Wednesday, September 23, 2009


Deflation vs. Inflation

Gary North reports that one of the leading deflationists has defected to our side. ("Us" meaning North and me.) It reminded me that I meant to blog an email exchange I had recently (with permission of the correspondent). Craig had emailed me to say I was still missing the point in my critique of Mish. I wrote back:
Thanks for the email. I have to be brief. Do you know that since December, the unadjusted CPI is up 3.7%? And I'm sure you know that gold is hitting (nominal record highs.

At what point is this credit deflation going to result in falling prices? There was a brief spell of falling prices in 4q 2008, but prices have steadily risen in the eight months since then.
I thought (like Darth Vader), "All too easy." But then Craig fired back:
I’m looking at the unadjusted CPI and it is up 2.7% since December, but DOWN 1.9% since its peak in July 2008. Moreover, the CPI understates deflation due to the owners-equivalent rent number. If actual housing prices were used (substitute Case-Shiller) you would already see price deflation. Just like the CPI understated inflation on the way up in housing it is understating deflation on the day down. So despite the absolute greatest amount of monetary and fiscal stimulus human civilization has seen over the past year (there is a reason there are so many hyperinflationists), the CPI is still down (even with bogus housing measures) and gold is right back to where it was in March 2008, i.e. flat since Bear Stearns failed and unprecedented stimulus was unleashed (and not much above where it peaked in 1980 for that matter). Moreover, T-bills are barely yielding above 0% and TIPS certainly don’t look very scary. Stocks and housing are down over 30% and oil down over 50% from their peaks.

I see bargains everytime I walk into any store—EVERYTHING is on sale—cars, shoes, you name it. The official CPI index will plummet once credit really begins to disappear. So far, it has basically just stagnated. The Fed’s Flow of Funds report released yesterday demonstrated the 1st decline in total debt in the U.S. since the data began in 1952—from $52.87 trillion to $52.81 trillion, oh wow (that’s sarcasm). Government borrowing has helped to offset the destruction of private credit so far. In a year’s time, I’m sure it will be much different after this bear market rebound ends. Nothing has changed from a year ago, in fact everything is much worse thanks to the government’s actions. Last fall will look like child’s play for what’s upcoming soon. No matter what, 2010 will settle the inflation/deflation debate either way. Unfortunately, we are losers either way.
So anyway, I think that was the best, succinct statement of the deflationist camp that I've seen. And I really like how Craig concludes, "No matter what, 2010 will settle the inflation/deflation debate either way." However, I think Craig is overlooking the fact that we could both be proven wrong--CPI could stay roughly flat over 2010, in which case Scott Sumner and Paul Krugman end up looking good.

I have to side with the guys who think cpi will be tame in 2010. Cpi increases come primarily from gov spending. Monetary pumping, on the other hand, tends to give us asset price inflation, or bubbles. That's one reason cpi stayed so calm in the 1920's while assets, housing and the stock market, exploded to new heights. Also, high unemployment will help keep cpi low next year. Expect a roaring stock market with low cpi inflation until 2011.
Correct me if I'm wrong here, but isn't the debate missing out on hidden forms of inflation that are quickly becoming inevitable?

What I mean is: yes, there is "spare capacity", but only in the sense that the market has quickly realized that a lot of its capital is worthless, or worth less. So, broadly speaking, for the products you buy, it certainly doesn't follow that they should fall in price, even if labor becomes cheaper; that labor is working with deficient capital.

Okay, so far that's the standard misallocation story. But there's more.

When government pumps in the stimulus money, it's diverting workers away from anything contributing toward consumer goods (any number of degrees away). So even though an injection may keep up NGDP at a desired level, much of that will be hollow. When you go to buy your potatoes and fish, well, suddenly you find fewer people are around to bring that stuff to market so you have to pay more.

And I don't know where "Craig" is coming from on discounts. Yes, if I want to destroy the iPod and TV I already have and get another one, then yeah, there are discounts. But at the grocery store, I track items that I buy regularly, and they've all gone up, even since last year. And I've noticed more product debasement, which I've discussed before, and which is consistently ignored in CPI.

Do you want to explain to all of us out in AustrianEconland why we should assume you're being serious when you say something like, "But check out, completely uncritically, the government CPI, which is UP. Also, it measures prices. But that's proof of inflation right there."

I read that and just shook my head. I have to imagine you're trying to make a funny, but I am not laughing.

