Posted by Frugal on 21st September 2009
There is an interesting ongoing debate on inflation versus deflation at financialsense.com. This week was a debate between Mish and Daniel Amerman. Mish has been one of the most vocal deflationist before the stock market collapse, and he has nailed it correctly. Getting the big picture correct on inflation/deflation is probably the single most important thing for your financial portfolio (and I just cannot emphasize enough).
So do yourself a favor, and listen thru the 1+ hour of online radio. I was expecting simultaneous asset deflation and commodity deflation back in early 2008. That seems to be what Amerman is saying during his debate. However, with Mish, he is more of a total deflationist, although he also agrees with the fact that there is no way for USA to pay out all the entitlement/welfare programs at the current US dollar value. What Mish adds into the debate is the timing of the next inflation, and that he doesn’t believe in a general commodity inflation in a consumer retrenchment. I must say that I personally sides with Mish more than Amerman. Here are a couple of noted points from the debate:
1. Amerman is taking a long term view that USA may follow in the footstep of Roman/Argentine style of hyper-inflation or high inflation. Even if inflation is not that serious, it’s very true that back in 1970, USA went thru a period of high inflation, where real estate gained in nominal value, and many homeowners benefited from the reduction in the real inflation-adjusted value of the mortgage debt. There is no doubt in my opinion that Federal Reserve would like this ideal high-inflationary scenario to unfold, without getting into a hyper-inflationary scenario, where the economy and banking industry simply gets trashed. That was my primary reason of forecasting high inflation coming due to an impending collapse in real estate market back in 2006. Under a well-controlled but high inflation scenario, Fed can reflate the housing market, and therefore make the banking/mortgage industry to be whole again. However ideal (for Fed) this is, there is a very big problem. A reflation in housing market can only happen along with a wage inflation. And that is just NOT happening, due to global wage arbitrage from globalization, and high (and lasting) domestic unemployment rate. In fact, because of that, I think the likelihood for USA to follow Japanese style deflation is probably higher than most people realize.
2. Amerman keeps saying that for average Joe, the monetary inflation/deflation is much more important than asset deflation. I definitely agree with that. Mish tries to argue that there is also a price deflation besides asset deflation, while Amerman doesn’t believe in that. With certainty, commodity prices have gone thru some deflation. The notable example is the crude oil prices falling from $150 down to $40, and now back at $70. That is a lot of deflation in a short time. With my own day-to-day observation, it appears that most companies are holding the price levels as much as possible. However, the actual deflation creeps in through various means of promotions:
A. In grocery, I’m seeing tripling coupon values now. And there is a constant ad wars going on for promotional items.
B. In restaurants, I’m seeing more heavy distribution of coupons, and the serving size of dishes are REALLY getting bigger (at a small minority of restaurants). I have been surprised that ordering the same number of dishes now is leaving my family with more leftovers to take home.
C. For “monopoly” business, such as Disneyland tickets or Legos, prices are not falling at all. They have been rising. But promotions do seem to go on slightly more frequent than before. However, without promotions, I’m definitely paying 3% to 15% more on every Lego box that I’m buying for my children.
D. In government, taxes & fines are going up. And I don’t see any possibility that this trend will reverse itself.
From the above personal observation, I must conclude that most business are handling the deflationary pressure (due to less demand) via more promotions. They obviously wouldn’t back-roll the prices if they don’t need to. I don’t know if we will actually see a more pronounced deflated prices at the stores. But certainly, I think the majority of the savings from the commodity suppliers have NOT passed down to consumers yet. With this economic background, I think there will be some significant differences to your wallet whether you shop with coupons or not.
Furthermore, due to more business close-out and bankruptcy and lack of credit for new business to come in, there is LESS competition for the existing survivors. Less competition will simply mean higher prices going forward. This is the economic cycles at work here.
3. One of the most important thing to recognize in this debate is Mish’s point in including CREDIT for arguing a deflation. This is actually quite crucial. The destruction of credit has been much more relentless, relative to money printing at Fed. The money printing for stuffing the banks with good tier-1 reserve money truly came AFTER mortgage credit creation, not before. There is no ways for banks to lend out these newly minted money, since they know very well that their mortgage assets are still deteriorating at an alarming pace. This is the point that I was missing when I forecast high inflation in 2006 (at #1 above). Certainly, for much longer term, it still doesn’t change the fact that either US dollar or USA liability needs to get trashed. But the timing of such event is likely to get postponed first due to current unfolding of deflation.
Overall I tend to agree with Mish who is blasting every hyper-inflationist out there. I don’t know whether the debate really puts an end to hyper-inflation, but I do think that Japanese-style deflation may be with us for at least a couple of years. However, Mish view obviously doesn’t jibe with the current optimism on Wallstreet and global stock markets. Just be careful holding equities. When the game is up, no one is going to ring a bell to remind you that the top is behind you.