Let’s suspend the suspense … yes, it’s deflation.

The current setup recalls my iTulip post on September 6, 2008, “4, 3, 2, 1 Deflation!”. I took a lot of heat for it, but only nine days later Lehman Bros collapsed, and within weeks the word became commonplace in financial media.

I usually try to avoid the terms “inflation” and “deflation”, because they’re so widely misunderstood and misused. I prefer “depreciating currency” or “appreciating currency”, but even those terms get confused with their forex usage.

I’ve referred to the appreciating USD dollar a number of times this year, which in the Financology lexicon is synonymous with deflation. So there’s nothing fundamentally new here, but it’s become deep and persistent enough that even some of the economic world outside these pages may soon be coming to use it.

Look. US Treasury prices have been sucked into a black hole. Stock prices are down. Gold prices are down. Copper prices are down. Oil prices are down. But I haven’t mentioned the one thing all these prices have in common … they’re in USD. Those who do their accounting in other units like lira or pesos or yen are not seeing the same thing. There is only one rational conclusion: USD is up.

This is the opposite of inflation. Sure, it was only days ago the US BLS reported an annual gain of 8.3% in the CPI. And the financial press is replete with headlines and analysis proclaiming that inflation isn’t going away any time soon. Even the Federal Reserve is expecting a protracted battle to defeat it.

It’s wrong. All wrong. They’re not even looking at inflation, they’re looking at the residue of inflation in consumer prices. The current story is deflation. We could argue it’s needed, we could argue it was inevitable, but it’s a reality. Unless it reverses promptly and powerfully, consumer price inflation will quickly become yesterday’s news.


20 thoughts on “Deflation

  1. shiny! says:

    The Fed always seems to react to lagging indicators rather than getting in front of things while there is time. Now I’m wondering if EJ’s old Ka-POOM theory still holds (did you agree with it, Bill?). If so, will there be a POOM to this deflationary Ka- or a decade of deflation/sovereign collapse?

    1. Mega says:

      I fear your not seeing the full picture…… in Blighty you can a almost smell the fear.
      The Pound has crashed after the goverment failed to lift rates enough & had a “Mini budget” were they done little more than try a 1970s “dash for growth” AKA Borrow even more cash to try to keep the House price ponzi scam going………..the markets dumped the £

      We have to look at this though the lens of the “west” V “The rest of the World”……we are at the point where TROTW wants paying for stuff by the West in other means than “Fiat”.

      The interest rates are a last grasp try to give their “Fiat” some value & the $ is the only “save heaven” to park up value while other Western “Fiat” dies

      1. Finster says:

        Thanks for bringing that up, Mega. I wanted to devote an article to the UK story, but there’s just so much going on right now and only so many hours in the day;-). It’s a huge issue.

        Suffice it to say that while the deregulation part seems sound, the notion of injecting an explosion of fiscal deficits into an already inflationary situation is dumbfounding. We can only hope the reaction in the currency markets leads to a more sober approach.

    2. Finster says:

      I don’t claim to have fully understood Ka-Poom theory, Shiny, but its philosophy and conclusions and mine seemed to jibe. EJ frequently spoke of excessive financialization. In one sense this decade will be deflationary … the value of debt will decline. The amount of debt grew to a level that was simply not supportable by the real economy. In the abstract, financial securities are ultimately all claim tickets to real things … their holders eventually hope to exchange them for goods and services. But if the value of all these claim checks vastly exceeds the body of goods and services available for purchase, their value must fall.

      But this highlights one of the reasons I prefer to avoid the terms inflation and deflation in the first place. I use the terms here to refer to decreases and increases in the value of currency. In this sense, while we’ve been seeing currency increasing in value (deflation) I expect inflation to predominate (currency decreasing in value).

      This may seem counterintuitive because the dollar has obviously been losing value in the consumer goods and services space. But this is due to lagged effects. Remember how bond and stock prices soared in 2020 when the Fed slashed rates to zero, vowed to hold them there forever, and printed by the trillions?

      That was the real inflation. This currency depreciation hit asset prices first, causing them to skyrocket. It took time for the effects to spill over into goods and services prices. Unlike asset prices which change in real time, tick by tick, consumer prices take longer to respond.

      Now we see the same thing in reverse. Bond and stock prices have been getting hammered in units of a an appreciating dollar, even as the effects of the 2020-2021 inflationary deluge are still kiting consumer prices. But consumer prices are just running on the exhaust fumes of inflation. Now we’re experiencing deflation. It will likewise take some time to filter through to consumer prices. But so long as it’s not quickly reversed, it will.

