Nov 132014
 November 13, 2014  Posted by at 9:26 pm Finance Tagged with: , , , , , , ,

Dorothea Lange Negro woman who has never been out of Mississippi July 1936

Looks I have to return to the deflation topic. I’m a bit hesitant about it, because the discussion always gets distorted by varying definitions and a whole bunch of semi-religious issues. The Automatic Earth has for many years said that an immense bout of deflation is inevitable because of global debt levels, and it’s all only gotten a lot worse since we first said that. Our governments and central banks have ‘fought’ deflation with more debt, and that was always the stupidest idea in human history. Or at least, most of us were stupid for believing it would work, or was even intended to.

Just so we don’t get into yet more confusion, i probably need to explain that the debt deflation we’re talking about here is not some subdivision like consumer inflation or price inflation or cookie inflation, those are just hollow and meaningless terms. Debt deflation is deflation caused by too much debt, and the deleveraging it must and will lead to. Deflation does not equal falling prices, those are merely an effect of it.

The reason this matters is that when you equate inflation and deflation with rising or falling prices, you’re not going to be able to know when you actually have deflation. Because prices can rise for all sorts of reasons. Inflation/deflation is the money/credit supply in an economy multiplied by the speed at which money is spent in that economy, the velocity of money.

It should be obvious that prices for some items can still rise, certainly initially, when deflation sets in. Producers that see less sales can try to raise prices for their remaining buyers. Basic necessities will always be needed. Governments can raise taxes. Rising/falling prices tell us only part of the story, and with a considerable time delay.

Ergo: rising/falling prices are a lagging factor, and if you look at them only, you will have missed the point where deflation has set in. What follows, obviously, is that you can’t measure deflation by looking at consumer prices (CPI) or production prices (PPI) numbers. You’d be way behind the curve. CPI and PPI tell you something, but they don’t tell what causes falling or rising prices. And that is a valuable thing to know.

I see even John Mauldin in this week’s The Last Argument of Central Banks talk about ‘good deflation’, but that doesn’t exist any more than cookie inflation, sorry, John. Prices for some items may fall due to innovation etc. while an economy booms, but if you call that deflation, you’ll miss what’s really deflation when it arrives.

Deflation is always bad. It either occurs when money/credit is so short that people can not get their hands on it no matter how hard and productive they work, and how much demand there is for their products, or it occurs when people are too poor, too much in debt or too reluctant to part with what they have.

In a deflation, people spend only what they absolutely must, provided even that they can afford to, which leads to large swaths of an economy being liquidated. Falling prices lead to falling wages lead to ever further falling prices lead to factory closings lead to more people who can’t afford to spend which leads to closings which leads to less spending which leads to faling prices etc. This continues until the debt has been deleveraged. Governments will lose tax revenue and raise taxes, but soon enough they will in quick succession disband and be replaced, rinse and repeat until even essential services can no longer be provided.

Until recently, a shrinking money/credit supply was very clearly not in the cards. Central banks have gone absolutely nuts in their stimulus plans, and this has artificially kept price levels up somewhat, though far less than they, and scores of ‘experts’ had hoped and expected. Now that game, too, is up. Japan went crazier than ever the other day out of fear that falling oil prices would sink consumer spending even more, but the US Fed has cut QE. That is an admission it has failed to do what it officially was supposed to, not the sign of triumph it’s made out to be, as in ‘the economy is doing so well, it doesn’t need our support anymore’.

Central banks have spent like maniacs, and consumer spending only keeps falling. Just ask Japan. And while you’re at it, ask them how entrenched deflation can become even in an economy that still has the benefit of growing world market to sell its products in. We won’t have any such benefit. The world has stopped growing, and there’s no massaging of numbers left strong enough to hide it. Not that it won’t be tried. As I said earlier this week, we now live in a world built on debt and propaganda.

