Nearly everyone has decided that markets and economics will not be the same as they were from 2003-2008 going forward. The primary question is whether we enter a 1930's variation or a 1970's variation, deflation or inflation? As always, most people are convinced they know which it will be. Until this past summer I expected a "vacation from inflation" for six to eighteen months and then a continuation of inflation for another ten to fifteen years.
Two fairly well-known internet writers are currently battling it out on opposite sides of the question, Adam Hamilton tilted toward inflation and Mike Shedlock toward deflation . Read both. They write logically and clearly and will not waste your time.
Hamilton believes that inflation is entirely an excess money result. If the Central Bank inflates the money supply, it is like puffing air into a balloon. The balloon expands and prices rise. This is sometimesd described as too much money wishing to buy relatively too few goods to spend it all on.
Hamilton's main chart in recent publications shows MZM money , which basically short term bank deposits and money market funds which is freely available to the owner, declining on an annual change basis from mid 2003 to mid 2005. Then with the rise of Bernanke the annual change rate increased from almost zero in mid 2005 to 16.4% in the first quarter of 2008. (To be fair, the rate of increase in MZM was about 3.5% when Bernanke actually took the reins.) The annual rate of increase dropped to "only" 9% by September 2008 but was back to about year over year 12.5% increase by the end of the year, per Hamilton's chart. His argument is that it was only irrational fear and panic which has driven prices down temporarily and that commodities, especially gold, are incredible bargains given the inflation that is coming due to the money suppy.
When Hamilton looked at M0 money , cash in circulation and in banks plus mandatory reserves that banks must keep on deposit with the FED, he is shocked that the 1960-2008 average annual increase of 6% went to +99% annualized by December 2008! He finds this shocking and ipso facto evidence that inflation will roar. Deflation case dismissed.
Mike Shedlock's argument is just as certain for deflation, which he says has been in effect for a year already and will continue. Shedlock admits that cash is clearly important but that credit, shorter term loans that facilitate all kinds of commercial activity and which dwarfs cash, has collapsed. He turns Hamilton's argument on its head that bank reserves at the FED are inflationary by showing that they account for most of the gigantic increase in M0 in 2008. How and why? Because banks have plenty of cash but are not lending it. They are hoarding it at the FED which now pays interest on it!
Furthermore Shedlock is certain he can demolish Hamilton's argument that the M0 rocket launch is inflationary by carrying the M0 chart which Hamilton started in 1960 back to 1919. It shows that M0 rocketed rocketed up from the early 1930's until mid to late 1940's, and thus was NOT inflationary at all! That's a devastating blow to Hamilton's main argument.
Shedlock also drew a table table of various events and whether they occur in each of six conditions, the sixth of which is "now". Almost all the events occuring now are deflationary.
Both Hamilton and Shedlock make good arguments, but what if it's a bit more complicated than just money or credit? What if it's both? We know that banks didn't lend much in the 1930's and that the government borrowed a lot of the cash. Industrial development slowed to a crawl, and unemployment was horrible. But at the same time many or most commodity prices rose, dramatically in some cases. As just one example for whch I have long term data, wheat, certainly a staple of life on the plates of most Americans and many others in the world, rose from a low of 31 cents ($0.30) a bushel in 1932 to $1.45 a bushel in 1937, a 368% rise while incomes were falling! Unemployment was rising, wages were falling, and prices for essentials like wheat were rising. That's brutal. Housing prices were falling in the 1930's, by all verbal reports I have heard, just as they are now, and the 1930's are considered the prime model for deflation.
Like many I have leaned toward the easy idea that we have some deflation now but will surely have inflation later. The "surprise-a-mental", as Ed Seykota called economic fundamentals overlooked by most and picked up by only a few early on, could be we that we will have both deflation and inflation concurrently as in the 1930's. Oddly enough, my Hillary/Obama portfolio of short term municipals and gold would work reasonably well in such conditions.
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