So, when you are looking at the world as a deflationist, confident of your opinion, what actions/investments/decisions taken by the inflationary crowd look foolish and why?
Also, how does this deflationary world differ, qualitatively from the stagflation world? Instead of slowing economy and increasing money supply, we have a slowing economy and decreasing money supply ?
I can go that far, but the implications/repercussions escape me.
Good question. I don’t have all the answers. This has been the subject of some of Rich and my most heated debates, usually over some sort of charred meat.
In deflation, cash is king. Interest rates drop to zero as demand for credit dries up. So lets ask ourselves why these two axioms are so? We get deflation so rarely its hard to believe there are axioms about it. Last time it happened my 87 year old father was 8. Inflation is a much more comfortable subject as I’ve lived with it my whole life.
So we have a fiat monetary system, where the Fed threatens to constantly increase the supply of money therefor making deflation impossible. That makes us all feel like deflation isn’t possible however the world rarely works the way theory dictates. The Fed doesn’t loan to you are I. It loans to Banks, big banks, who in turn loan to smaller banks. The check on the Feds ability to print and print is that these banks want collateral for loans. So without good collateral the Fed can give away free money and you still won’t get it. This gets to the heart of demand for credit. You may want a new Lexus, but if you aren’t a good risk, or the collateral isn’t enough the bank won’t lend you the money.
Inflationistas ultimately believe that this is not a problem, that there is no liquidity trap. Another avenue and one I’ve discussed with Rich is extraordinary measures. This seems to be taking shape. The Fed using extraordinary measures to get the credit out to people who will use it via other means, like the TAF. I don’t think it will succeed, the problem isn’t liquidity its trust and solvency.
That brings us to the second point, cash is king. If you can’t get credit, your natural reaction is to stop spending as much and start saving. Another word for this is hoarding. The Fed considers this disastrous since our economy is built on all the lemmings spending spending spending. It causes debt defaults to rise, as the cost of getting money to service debt rises. This causes a cascade effect (or should) in defaults, which in turn causes more of the same.
I bought a motorcycle 2 weeks ago, used. I went to the Credit Union and they wanted 15.5% for an unsecured loan of 7k. I almost didn’t buy the bike. The days of easy access to credit are over. Prices will adjust accordingly, painfully so.
Just so people understand, I am not particularly a gold bug and I don’t believe the Fed is evil. Misguided, but not evil. All of the options on the table have high costs, some higher than others. I personally would rather see all the shit come out at once, burn down the system and be rebuilt on more honest foundations. That however IS NOT the Fed play book. They’d rather have a replay of Japan, which I don’t think is possible, but we’ll see.
On a final practical note, check out the ^IRX, the 13 week treasury. Its getting damn close to zero and yet the ^TNX is actually going up. To me that is just raw naked fear. Those numbers tell me something wicked is about to happen. I don’t know what but we should all be suitably chastened. For those of you who don’t follow bonds at all those are the short and long term ends of the treasury yield curve (13 week vs 10 year.)