      This will not be long lasting though. Once consumer prices ease, the same interests that wanted asset prices to inflate and the dollar to depreciate (Wall Street and Washington) will be at it again. Rinse and repeat.

      1. Mega says:

        I would be very interested to read that when you done.
        My question is this:-
        The powers to be talk of “normalizing rates” eg rates going back to were historically be, eg 4-8% ish.
        Is this possible?…….or are we simply going to see what i call “Spike inflation” were an event causes jump in inflation only for it to fall back to deflation again?


        1. Finster says:

          I believe it’s possible, Mike, and after this epic crash in bonds, we’re not far off. Parts of the Treasury yield curve are already trading with 4+% yields … for instance the 1-3 year portion of the curve closed the week solidly above that level.

          Will it stay that way? I doubt it will for long. Probably 3%-6% is more representative of “normal”, but as we’ve seen yields can trade well below or above that range for years.

          The big picture has been falling rates and yields for over forty years. We may well have hit bottom in bond yields and the peak in prices of this secular bull market or it’s not far off … and may have entered a new secular bear market in which yields rise and prices fall for decades. But even if that’s the case, that larger trend will be made up of a series of cyclical bull and bear markets, so there will continue to be a case for owning at least some bonds most of the time, and possibly even sizable allocations some of the time. I suspect we’ll soon see one of those cyclical bull markets.

          This deflationary spell is temporary … as I noted at the beginning of this decade, I think it will be broadly inflationary and that physical commodities are likely to outperform stocks for much of it.

  2. Mega says:

    A major new report from investment banking and wealth management giant Credit Suisse has found that the average Chinese adult is now wealthier than the average European.

    Although North America and Europe together account for 57% of total household wealth globally, China is squeezing out Europe in rankings of wealth per median adult.

    Credit Suisse’s annual Global Wealth Report, which was released this month, estimates the average wealth of households around the world.

    It found that Chinese median wealth per adult, at $26,752, now outstrips Europe, where the average adult has a wealth of $26,690. The European figure takes into account the whole of the continent, which includes many less wealthy nations in its southern and eastern regions.

    Median wealth in China was more than four times greater than in Russia, where median wealth was $6,379 in 2021

    China’s average wealth, however, was still less than a third of the wealth of the median American ($93,271) — and only about 10% of the wealth of the median Belgian ($256,336).

    Global wealth increased by 9.8% in 2021 compared to the year before, reaching a total $463.6 trillion.

    “All regions contributed to the rise in global wealth, but North America and China dominated, with North America accounting for a little over half the global total and China adding another quarter,” the report said.

    Europe, Latin America, Africa and India account for only 11.1% of global wealth, which the report puts down to local currency depreciation against the dollar in those regions.

    In Europe for instance, the euro reached parity with the dollar for the first time in 2022, while the pound has plunged to near four-decade lows.

    China has squeezed out countries in Europe which previously dominated its rankings through its “exceptional rate of wealth growth.”

    China attained the top spot for fastest median wealth growth out of any region, rising more than eight-fold in the past two decades, growing from $3,111 in 2000 to $26,752 in 2021, Credit Suisse said.

    1. Bill Terrell says:

      Thanks Mike, that’s interesting. China reminds me of Japan a few decades earlier.

    2. Milton Kuo says:

      Doesn’t much (most?) of Europe have defined-benefit pensions? That’s actually worth quite a bit of money–assuming the pensions don’t go bust–and should be factored into wealth calculations. Most people in China do not have a pension just as it now is in the United States.

  3. Mega says:

    So, Given that China is “there” & India not far behind, followed by Africa this must point to demand for raw materials/ hydro Carbons rocketing?

    Thus Inflation in falling/dying Western “Fiat” currency?


    1. Bill Terrell says:

      Yes. Although I want to distinguish inflation and deflation as a financial phenomenon from the price effects of real economic phenomenon.

      Let me explain. My January 2020 case for a decade of commodity outperformance was based on massively inflated financial asset prices. Bonds and stocks. They’re ultimately claim checks on real goods and services … their value to their holders resides in the hope of one day exchanging them for things of practical value. Their notional value however had grown to far exceed the body of goods and services available for purchase. The books eventually have to balance. My expectation of commodity outperformance was based on the inevitable reconciliation of financial asset purchasing power with the actual stuff that can be purchased.