Since QE and other ‘plans’ never reached the real economy, most nations’ money supplies have also either fallen or at best remained stagnant. We have the perfect set-up for deflation, and we therefore have deflation. It hasn’t reached the US yet, though we should be careful with that because the numbers being reported are notoriously flaky. But it has reached Europe and Asia. Which means the US is only a matter of time. And people, reluctantly, start taking notice. Steve Hochberg and Pete Kendall penned the following for Bob Prechter’s Elliott Wave:

Deflation Rearing its Ugly Head in Subtle and Not-So-Subtle Ways Around the Globe

According to the latest figures, deflation is now perched on China’s doorstep. In September, China’s consumer price index was up 1.6%, but its producer price index fell 1.8%. The CPI increase was its lowest since 2010. [..] in September, demand for electric power, a “bellwether for China economic activity,” fell 8.4% from the prior month, the second straight monthly decline.

“Deflation is the real risk in China,” stated the chief economist at a Hong Kong bank. In Europe, deflation is no longer a possible risk; it’s reality. In September, eleven of fifteen European Union members experienced lower goods prices, and the latest quarter-over-quarter Eurozone growth in real GDP is zero.

With Alice-in-Wonderland naiveté, U.S. financial media place the United States outside the risk of global deflation. Headlines talk of “Mild Inflation” and insist that the U.S. will gain “From Good Deflation.” On October 14, Bloomberg reported that consumer spending is strong enough “to steer the U.S. economy safely through the shoals of deteriorating global growth and the turbulent financial markets.” In early September, we stated that it was only a matter of time before economic weakness and deflation (which will be anything but good) jump the Atlantic and Pacific oceans and arrive in the U.S.

According to the U.S. Labor Department, real wages for full-time employees averaged $790 a week in the third quarter, about $1 less than in the third quarter of 2007. “There’s been no net gain for workers since 1999.” In recent months, spending has been uneven. Retail sales fell 0.3% in September. Most economists are baffled: “one of the great mysteries is why the U.S. has lacked inflation despite all the money being pumped into the economy.” A study by the St. Louis Fed finds that the answer is “a dramatic increase in the private sector’s willingness to hoard money instead of spend it.”

Note: the ‘hoarding meme’ is habitually used by economists, re: Bernanke and his Chinese savings glut, to point out situations which are more often than not characterized by people being too poor to spend, not sitting on anything at all. For economists, if people don’t spend, it must be because they save, never because they’re poor. I kid you not.

For years now, the Fed along with most economists have anticipated the imminent return of inflation, but it continues stubbornly subdued. This long-term chart above of the CPI shows a succession of lower highs since the early 1980s, as inflation turned into disinflation, which is on the cusp of leading to outright deflation. Some argue that the CPI is rigged to show milder levels of inflation, but the bottom graph shows the same steady move toward the zero line in the Personal Consumption Expenditures Index, an alternate inflation measure favored by the U.S. Fed.

When outright deflation hits, recognition of it will play an important role. Once its presence becomes widely observed, investors and the debt markets will belatedly take defensive action. Eventually, notes Conquer the Crash, “default and fear of default exacerbate the trend as it causes creditors to reduce lending. A downward ‘spiral’ begins feeding on pessimism just as the previous boom fed on optimism.”

Moving from theory to practice, we end up with our old friend Ambrose. Though he confuses inflation and consumer prices, and thinks they’re one and the same thing, he does have useful numbers:

Spreading Deflation Across East Asia Threatens Fresh Debt Crisis

Deflation is becoming lodged in all the economic strongholds of East Asia. It is happening faster and going deeper than almost anybody expected just months ago, and is likely to find its way to Europe through currency warfare in short order. Factory gate prices are falling in China, Korea, Thailand, the Philippines, Taiwan and Singapore. Some 82% of the items in the producer price basket are deflating in China. The figures is 90% in Thailand, and 97% in Singapore.

