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June 29, 2009
By Joshua Burnett
If you’re anything like me, one of the
problems you run into when trying to
convince someone that the hyperinflation
scenario will occur is an argument that
revolves around us currently being in a
deflationary period. People (and those
involved with the economy and stock market
especially) have a hard time seeing looming
hyperinflation (that might occur as soon as
a year and a half away) when what they’re
currently seeing is… deflation. But wait a
second; how in the wide world of sports are
we seeing deflation when we’ve been printing
money like our lives depend on it?
Let’s return to market fundamentals, and
the ever-present difference between macro
and micro economics. First, let’s look at a
definition of deflation. Deflation has a
primary definition and then a commonly
understood method of measure, the latter of
which is unfortunately normally mistaken to
be the definition of deflation itself.
Definition: “Contraction of credit and
available money.”
Measure: “A fall in the general price
level.”
This measure is seen in changes in the
Consumer Price Index, or CPI, which is a
measure of the average price of consumer
goods and services purchased by households.
This is the simplest way to measure
inflation or deflation simply because it
does for prices what the gold standard did
for the dollar: it ties abstracts to
concrete definitions. A loaf of bread is a
loaf of bread; always has been, always will
be. We get the same level of nutrition out
of it that we did a hundred years ago and
we’ll get the same amount of nutrition a
hundred years from now (assuming a constant
recipe, of course). Whether we pay 25 cents,
$1.50, or $100 a loaf gives us a relative
measure of the purchasing power of the
dollar. Since the measure of deflation is a
lowering of the CPI, people often mistake
that for a sure-fire sign of deflation.
By people, I mean micro economists.
But instead of looking at the measure, we
should turn our attention to the definition.
The definition of deflation is a
“contraction of credit and available money.”
THAT is obviously not happening. So why do
people think that we’re currently in a
deflationary period? Well, the CPI is down
1.3% from a year ago, which happens to be
the largest annual decline since April of
1950 There is a two-fold reason for this:
the first involves the incredibly high oil
prices we saw as recently as 13 months ago
when oil spiked at approximately $140 a
barrel. Because of this we saw the price of
literally everything go up as the cost of
transporting goods and services drastically
increased. Since then the price has
plummeted. See the chart below.
If I could drastically simplify things and
say that the CPI closely follows the price
it costs to transport everything, you’ll
instantly see the greater of the two reasons
why the CPI shows prices declining; it’s
because they are.
The second reason is simple and very much
tied to the recession: if you’ve walked
through a mall recently you’ve seen more
sales than Black Friday and the day after
Christmas combined; it approaches the
relatively absurd. Businesses are selling
things much more cheaply to simply continue
to do business; it’s not that the prices of
goods are going down to them, they’re simply
choosing to take a cut in profits to
continue to do business.
So by combining:
(a) the fact that things legitimately got
cheaper as oil prices dropped at an
incredible rate and
(b) businesses are selling things more
cheaply to compensate for lessened consumer
interest (incidentally really the only
stocks that gained in value through the
worst of the recession were the ones selling
cheap stuff, e.g. Wal-Mart and McDonalds,
etc) and you have the recipe for a false
deflation reading: i.e. “a fall in the
general price level.”
What we must do is forget for a moment
what the commonly accepted measure of
deflation is and look instead at its
definition.
This year we’ve seen a budget deficit of
$1.85 trillion and we’ve seen the Fed
increase the money supply by almost a fifth
in a matter of three months.
The Congressional Budget Office has
predicted total deficits of $9.3 trillion
over the next decade (without, incidentally,
compensating for any type of universal
healthcare system).
We’ve even seen Chinese students openly
laugh at Secretary of the Treasury Geithner
when he made the statement that the dollar
is a safe place to store money.
A measure is only good as long as it
accurately gauges what it’s supposed to
gauge. If conditions exist that influence
the CPI beyond the realm of strictly
determining money supply we can no longer
look to the CPI as the sole determiner of
inflation or deflation. Because of the
peculiar economic circumstances of the past
13 months, we have to look to the macro
events for perspective.
For more information see:
The Primary Precondition of Deflation --What
must happen for Deflation to take over.
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