I think it's odd when Austrians even refer to the CPI at all, let alone refer to it in a way different than, "Oh, man, the CPI, that ess is wack! Totally useless, ignore it."

What the heck are you talking about? I have written repeatedly that the government is suppressing the CPI.

My point in the very brief email was that most people would probably say the CPI has been flat since the crisis began, since every month that's what the media tells us. So I wanted to make sure this guy Craig knew that the non-adjusted CPI has risen steadily since December.

I am talking about the fact that your brief case for inflation that you sent to Craig relied solely on price and a large part on government price statistics, with no caveat.

Do you know that since December, the unadjusted CPI is up 3.7%? And I'm sure you know that gold is hitting (nominal record highs.

I would've expected you to follow the CPI remark with, "Of course, I might as well not even mention to you what CPI is doing because it's a phony, useless figure." That's why I was puzzled, given what you have written, that you'd make a 'short case' that was essentially, "A-HA! But CPI is up 3.7%.... inflation, buddy."
Isn't this argument just another reason to END THE FED?

Is anyone worried about capital investment in the next great tech breakthrough? No.

Everyone is on the edge of their seat waiting to see what horrible effect will ensue from the Fed and its money dilution program. Up or down or stay the same, we are all waiting to see.

Let's be clear: A right or wrong prediction on inflation/deflation does not suggest that Austrian theory has failed. But you can bet that if we have more deflation and/or the gold price collapses, that will be the Keynesian line.
Note: Anonymous poster above is me, Silas Barta; Blogger login went through some stupid upgrade that kept me from logging in.

But you probably already knew that away from my style of writing and choice of topics ;-)

Have you been listening to the 4 part Financial Sense Newshour inflation v. deflation series? Schiff hits a homerun in his discussion, but I think that Mish loses his debate against Daniel Amerman.

Mish being pwned:
I just don't think the deflationist are being rational. First off, inflation is increasing the monetary supply, so they are talking about price deflation. But has anyone experienced their bills going down over the past decade? The only way we will see deflation is if you are talking about priced in gold. Priced in dollars prices on most things we buy will continue to rise.
"I have to side with the guys who think cpi will be tame in 2010. Cpi increases come primarily from gov spending. Monetary pumping, on the other hand, tends to give us asset price inflation, or bubbles. That's one reason cpi stayed so calm in the 1920's while assets, housing and the stock market, exploded to new heights. Also, high unemployment will help keep cpi low next year. Expect a roaring stock market with low cpi inflation until 2011."

That´s the main reason why "austrians" should be prudent in the "inflation" debate because this debate is about cpi inflation, and:

* cpi price inflation tends do appear through deficit monetization

* but credit expansion tends to create asset bubbles

So, what is the mix at this point? Not clear. Credit have decrease off-setting deficit monetization.

M2 has not grown since March/April 2009.

Carlos Novais
Mish's entire deflation argument rests upon his definition of the money supply (more on this shortly). Mish also prefers to use the Case-Shiller index in his calculation of the CPI. If this index is included in the CPI, then the CPI is in fact negative. If you read Mish's blog with any distinct regularity, you will discern that he references professor Steve Keen -- a post-Keynesian economist.

Professor Keen, from what I am able to gather, believes, in no uncertain terms, in the Minsky moment -- that is, capitalism by its very nature is unstable and during periods of prosperity, asset bubbles will undoubtedly form. Professor Keen also believes that Keynes has been severely misunderstood and misrepresented. Nevertheless, Keen believes that credit money is created before government money, and subsequently, through this analysis of the money supply he suggests credit outstanding is part of the money supply. As companies and individuals deleverage themselves, outstanding credit decreases at a fast rate (allegedly faster than the rate at which new money can be created). Herein lies the apparent deflation Mish speaks of -- debt deflation.

Mr. Murphy, I would love to see a debate on this topic (the true role of credit and debt in the money supply). While I personally reject the Minsky moment for the same reasons Frank Shostak does (central banks creating asset bubbles), I do find the post-Keynesian theories interesting nonetheless.

To be honest, I have not made up my mind on the inflation/deflation debate. Perhaps we should be looking more closely at the pool of real savings as Frank Shostak suggests, as this pool may be nearly exhausted.

I digress.

Thanks for the comment. I would like to echo your request and add some of my own observations:

Gary North, who regularly calls the deflationists/Mish out with some challenge homework question for them to explain, regularly ignores credit, even though Austrians seem to concur that credit counts as fiduciary media and it is fiduciary media, not cash and bank deposits alone, that can be used to bid up prices.

