Sharon July 9th, 2009
Stoneleigh over at The Automatic Earth has done a really spectacular series of pieces lately on the nature and reality of deflation, and why hyper-inflation isn’t a real danger. I find her work very, very compelling, and I think she’s just plain wonderful to sit down and spell out the details, and answer the questions.
I think deflation is a hard concept for a lot of us, simply because we tend to associate flation of all sorts with price changes. Most of us are familiar with inflation when the cost of things starts going up. Indeed, there’s a credible case to be made the popular language of “inflation” as shorthand for “increasing prices” and “deflation” as shorthand for “decreasing prices” may actually have gained so much traction that we should stop using them in their technical meaning, and just talk about “expanding” or “contracting” money supplies.
That is, deflation and inflation, in and of themselves, are not about prices and affordability, but most of us think they are. And when enough people come to understand a word one way, it is often not very useful for economists or experts to go on say “but it doesn’t really mean what you think it does.” There is, for example, no point in my observing that 99% of the ways people use the words “ironic” or “tragic” aren’t actually “ironic” or “tragic” – I’ll just have to suck it up and accept that most people think something is ironic if it is a little bit coincidental and tragic if there’s any death involved.
But regardless, Stoneleigh does a great job of explaining why deflation is not falling prices, why most of us aren’t experiencing falling prices, and why we’re having deflation anyway. I really recommend you read all of this, and carefully. Here’s an excellent excerpt, on why credit doesn’t work in parallel when it is being extended and when it is being retracted:
“The period of time where money was chasing its own tail was adding to wealth expectations, and much of that wealth effect was propping up prices. Those who are of the opinion that they have a claim to a certain percentage of the real wealth pie will not readily concede that they do not. While currency inflation divides a wealth pie into ever smaller pieces, credit expansion creates multiple and mutually exclusive claims to the same pieces of pie. Everyone feels wealthier, but it is an illusion. Little or no wealth has actually been created, but the proliferation of claims has led to a very dangerous situation. Deflation is the process of extinguishing those excess claims once their existence has been generally recognized.As there are probably at least a hundred claims to each slice of pie, thanks to leverage, the vast majority of claims will face extinction. This will not be an orderly process following legal niceties. On the contrary, those higher up the financial food chain will reach down and grab whatever they can in the way of real wealth in the biggest margin call in history. In other words, say good-bye to anything owned on margin.”In practical terms, I think we are seeing this now – those of us with small claims on our assets – retirement and pension funds, etc… have already been cut out.
Here’s the first piece I recommend, in which she really covers the subject of deflation clearly and brilliantly: http://theautomaticearth.blogspot.com/2009/07/july-5-2009-unbearable-mightiness-of.html
Here’s her debate on the subject with another blogger – it is excellent: http://theautomaticearth.blogspot.com/2009/07/july-8-2009-stoneleigh-and-aaron-krowne.html
Her partner in crime, Ilargi, adds a good and useful commentary as well here: http://theautomaticearth.blogspot.com/2009/07/july-6-2009-inflation-least-of-your.html
I think his additional point is worth emphasizing, although I really, strongly encourage you to read both of Stoneleigh’s pieces. Ilargi writes:
“Perhaps I should clear up a point that Stoneleigh didn’t emphasize in yesterday’s The unbearable mightiness of deflation. We fully expect inflation to set in in the US, and likely in many other parts of the world. But that will become an issue only after debt deflation, propelled by a deleveraging that boggles the mind, will have run its course. And, as I’ve indicated before, the damage to our societies caused by this deflation scourge will be so severe that inflation will be the least of your worries.The deflation we’re talking about will be a scourge of truly Biblical proportions. And it won’t be so short that it can be brushed off, either, as I saw Peter Schiff contend recently. Our economic and financial system lived the high life off the credit expansion of the past few decades. Now the bill is presented in the (yes, predictable) form of a credit contraction, and there’s no way we can escape it, or wish it away, or outsmart it by creating more debt -as our political class tries to make us believe-. Yes, there is a huge risk of inflation, but it’s not now. And when we get there, we will all have completely different concerns from the ones we have now. Or, at least, that is, should have.We are not alone in warning of this debt deflation. Today alone, I can present Steve Keen, Martin Weiss, Hugh Hendry, Niels Jensen, John Mauldin, Antal Fekete and Minyanville’s Mr. Practical. They all predict deflation. Not bad for one day, if I may say so. And many more will follow, while most of those who don’t will be held back by the immovable stone their ideas are held captive in. “
My own analysis mirrors theirs in many (not all, but quite a few) respects - we are facing a deflationary spiral that will last for some time. And our preparations ought to take that into account – I’ve always said that our shared crisis will function mostly to make us much poorer, and I believe it is. I will write more about preparedness for a specifically deflationary crisis (oh, wait, a contraction in the money supply 
), in the coming weeks, but I think first we have to understand what it is we’re facing.
Sharon