These include machinery, telecommunications, and electrical equipment, as well as commodities. Chetan Ahya from Morgan Stanley says deflationary forces are “getting entrenched” across much of Asia. This risks a “rapid worsening of the debt dynamic” for a string of countries that allowed their debt ratios to reach record highs during the era of Fed largesse. Debt levels for the region as a whole (ex-Japan) have jumped from 147% to 207% of GDP in six years.

These countries face a Sisyphean Task. They are trying to deleverage, but the slowdown in nominal GDP caused by falling inflation is always one step ahead of them. “Debt to GDP has risen despite these efforts,” he said. If this sounds familiar, it should be. It is exactly what is happening in Italy, France, the Netherlands, and much of the eurozone. Data from Nomura show that the composite PPI index for the whole of emerging Asia – including India – turned negative in September.

China itself is now one shock away from a deflation trap. Chinese PPI has been negative for 32 months as the economy grapples with overcapacity in everything from steel, cement, glass, chemicals, and shipbuilding, to solar panels. It dropped to minus 2.2% in October. The sheer scale of over-investment is epic.

The country funnelled $5 trillion into new plant and fixed capital last year – as much as Europe and the US combined – even after the Communist Party vowed to clear away excess capacity in its Third Plenum reforms. Old habits die hard. Consumer prices are starting to track factory prices with a long delay. Headline inflation dropped to 1.6% in October. This is so far below the 3.5% target of the People’s Bank of China that it looks increasingly like a policy mistake. Core inflation is down to 1.4%.

China has flirted with deflation before: during its banking crisis in the late 1990s, and again during the West’s dotcom recession from 2001-2002. Both episodes proved manageable. This time the level of debt is greater by orders of magnitude, with a large chunk in trusts, wealth products, and other parts of the shadow banking nexus, and a further $1.2 trillion in “carry trade” loans from Hong Kong.

Standard Chartered thinks total debt has reached 250% of GDP. This is roughly $26 trillion, the same size as the US and Japanese commercial banking systems put together, and therefore a headache for us all. Larry Brainard from Trusted Sources says China is sliding towards a European debt-compound trap. “It’s arithmetic.Deflation will kill you if you’re leveraged. It is just a question of how quickly. We don’t know how big the problem is because China is playing a game of three-card Monte and moving the debt to different buckets,” he said.

Asia is not yet in a full-blown currency war, but no country can stand idly by as neighbours dump toxic deflationary waste on their front lawn. Korea has threatened to force down the won, pari passu with the yen. The central bank of Taiwan has been intervening. These skirmishes are happening in a region of festering grievances and territorial disputes, with no Nato-style security structure – or for that matter EU-style soft governance – to damp down fires.

[Chinese] purchases of foreign bonds have dropped to zero, down from $35bn a month at the start of the year. The yuan has appreciated 22% against the yen since June, and 50% since mid-2012. It is up 12% against the euro since the early summer. China is in effect strapped to the rocketing dollar through its quasi-peg, increasingly a torture machine.

George Magnus from UBS says this cannot continue. “What is happening in the property market is the tip of the iceberg for the whole economy. China will have to resort to monetary reflation over the winter, and I think this will include a lower yuan. We are heading into a currency war,” he said.

We have the debt. And we recognize it. Still, the line politics and media feed us is that more debt can be a good thing, that we need more debt in order to attain what they like to call ‘escape velocity’ from the financial crisis caused by that same debt. Oil on fire.

We have the propaganda. We don’t always recognize it for what it is, but the, that’s the idea, isn’t it? It’s to make people think that things are not really what they really are. That we need to spend more public funds on saving banks, not saving people, or else armageddon. There’s hardly a news story left today that is not to an extent phrased by propaganda.

And now we have deflation. Which is not the falling prices, though they are a – delayed – symptom. Still, other symptoms are as valid, as nobody is spending. Mass unemployment in southern Europe is a symptom. West Texas oil at $74 dollars today is one. The Chinese economy, allegedly still growing at $7.5%, but at 250% debt-to-GDP, is another. Throw in 207% debt-to-GDP debt levels across southeast Asia.

