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September 23, 2009
By Tim McMahon, Editor
It seems the debate on whether we will be facing inflation or
deflation is heating up. This week I received emails from
two different subscribers insisting that I was wrong. Well
that is always a possibility but we will see...
The first letter I received was from Jeff L. it said, "Your
current "Annual Inflation" chart, graph, and commentary are very
helpful. Thanks very much. The data would appear to contradict
a recent article on your own site predicting a long period of
deflation."
My response
was, "Personally, I think we are in for inflation. Robert
Prechter (who is much smarter than I am) believes it will be
deflation. At this point we are on a “knife edge” and it is
still possible to fall either way. So I publish both views".
The current short term trend appears to
indicate that there is more
price inflation waiting in the wings and the stock market
appears to be indicating that asset inflation has already arrived...
The other
email was sent by reader and contributor Jim Step and includes a
quote from an article published by Agora and insists that we are in
for deflation. Agora makes some good arguments and there is a
precedent in the "Great Depression". During the 1930's no
matter how hard the government tried it was unable to increase
the money supply because it was like "pushing on a string."
This is how Bill Bonner put it in Agora Financial, "The
problem with inflation is that there is none. Consumer prices
are falling in China, Europe and America. And if we look harder,
we find out why. The feds are pumping the money supply as hard
as they can. David Rosenberg reports that the monetary base rose
at a 141% annual rate over the past four weeks. But the money
fails to reach the real economy. The money supply figures that
relate to actual cash in people's hands - M1, M2, and MZM - are
shrinking, at -28%, - 4.9% and - 6.2% respectively. Why?
Because the banks don't lend and consumers don't borrow.
In short, the
feds' money goes into cool bank vaults and hot speculative
trades. When it tries to find its way to the consumer, it gets
lost. As Rosenberg explains it, the transmission mechanism has
broken down. We live in a bust economy, not a boom one. In a
bust, consumers cannot borrow. They have nothing to borrow
against. Both their wages and their assets are going down. Who
would lend to them under those conditions? Not a bank that
almost went broke itself 12 months ago.
And even if
consumers had access to credit, they wouldn't take it. Consumers
too, almost went broke a few months ago. Instead of saving money
during the boom years, they spent it...or gambled with it. Then,
when the bust came in '08, they realized that they were 10 years
closer to retirement with little money saved. Now they have to
make up for that lost decade, by cutting spending and saving as
much money as they can".
This is exactly the argument that Robert Prechter makes.
When it is time for a deflation nothing can stop it... See
Inflation vs. Deflation? by Robert Prechter
to learn more about how
deflation can become unstoppable.
On the other hand, in the 1930's they weren't able to create
money out of thin air like they can today. Back in the
days of FDR there was a pesky thing called a gold standard.
In those days the dollar was backed by gold so they couldn't
just print more money, there had to be gold in the treasury.
Since 1880 the U.S. dollar official gold price
had been $20.67 per ounce. But from 1913 through 1920
inflation (as measured by the CPI) had increased by almost 98%
(in other words in 7 years prices had almost doubled) but the
price of Gold remained flat (by Government decree). Not
surprisingly the "Federal Reserve" was created in 1913 and that
is when the inflation began.
But because of the official gold price the government had gold
on its books at a much lower price, so the backing was out of
sync with the inflated dollars. So in a classic government
swindle FDR mandated that citizens turn in their gold at the then
current fixed price and then promptly raised the price to the
"real" market price of $35 an ounce. Poof instant money,
no matter that is was stolen from the American people. In those
days though it was a one time trick, FDR couldn't do it
again. First of all, gold was no longer undervalued and
second of all the people didn't have any more gold to steal.
For more info on the history of gold
These days the Fed just "monetizes the debt" without
having to worry about gold at all. In other
words, they create a debt by issuing "T-Bonds" and they sell
them to the highest bidder. Over the last few decades the
highest bidder has been foreign countries like China. But
recently, unbeknownst to the average American a major shift has
occurred. Foreigners are no longer interested in buying our debt
(that's no surprise) the surprise is what does the FED do when
there aren't enough buyers of its debt? It steps in and
buys its own debt.
What? That's like printing an IOU and putting it in your
right pocket and then transferring it to your left pocket and saying
oh look now I have all this money... That is how they can print
money out of thin air. That is true monetary inflation which
should result in price inflation.
So to answer Jim's (and Agora's) question, how will all this money get
past the banks logjam and into the consumers pockets? How
about through the stock market? The market is up 50%
so consumers feel richer. Some might sell stocks, some
might borrow against them. Some might just stop saving so
much and spend the extra, asset inflation may
be the vehicle that re-inflates the consumer.
For more info see
Why the Bailout Will Result in
Hyperinflation .
For more information
on Deflation see:
The Primary Precondition of Deflation --What
must happen for Deflation to take over.
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