Jay’s Inflation/Deflation Watch

In my view, a depression of some variety is baked in the cake, given the defiance of natural laws of economics practiced by our ruling elite. The notion that unlimited amounts of debt-based money can be created out of thin air without repercus­sions is a Keynesian lie that that people have accepted at face value simply because it feels good. Apparently not only in economics but in all social spheres of our lives in the western world, the elite as well as the college “educated” masses by in large have adopted and chosen to live by the phrase that was popularized by my generation during the1960s, namely that “if it feels good, do it!” The politicians and central bankers tell us we can have all manner of material goods for zero cost and so the masses have chosen to accept that big lie.

But alas, lies are eventually discovered, especially when natural laws are defied. Sooner or later the piper must be paid. Can there be any doubt that a gigantic hellish payment awaits us because natural laws governed within the four dimensions of time and space cannot be defied forever without a cataclysmic end?

Of course ours is not to know the time of this impending earth-shattering end. Nor is it possible in my view to know the shape of the impending depression, which some rightfully argue has already begun.

Will demand for repayment of debt by creditors or some other fearful event trigger a run down John Exter’s inverted pyramid, thus sending prices of virtually everything except gold plunging to a fraction of their fraudulent highs?

Or will central bankers freak out at the prospect of a deflationary depression and begin to not only pump money into the system but to scatter it out into the masses, thus once again taking what they think is the path of least resistance lest they be driven out of office in a violent revolution of the hungry, tired, and poverty-stricken masses?

Recently Chris Hamilton opined with some solid logic in my view that the Fed wouldn’t have any choice but to take the easy way out once again, given the ingrained mantra stemming from the 1960s social revolution that it if feels good do it. Chris though thinks that we won’t have a hyperinflation because the economy is so weak that prices won’t get any traction.

In my view, where I respectfully think Chris may be wrong is in his view that the dollar will remain a viable currency. If you share my view that the dollar may continue to lose its value, vis-à-vis other currencies, as it has started to do in a new bear market, then everything priced in dollars will rise whether the U.S. economy is booming or busting. That is the case for hyperinflation made by John Williams, James Turk, Ron Paul, and many others of an Austrian persuasion.

As far as my IDW is concerned, the jury is still out on the inflation/deflation question. But an excellent article published at the Global Macro Monitor titled “This Rhyme Is Different: Base Money > M1” makes the case that the Fed may indeed be fearful of a runaway inflationary problem. Until now the Fed always held that the big risk is a deflationary depression, not hyperinflation, as it has always focused on the last war, that being the 1930s depression. But now there is evidence some at the Fed are beginning to fear a wildfire of economic stimulus or perhaps a plunging dollar is about to set prices out of control into a hyperinflation. 

Of course they would not openly admit such fear or it will be a self-fulfilling prophecy. After all, propaganda is at the heart of any success the Fed has had in modifying outcomes. There is zero evidence that the Fed has a clue as to how to run an economy. No one does, as our Founding Fathers understood. But that won’t keep them from trying and their continuing talk of raising rates when the economy remains in the tank suggests the Fed may now be secretly fearful of a runaway inflationary problem.

The Key Is Velocity 

As my IDW reveals, despite trillions of dollars of money created by the Fed in the Monetary Base, except for financial assets, prices have remained tame. My IDW has a balance of commodity prices as well as financial assets from the most important global economic sectors. The real economy, which is impacted by commodity prices, has remained tame, thus holding down the inflation as defined by the government statistics, while financial prices continue to head through the roof, thus enhancing the power and wealth of fewer and fewer people. 

The reason that prices in the real economy have remained tame is in part due to debt loads that have impoverished the masses. But it is also a result of a psychological view that the currency is relatively stable and thus there’s no need to be in a hurry to buy things now rather than waiting until purchased items are required.

As the Global Macro Monitor reveals in the chart laid out above, since the financial crisis, “The M1 money multiplier is still less than one, which reflects that for every dollar created by the Fed—an increase in the monetary base—results in a less-than-one-dollar increase in the money supply (M1). Credit and deposit creation of commercial banks is thus still impaired though improving, and its repairment may be one reason why the Fed is a bit nervous and in tightening mode.

A rapid turnaround and improvement in the money multiplier, which may be also be reflected in improving bank net interest margins and growing balance sheets, could act as an early indicator of potential inflationary pressures and a flag that the massive amount of high powered money in the financial system is being converted to credit based money.

The Fed is therefore walking a tightrope of an unstable equilibrium with inflation on one side and deflation on the other, especially if your main policy tool is to pay interest on a large portion of that high-powered money. This, as the markets become increasingly convinced the global economy is now in a ‘Goldilocks’ scenario, justifying extreme asset valuations and the record low volatility.

I think the Fed walking a tightrope is a very accurate description of where we are in the Inflation/Deflation debate. One tiny mistake in this balancing act can result in a disaster with the psychology resulting in either a massive rush out of the dollar to buy stuff or a continuation of the opposite where a poverty-stricken populace continues to hoard and policymakers raise rates simply out of a geopolitical concern to retain the dollar’s purchasing power wrecked through the fires of hyperinflation.

We will continue to monitor this tightrope scene weekly with our IDW. But certainly, Michael Oliver’s work indicates that the tip is toward the inflationary side in the commodity sector while financial asset prices are likely to plunge. As James Turk notes, the only currency that will see its purchasing power rise, vis-à-vis fiat currencies no matter what the future outcome, is gold.