With deflation becoming a daily topic in our propagandistic media, despite the fact that governments and central banks are vehemently allergic to it (for good reasons), rest assured that we are entering a next phase of the crisis. Just not one that they would like you to think we are. When debt starts being deleveraged for real, deflation cannot be avoided. And debt must be deleveraged, we can’t sit on it till Kingdom Come and keep adding more while we’re at it. That was never in the cards. And we’ve accumulated too much of it to ever outgrow it. We simply can’t sell or make enough iPhones to accomplish that. Or eat enough burgers, hard as we try.

Our world, our life, has been built on debt and propaganda for many years. They have kept us from noticing how poorly we are doing. But now a third element has entered the foundation of our societies, and it’s set to eat away at everything that has – barely – kept the entire edifice from crumbling apart. Deflation.

It’s time to check where your basic needs will come from when it becomes first harder and them impossible to obtain them from the sources you have been used to. And please, get out of debt. Debt during deflation is a cruel and unforgiving mistress. Think of deflation as a biblical plague.

Home Forums Debt, Propaganda And Now Deflation

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    Dorothea Lange Negro woman who has never been out of Mississippi July 1936 Looks I have to return to the deflation topic. I’m a bit hesitant about it,
    [See the full post at: Debt, Propaganda And Now Deflation]


    You had it right first. Now it’s all over, as you predicted. It’s just creeping in slowly like the Blob. But they don’t really believe it, or they think they can ward it off with garlic or something. In the USA I get the feeling it’s something they think happens to other people but not to us. I find it hard to understand how we are supposed to keep standing when everyone else falls down? On the other hand I don’t think it’s getting here tomorrow. The holiday buying season should be interesting!


    At the risk of getting all religious, I’ll just repost this from my comment on the day’s debt rattle articles. Really, the Fed hasn’t begun to fight.


    Ah, the holiday buying season. I wonder, will PM’s be included in drastically discounted Black Friday sales, or mightn’t it be better to wait until the new year for deeper discounted bargains?


    Ok so here is how i think it will go down.

    The U.S. will probably raise rates in the 1st quarter to give some juice to the banks….it will however set off a massive global financial crisis (part 2 lets say)….the fed will the go back to ZIRP and resume QE (QE4) and they will again try and kick the can down the road…im 50/50 on whether they will be successful this time.

    Illari, what do you think?


    Btw Illargi,

    I urge you to check out this talk give by Dr. Seyyed Hossein Nasr, given in the 90s, called The Misgivings of Progress and it’s Impact on our Environment.

    Hes probably one of the greatest muslim thinkers in the West, and this talk really is profound.


    The stock market is the mirror through which most everyone sees the economy. Although virtually nobody consciously understands rising share prices as inflation, it’s always increased ‘value’ and on some subconscious level rising share prices equate with those cousins of inflation growth and confidence. Bernanke made no secret he intended rising stock prices and the reason he wanted that, to boost confidence. It’s all one big mixed up mash up of illusions.

    It’s a shame in a way the Great Depression was foretold by the stock market crash. For that lead people to think falling stocks caused the deflation, ie. the Great Depression, Bernanke included to some extent and so he built his career on the idea. The stock market crash was coincident with the great deflation not the cause of it. However belief is a very strong thing so nobody in American will believe in real serious long term deflation until stocks deflate. Which is why I perhaps wrongly think QE infinity is just around the corner.

    Fed head Dudley I think it was called the October stock market bottom to the second with his suggestion that QE should perhaps not end that month. The most effective use of Fed words that I can recall in recent times. The October swoon had no underlying justification on a liquidity basis so the snap back has been historic. Along with help from Uncle Abe’s boys at the BOJ. A hint the size of a 500 pound weight dropping on the Yellen’s Fed’s head. How can they not take the hint? In the mash up of illusions the first and last one is if stocks don’t fall deflation won’t ensue and the system will live another day. How can they resist.