      Currencies are financial assets too. What causes them to lose purchasing power (inflation) is pretty obvious. Their supply increases beyond the supply of stuff available for purchase. What causes their value to increase (deflation) though is little less obvious.

      The supply increase comes about via lending. The newly created currency is lent into existence. Interest rate cuts make borrowing more attractive, causing currency supply to increase. But the currency is borrowed … this debt is eventually due to be repaid. The need to acquire currency to repay debt represents demand for currency. So inflation is springy … it is ultimately the cause of deflation. An increase in interest rates shifts the balance of supply and demand … it becomes marginally more expensive to be in debt. The demand for currency to repay debt increases and the currency increases in value. So an excessive buildup of debt is like tinder … the attempt to counter consumer price increases can trigger a massive short covering rally in the shorted (borrowed) currency causing it to spike in value. This is what happened in 2008.

      Then to counter that, the central bank cuts interest rates and creates more currency, lending it into existence. This devalues the currency, first in real time asset markets, driving up asset prices. But eventually asset holders want to spend their increased notional wealth, so the price effects spill over into goods and services. Rinse and repeat.

      Over time, this game has a corrosive effect on the real economy. Inflation not only depreciates the currency, but also serves as a wealth transfer mechanism. It becomes more profitable to acquire wealth by gaming the financial system than to produce real goods and services. The rich become richer at the expense of everyone else, but this wealth rests on a progressively smaller base as the aggregate productivity of the economy declines. The growing wealth gap gets blamed on free market “capitalism” and socialism rises, even further exacerbating the decline. The nation grows poorer and its living standards fall. This is how central banking and fiat money destroy an economy.

      What we’re seeing is the result of the “advanced” and “developed” economies being further along this road to destruction than the rest.

  4. Mega says:

    Thanks Bill
    Markets only just opened (Far east)…….so far its not looking good.
    I suspect the that they mis judged this crisis as they can’t see it coming.

    Time will tell.

  5. Mega says:

    Its Monday, in over night Far east trade the pound fell to $1.03 !
    Now back to $1.067 as people hear hold their breath

    Could there be a statement from the Bank of England soon?
    Sky’s economics editor Ed Conway says he “wouldn’t be surprised” to see a statement from the Bank of England “very soon”, following a morning of market turbulence.

    All eyes are on the BoE to see if it will bring in an emergency rates hike as it tries to control inflation.

    1. Bill Terrell says:

      Talk about getting pounded! It’s a little disappointing the new government didn’t trim the deficit package, if only to show the markets it cares about the pound, but this now leaves it up to the BOE. An emergency hike is a tough call … on one hand there is an emergency and on the other the BOE doesn’t want to signal panic either. It might settle for tipping a larger increase at its next regularly scheduled meeting.

      Personally I think it’s a mistake for CBs to lock themselves into a preset schedule in the first place … this pickle is a great example of why. If policy tweaks were always on the table and fairly routine then making one when it’s called for wouldn’t be burdened with unnecessary and unwanted market psychology baggage.

  6. Mega says:

    OK, Boe to say “Something” after 5 pm (UK time)….after the markets have shut…
    This caught my eye

    Bank of England prepares to ‘stress test’ banks as economic picture darkens
    The UK’s largest banks will be tested against a new scenario as the Bank of England examines their resilience.

    The scenario includes:

    UK GDP falling by 5% over the first year
    UK unemployment more than doubling to 8.5%
    Residential property prices falling by 31% over the first year
    Inflation peaking at 17% in 2023 and averaging around 11% in the first three years
    The bank rate rising rapidly to peak at 6% early 2023
    Remember, this is not a forecast – it is a kind of “worst-case scenario” used to see how the country’s banks would cope and whether they hold enough capital to do so.

    The aim is to avoid a repeat of situations where taxpayers have to bail out lenders like they did during the financial crisis.

    The last stress test was in 2019, followed by two years of crisis-related stress tests during the pandemic.

    The results of this year’s stress test is due in mid-2023.

    In a statement, the BoE said: “The stress scenario is more severe than the global financial crisis for both the UK and the world.”

  7. Mega says:

    Its almost 5:00pm
    The BoE as said (I joke you not!) that it watching the £ closely.
    Pound falling once again

    1. Bill Terrell says:

      Thanks very much for your perspective Mike … the worldwide interest in this situation prompts an article of its own. Welcome any insights you can add to it.

      Pounds & Gilts