I've noticed that while Mish ignores money supply in favor of, essentially, undefineable credit supply, North ignores credit supply as fiduciary media, leaving a large hole in his reasoning and challenges. In other words, the two sides are speaking past each other. The first debate that needs to be settled is, "What IS the money supply? Does it include credit? What kind? And how do we measure it?" Once that debate is settled, the answer of "Are we experiencing/will we experience inflation/deflation?" seems like it should be obvious, outside of the fact that part of the answer is controlled by political whim.

The other issue I think is that money supply is 'tangible' and its expansion/contraction is a fairly concrete phenomenon, whereas credit is more psychological. I could let you 'use credit' in purchasing goods from me for years if I psychologically feel like allowing you that privelege. I think you'll notice that Mish focuses on psychology a lot more than Gary North does as well. North is more systematic, 'sciencey', in that he pursues reasoning of "If this occurs, then that will occur"

I've been dissatisfied with the debate so far and would like to see it continue, in a constructive fashion, by addressing some of these points.
One other thing: North always puts out these challenges and claims no one responds. Has anyone tried e-mailing North? You get a robot. It's impossible to get in touch with him unless you're Lew Rockwell. I've tried e-mailing him some devil's advocate responses as well as some of my own 'challenge questions' such as I mentioned (what role does credit play?) and I just can't get through. Kind of hard to have a debate when one guy is on the see-through side of a one-way mirror, so to speak.

Thanks for the response. I entirely agree. I have never attempted to send an Email to any of our libertarian giants, thus it remains impossible for me to speculate on the respective potential responses one might achieve.

My opinion on Gary North is that he is considerably intelligent; however, arrogant and stubborn. The complex study of economics should not be a competition. Instead, economics should be about understanding human interaction with the goal of producing the most efficient means of raising the living standards of every human being.

As for Mish, well, Mish is also quite intelligent (although his writing could be better), but alas also, seemingly arrogant. I will say that Peter Schiff has been wrong about certain economic phenomena; however, the severity of Mish's fisking was quite extreme. At least Mish has come out in support of Peter Schiff and Rand Paul in their respective Senate campaigns.

Nevertheless, you are correct in the dire need for a clear definition of the money supply. When we consider the components of the money supply, how significant is debt/credit? Demand and time deposits? Money market funds? Etc...

What about the pool of real savings? Didn't Rothbard write extensively on the reluctancy of banks to lend during the early stages of the Great Depression?

I will note that Gary North believes that since the Fed has propped up the large banks this time around (for the most part) that we would not see the monetary deflation seen early on in the Great Depression created out of massive bank failures. But what of the debt? We do have more private debt relative to GDP than we did in the 1930's.

I will say we have the TMS that I believe keeps track of. I know Frank Shostak references these figures regularly.

Gary North also believes in the suppression of gold prices by central banks and the colluding bullion banks. He may very well be right, but to many people such beliefs make him a conspiracy nut. Mish on the other hand does not believe in the suppression of gold prices.

We can compare and contrast Mish and North all day and effectively move nowhere. Notwithstanding their apparent differences, both North and Mish are anti-Fed and anti-intervention -- both stances that remain very honorable.

But like you, I want to see a real debate. I don't want to see immaturity. I want science.

I will admit though, our situation does look quite familiar to Japan in the 90's.

On a completely unrelated topic, I am growing most displeased with many Ron Paul followers. So many of them have jumped right onto the Ron Paul bandwagon and they in many notable instances completely misrepresent Dr. Paul. We can thank people such as Glenn Beck for that. Does anyone else agree?

I do, again. All I'll say in explanation is that politics is not the way to freedom but the way to intervention. It's that simple, if you ask me.

Wise words, sir.

I have also found that if your desire in life is to be left alone, to be permitted to honestly earn a living and to be free of all forms of oppression, then you needn't live in the US of A.

Wow I come of pessimistic.

But I agree. Democracy allows the majority -- whether just or unjust, moral or immoral -- to rule over the minority. That is not freedom. That is not liberty. Democracy and the sorresponding politics are nothing more than tyranny masquerading as liberty.

of = off

sorresponding = corresponding.

and I give Mish a hard
Post a Comment

Subscribe to Post Comments [Atom]

<< Home

This page is powered by Blogger. Isn't yours?

Subscribe to Posts [Atom]