It’s De-Lousy, It’s De-Testable, It’s De-Flation…

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:

 Here’s her debate on the subject with another blogger - it is excellent:

Her partner in crime, Ilargi, adds a good and useful commentary as well here:

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.


8 Responses to “It’s De-Lousy, It’s De-Testable, It’s De-Flation…”

  1. steve from virginiaon 09 Jul 2023 at 6:05 pm

    Hmmm ….

    Having Stoneleigh and Aaron Krowne - both deflationists - ‘argue’ is not really much of an arguement. It would be like her and Mish (Shedlock) or her discussing with me. I can’t argue with a deflationist, I am one myself! If nothing else, we export our inflation, such as it is, overseas. More on that later …

    Stoneleigh should argue with an a) inflationist such as Doug Noland and b) with a real economist - who is also an inflationist and would probably clean her clock like John Taylor.

    Stoneleigh and Willem Buiter would be a good discussion, too.

    This doesn’t mean Stoneleigh is incorrect, BTW.

    I’m much more bearish than she is. the Economic Undertow mantra is …’ whatever is the most destructive to the greatest number is the most likely.’

    And; ‘We have to propel ourselves forcefully into the 19th century or we will wind up in the 14th century’.

    Otherwise, I agree with the deflation then inflation scenario. Whatever is most destructive …

    One issue with US inflation is we (can still) export it to China. The America- China relationship is identical to the George W. Bush- Democratic party relationship. Dubya could never beat the hairy, shirtless enemies of America in Iraq and Afghanistan, but he could endlessly pound the living crap out of his most important adversaries, the Democrats.

    I’m not surprised the Dems never call on Dubya.

    China is always a sucker for everthing American, even as they hate the relationship. They hate the relationship, they hate us for always calling the shots in the relationship and they hate themselves for being unable to do anything about it. We Yanks are barbarians, after all … but the Chinese will always buy into our ideas and intellecrtual property and our culture and out securities even as all are completely useless and worthless.

    We cannot beat the deflation but we certainly can beat the Chinese.

    Funny thing is, China had a millenia- long sustainable civilization that could have been a model for the rest of us … trashed in favor of American style auto culture and the embrace of American style industrialization.

    They buy us when we are going down the toilet. What losers. All of us.

  2. Henry Warwickon 09 Jul 2023 at 9:34 pm

    I disagree. I think we are looking at a spastic economy, where sections will deflate (consumer goods) and others will inflate (energy and food). The net result will be a general inflation.

    Those who bark about hyperinflation caused by the trillions spent on the banks don’t understand that the velocity of the money spent on banks is essentially zero. It’s as if they printed up a trillion dollars and burned it in an incinerator. Poof. gone. Not inflationary - it never chased any goods - it just covered a nasty hole in the banks’ bottom lines. The banks are still broke: they’re just not being dematerialised by the black hole of the debt canyon they built. Hence: no inflation.

    At the same time, the simple facts of energy and resource depletion points at an inflation for those items, as they ALWAYS have a required market. Consumer goods will deflate as there’s no money to buy or borrow for them, so those prices will tend to sink, especially when you bring hedonics into the equation.

    The net result? A spastic economy staggering through the nemesis of the late 1970s (US) and the 1990s (Japan): stagflation.

    cheers. I guess…


  3. Ilargion 10 Jul 2023 at 12:10 am

    Oh Sharon, bravely venturing into the deep…

    commenter 1: Aaron Krowne is far from a deflationist
    commenter 2: You can’t have inflation here and deflation there

    And Sharon: yes, the use of words in confusing, or can be, but in the end, in this case, you would really need, if you want to expropriate the term inflation, to come up with a new term to replace it.

    Just wait till deflation sets in for real to understand how important that is. We’ll be left with no words to describe what it is we’re experiencing, which will only be the most devastating thing we’ve ever known.

    And we’ll no longer know what to call it.

  4. Green Assassin Brigadeon 10 Jul 2023 at 7:28 am

    The end game will have to be inflation , but a period of deflation will be happen as long as money is being destroyed in bank loses and leveraged products faster than the Gov can print it.

    The problem is China and others are getting out of the subsidize America business buying less and less of the increasingly large treasury auctions.
    Once full monetization of debt kicks in the U.S. will no longer being dispercing its inflation to its creditors. Big moves to limit the U.S. dollar a reserve currency are also gaining credibility as China, Russia, India and Brazil have all called for a chance. The talk of gold backing the Ruble, the Remimbi and a Pan arab Gold backed currency if actually implemented will greatly diminish the Dollars importance. China has also suggested the U.S. issue bonds in Remimbi so they can no longer devalue the dollar to get out of fair payment of their debts. The dollar’s day is soon done.

    This means the U.S Gov will eventually have to print ALL of the money to cover bank losses or watch every major financial instiutuion in the world go under from exposure to a derivatives market many many times the world GDP and then print more to cover their own debt and unfunded liabilities.

