As to the “flation” debate

The “flation” debate is alive and well and in some quarters it borders on violent confrontation. So I’d like to get another crack at it.

Armchair inflationists observe the flare-up in commodity  prices and claim hyperinflation is around the corner. The more technical inflationists observe the flare-up in money aggregates which rightly result in flaring commodity prices and claim hyper inflation is around the corner.

Western economies are service based consumer economies.  In the USA for example, consumers till very recently accounted for 70% of GDP of $14Trillion.

Thus, in the USA if the consumer should for some reason be unable to carry on spending as it did till recently, it follows that US GDP would suffer significantly.

But empirically, since the crash of 2007, official data seems to indicate that US GDP has not really suffered that much. This leads observers to opine variously that either we are out of the crisis or at least coming out of it. Certainly, the rise in unemployment seems to have stalled if not reversed so that if people are no longer losing their jobs the explosion in the monetary base will translate in inflation and hyperinflation is around the corner… because we are a consumer based economy… so that if the consumer is doing well then GDP will explode nominally thus giving us inflation…

But I with my $800 computer am not convinced that inflation looms on the horizon. Hyperinflation is a different animal alltogether and I’ll touch on it later on. But I cannot countenance inflation … yet.

Here are a few spanners in the inflationist argument.

If the rise in unemployment has stalled and, according to the most recent data, has reversed, then why has food stamp usage not even abated?

But more importantly, if the rise in unemployment has already stalled and has now reversed, why is the participation rate plumbing new depths?

FRED Graph
FRED Graph

But then, if indeed the official employment statistics are fudged as these official graphs suggest, then how come GDP hasn’t really suffered that much since the crisis began?

One reason is the extraordinary, galactic, gargantuan and thoroughly unprecedented fashion in which our governments are attempting to substitute for the consumer by injecting money into the economy in ways that have never been attempted in the history of man. Subsidies, TARP, Quantitative Easing and good old fashioned fraud perpetrated at the highest levels of government have helped keep up appearances of normality.

And here is the conundrum. You may or may not agree that the rise in unemployment has not yet stalled but, say you, even if it has not, then obviously government has been successful in compensating the loss of  consumer expenditure because it is plain to see that commodity prices are flaring. So somebody is buying these commodities which in turn means that somewhere there is demand. And if there is demand then we will have inflation… right?

Graph: Personal Saving Rate

Graph: Household Sector: Liabilites: Household Credit Market Debt Outstanding

Clearly, from 1980 till 2000 consumers egged on by state mandated reductions in interest rates, gradually depleted their savings whilst at the same time gorged on debt thus contributing to turning the US economy in a raging consumer based economy (declining interest rates discourage saving and encourage debt thus goosing inflation).

But since 2007 consumer trends have clearly reversed thus undermining the consumer based economy. In the recent past, consumers have been saving more and have been taking out less debt. The trend is similar in Europe. Ergo, in the West today consumers are taking a break if not outright retrenching… and for good reason… unemployment is rampant in the UK, in France, in Spain in Greece in Italy, in Portugal and in the good ol’ USofA.

If that is the case, then I don’t see how in a consumer based economy inflation can once again be revived in the absence of the consumer. I see how the government is for now compensating for the lack of consumer. But Keynesian monetary injections are not going towards expanding the productive economy. If monetary injections were successful then the participation rate would be turning up signifying that business was hiring again. Instead, money injected by the authorities is going directly to line the pockets of bankers and selected entities whom in turn go on to protect the purchasing power of their monetary gift by investing and speculating in commodities because they are fully aware of the deleterious nature of state directed policy.

Investment and speculation in commodities by privileged parties of course results in severe dislocations in the energy and food markets with consequences that are as much economic and political as they are social on the global stage.

