these commodities (grains, energy). And it is precisely this fear (OMG, I might not be able to feed my family, "I'll take 10 sacks of rice!") that characterizes the CuB.

Until I see that kind of fear and still no willingness to quash it from central bankers, speculation of runaway inflation is premature.

One thing we can likely all agree on is that deflation "should" happen. We have too much debt and asset prices are too high to be supported by our incomes. And the easiest solution to this problem for those without access to a printing press (small businesses and consumers) is deleveraging. Considering they compose the largest sectors of the economy, their actions will determine the overall outcome.

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Willy2 said...

James Grant made back in june some very interesting remarks:
1. Inflation is the result of printing of money. That money will chase something: stocks, bonds ("good inflation"), oil, skirts, toothpaste, base metals ("bad inflation"). What the money chases depends on what the "flavor of the month" is.
2. Deflation is the destruction of credit.

Both things are happening at the same time. So, both inflation and deflation can co-exist. But in the current financial environment "bad" inflation (i.e. price inflation) is an additional DEFLATIONARY force. And that's what a lot of folks tend to overlook.

Willy2 said...

I agree, the CPI numbers are too low and flawed because food and energy are excluded. But, as MISH has pointed out, the price inflation as measured is TOO HIGH as well. The CPI contains the socalled OER (Owners Equivalent Rent), an estimate of what a home owner would pay to rent his house. According to the BLS rents are still rising. But in the REAL american world rents are falling across the board. To be able to compute the CPI MISH replaces the OER with the (change in the) Case-Shiller real estate index. And then we get an official CPI number which is already negative.

I agree, higher price inflation (taxes, food, energy) reduces the spending power of the consumer but the consumer isn't able or willing to go deeper into debt. Reduced spending power for consumers also forces the consumers to retrench even more and that's very DEFLATIONARY.

Why would oil prices not go down AGAIN in the next leg of the credit crisis and thereby reducing price inflation ?
E.g. when the US goes bankrupt, then the US is no longer able to pay for its army. The army WILL have to be shrunk (dramatically) or even have to be gotten rid of. And the US army consumes as much oil as that country called Sweden. That would dramatically reduce demand and as a result push the price down again.

Anonymous said...

Question: Other than as an interesting academic question, does it really matter if there is deflation or inflation for the next 12 to 36 months?

I don't ask that as a troll, but it seems to me that at some unknown (unknowable?) point in the future, there will be high inflation. At least that is my 90% scenario. The other two possible scenarios (each 5% liklihood): 1) The Fed perfectly times the economy which means we have a mild/moderate recession for 10 years as the liquidity is slowly drained from the system or 2) There is some world-wide massive catastrophe that requires the U.S. to unleash that capital as we did after WWII and it is put to productive use by the 50% of the world that needs to buy stuff from the 50% of the world that is not wiped out (under such a scenario capital would have been wiped out along with people and buildings so the added US dollars would not necessarily increase the total predisaster capital in the world markets).

For 1) the Fed apparently never saw the bubbles they created, so I have little faith in them managing their own checkbooks, let alone the US economy. As for 2) this isn't 1940 and we are no longer a young dynamic economy that will power the world's growth nor is the world "just now" switching to the US $ as the reserve currency -- both of which were very forgiving of bad monetary policy in the 1930's.

I don't see how the current situation can end any other way than inflation. We can forestall it, we can bury it, heck we can even delay it and hope that the "other" party is in power (regardless of which party you have affiliation) when the ticking time bomb explodes.

Back to my original question, of course we'd all like to know for investment purposes, but I suspect that when (real) inflation starts showing it will move quickly and major decisions like real estate, interest rates/loans and managing our individual debt will be very difficult to do as the markets will move quickly since everyone has a wary eye out for pending inflation.


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