    The second wave of mortgage defaults are just starting as the Sub primes subside and the Option arms begin to reset, This wave plus failing commercial mortgages will lead to at least as large bank losses in 2010 as last years, as it is Cit is on the verge of failure today, Fargo not far behind.

    if the U.S. holds the course add another 3-4 trillion to the debt by the end of next year above current pedictions.

    Velocity is an important issue and at some point veleocity will increase sending all that new money bouncing around the market, add in the depencancy on imports and the likelyhood of the U.S. dollar collapsing to half it’s buying power and the you can see the posibility of both declining U.S. asset prices, (property, unless productive like farms) all while everything imported such as food, energy, pharma, goes to the moon. Resource depletion will also raise prices while assets decline, this is going to be a bloddy mess and western and especially U.S. standards of living will be brutalized.

    Inflation/deflation is not the issue, self reliance so neither can kill you is.

  5. Louison 10 Jul 2023 at 7:53 am

    True, certain resouces like oil may increase due to outside factors like population growth in emerging markets. But one cannot throw that into the statistical stew and say that overall we’ll muddle through with an ‘average’ inflation. There is nothing average about our personal experiences. If your house falls by half and gas goes up one dollar…

  6. Sharonon 10 Jul 2023 at 9:25 am

    Henry, the problem with your analysis is that you are again using inflation in common parlance, rather than technical parlance, while Ilargi and Stoneleigh are talking about a (IMHO more important) larger monetary phenomenon. I agree with you that some prices will go up, and I’d happily place the same bet on food and energy (I’m at work at present on a piece on what it will be like when food hits 30% of the average American income). But it isn’t possible to have technical inflation and deflation simultaneously - it is possible to have some prices going up, and some going down, but not a monetary supply that is overall simultaneously expanding and contracting. “Stagflation” which refers to a contracting money supply and price increases is possible, but that’s because there are two different phenomenon going on, both being described in the same language.

    I also think you may be understating the obligatoriness of the market for energy, at least - one of the fascinating things about the last few years has been the proof of just how many people can go to near 0 usage of energy. Yes, they were mostly very poor people who hadn’t used much energy until not so very long ago, but as prices rose, nations simply stopped having energy, as CIA figures showed - most of the demand destruction occurred among the very poor. My claim is not that our usage will drop to 0, but that it could drop extremely low - sure, we say people need to heat their homes, but if they can’t buy heat, they simply will sit in their homes and be very cold. We say they need to drive to work, but if they can’t, they won’t go to work. This happens quite often in the poor world, and the idea it can’t happen here seems to me to be wrong - we are already seeing it, as more and more people can’t feed themselves - they don’t go on buying food with money they don’t have, they go hungry, or they go to food stamps, WIC and food pantries - but there’s no evidence that in the absence of such things, they would magically keep buying food.

    Ilargi - I agree a new term is needed - and honestly, I don’t think I’m doing the expropriation - even people who should definitely know better are deeply confused by the common vs technical parlance problem - so I think the obligation to cede and create a new term lies on those whose work is being consistently misapprehended because of a fundamental change in the lanaguage that has already happened. My current favorite choice is “monetary puffiness” and “monetary dessication” ;-).


  7. Stoneleighon 10 Jul 2023 at 9:37 am

    Thanks Sharon :)


    I would sincerely like to know in what way you think you are more bearish than I am. Such a thing is a little difficult for me to imagine. Are you thinking of imminent nuclear war or something?

    Aaron Krowne is not a deflationist. IMO his position is somewhat confused by his use of terms, but he is expecting rises prices (which he mistakenly calls inflation).

    If you read what I wrote you would have a better understanding of my position I think. By the way, it is silly to imply that someone cannot understand the fundamentals of this issue without the several years of indoctrination in neo-classical economic mythology that it takes to become a ‘real’ economist.

  8. gaiasdaughteron 10 Jul 2023 at 3:29 pm

    Interesting discussion, though most of it is above my head :-). At least I now understand why it was called “The Great Depression . . . ”

    I read through several of the posts on The Automatic Earth — for me, it is the bottom line that matters. If Stoneleigh is right, what is the wisest course of action for a poor slob like me? I am grateful to TAE for giving some actual guidelines, free of charge, to those of us who are interested. But I keep coming back to this mortgage thing. If one’s options are to continue renting a small apartment with a tiny kitchen and no yard or to take out a loan at current low interest rates and buy a house with a large garden area, big-enough-to-cook-and-can-in kitchen, a basement that could serve as larder and root cellar, and a backyard workshop for a home business, wouldn’t it be preferable to take on the debt regardless?

    It seems logical to me that if enough people find themselves unable to pay their mortgages, lending agencies will decide against foreclosure and eviction. It makes better business sense to leave people in their homes and let them pay when and if they can than to put them out on the street and play watchdog over another vacant, unsellable house. It’s a gamble, but everything these days seems to be . . .

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