Notice the trend of government debt (the debt that has to be serviced and eventually paid back through taxation) since 1980

Graph: Federal Government Debt: Total Public Debt

Now check out GDP progression since 1980

Graph: Real Gross Domestic Product
Notice how since 1980 Federal debt progresses from $1Trillion to about $14Trillion but GDP barely doubles from $6Trillion to barely $15Trillion. The entirety of US GDP today is made up of debt.
There are other significant charts that buttress the above contention and that you can see under “My Charts” in the right hand side column. Chart 135 on page 1 is particularly significant and should strike fear in the hearts of any citizen that is about to retire as well as the hearts of sovereigns and investment funds the world over as well as, yes, your (the person reading this blog) insurance and pension fund.
To wrap it up.
The final arbiter of whether the authorities have been successful in inducing inflation is tax revenue. For as long as tax revenue stalls or declines, there is no inflation in sight. That’s because in a consumer based economy, for as long as consumers do not spend money in the general economy, business cannot pay taxes. And since unemployment is still rising, the wider economy is not working thus taxes cannot be paid thus there cannot be inflation. Moreover, flaring commodity prices due to aberrant monetary policy act as a further tax on consumer as the extra money that has to be spent on gasoline, electricity or food cannot be spent in other aspects of the economy.
The important thing in understanding what the outcome will be is not mere idle speculation. Understanding which flation will befall us is vital to surviving this crisis. One of the more immediate concerns for example is that if indeed we should be in deflation as I contend, economic actors that are struggling with heavy debt loads would be better off selling whatever assets they have now, in an attempt at lightening or extinguish the debt load now, because in deflation assets will only lose more value. Alternatively, in the absence of assets owned outright, economic actors could contemplate walking away from debt i.e declare bankruptcy now before things get worse.
On the other hand, if inflation should befall us then economic actors struggling under heavy debts would do well to hold on to the debt and, eventually, even increase the load (as governments are doing). In this event, even people that own nothing would be well advised to take out a loan and buy assets.
In the immortal words of Inspector Harry Callaghan: “Well? Do you feel lucky punk!?”
Just a few words about hyperinflation.
Hyperinflation is a political event more than a monetary or economic event. Hyperinflation is only partly related to inflation but does not result from it. Hyperinflation results from the loss of confidence in a government. That is; when in a floating exchange rate monetary system as we have today in the West economic actors lose faith in a sovereign, said sovereign can no longer obtain funding. Being unable to sell sovereign debt to fund its own activity the sovereign must resort to printing money without corresponding creation of financial instruments held by third parties. Thus the national currency is thoroughly and aggressively debased resulting in hyperinflation. Argentina and Zimbabwe are but two of the more recent examples of hyperinflation.


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4 Responses to “As to the “flation” debate”

  1. Patrick Donnelly Says:

    Money is just a game.

    When a political crisis is reached, the knot will be cut. Life will go on.

    The winners will have wealth and the losers will have paper. Some will be angry. I was.

    Since you do not comment on my comments, I take it I have insulted you? Consider yourself in good company!~

  2. Patrick Donnelly Says:

    Very true.

    I like your acid test of inflation: it is as a result of government collaboration with the money makers/printers and therefore taxes should be increasing as part of the theft from savers. Excellent as a rule of thumb and quite beyond the ken of “economists”!

    My take:
    Deflation set in after the credit boom of 1999/dot.COM mess. 2001 comes along ……. the interest rates can be nullified and we have the far greater mess that we live in. Deflation is again being resisted by using OPM in every form. Now the taxpayers and savers are all being stuck with the bill and the assets are ending up with the kleptocrats. This is known across the system so it is also being used to destabilize the MENA. And elsewhere, wherever imports of food or oil are vital, giving the lie to interdependent globalization!

    Bad weather, weather control, is the icing on the cake, but also “global warming” has distorted the bio market so foods are now diverted into fuel for gas guzzlers.

    While most have decried the lying, they have not said why the lies are propagated. With disruption comes loss of supply and increased demand, tantamount to pillage without war?

  3. guidoamm Says:

    hi Tim

    I Agree. Hyperinflation can indeed be brought about by a bout of deflation. There are reasons to believe this is what is happening now.

  4. Tim C Says:

    Guido, some very observant points. Totally agree re Hyperinflation – you can get that from a deflationary environment if everything goes pear-shaped enough.

    It strikes me that we’re in some form of bi-flation – ie we are experiencing heavy deflation in some segments of the economy and noticeable inflation in other parts. The conundrum is that because the authorities, particularly the FED are so scared of the deflationary aspects they are forcing inflation in other aspects. Which screws the average person across the world because the purchasing power of assets they might hold has deflated (ie selling something like a house is less worthwhile than before) but the price of things they need, eg gasoline or food, has inflated. It basically puts the economy in a perilous stasis.

    Which worries me that eventually some major sovereign will find itself the victim of hyperinflation. That of course, or we’ll have some major global war break out… but you and I know that’s pretty much the inevitable endgame…

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