    Retail is way down year over year, so we can expect glowing reports for the season to be revised ever downwards. New construction all around t-town, but only about a third of what was headlined. Continual short falls in Tulsa proper budget, like the holes in all the existing retail strips, hard to pull back previous infrastructure spending poorly spent.



    My father always said the stock market crash was when the wealthy found out the Depression was already here for the rest of us. I recently read that Ford and GM bought up thousands of used cars in 1926 and scrapped them as there was a perceived glut of used cars affecting new car sales. Kinda sounds like “Cash for Clunkers”, doesn’t it. Also, the years 1924 to 1930 saw massive money and infrastructure exit from the car manufacturing arena. Perhaps a hint of what was to come?

    Dr. Diablo

    Thank you for a great, straightforward, cogent article.

    In rough terms, “inflation”, or what they call “expansion” under a debt/money model, is simply an increase in the number of promises in circulation. Debt means you promise to deliver something in the future. More debt=more promises.

    Deflation, or lack or expansion/actual contraction means the number of promises starts to decline. That’s deleveraging. So…problem? Why not just let them decline? Well, if the number of promises declines, collateral is removed from the system, collateral that backs some multiple of other promises. So those promises disappear. In addition to promises disappearing by being paid–what Abe and Benanke don’t want to allow citizens to do–eventually you have someone who simply defaults and doesn’t pay at all. Then their $200k house, or whatever the collateral is, gets marked to it’s forclosure price, $80k. The $120k loss of collateral value is then multiplied by 30:1 leverage for a theoretical $3,600,000 loss.

    This default on promises leads to the next guy owed to default on HIS promises until the number of promises declines to a more realistic level, generally way, way down from the peak. Historically 90% down as measured by most stock declines.

    Again, all the “money” is the system is debt, or promises. Which from the state of the energy production, infrastructure, and manufacturing, can NEVER be fulfilled. Or, as Greenspan admitted in 2005, “we may have already committed more fiscal resources to the baby boom generation in its retirement years than our economy has the capacity to deliver,”
    Conclusion: the promises, this DEBT, can and will not be paid. And because the problem is debt, it cannot be cured by debt, whether deficit spending, “bailouts” (which are usually loans and/or extensions, as per Greece) or otherwise. Because our money IS debt, unbacked fiat worldwide, it cannot be inflated away–or at least under the current system. Nations COULD create a system of firing the central banks, taking over the presses and printing national (not debt-backed) currencies and handing them directly to workers as Wiemar did, but the present system isn’t built that way, and there’s been no movement to change that. That means the level of promises will contract through default, which is “Deflation.” Money supply = Debt supply, and both contract in unison.

    There is one other option: the system is failing because most collateral is already been financialized and levered into the system. That’s why there’s a world-wide scramble for anything that might be secure collateral. And in a Deflation, “real goods”, that is, raw materials, markets, factories may not retain value, as consumption–therefore demand and sales–are slashed. Prices of iron, copper, oil, malls, may already indicate this. So fleeing into hard assets is a mixed bag.

    BUT–if the system wished to–and it may not wish to–it COULD decide that gold, a completely useless object for which there is no end consumption, would be worth multiples of the present price. With its value arbitrarily decided higher by the nations/banks who can find no other imaginary collateral with which to back existing leverage (thus having no other choice to save themselves) then the system is re-collateralized.

    How high? History has been through this many times before. 10-20% of the system backed by “real” collateral will do–even as the price of that “real” collateral is totally “un-real”-ly and “arbitrarily” re-set to a number also detached from reality (as per mining costs, for example). I don’t claim to understand it, but historically that’s what humans do. They need collateral, and it’s not like they can just decide OIL will be $3,000/bbl, or wheat is $100/bu, or houses, or 16′ sailboats, or winter hats. They either don’t serve, or would completely dis-order the economy of trade and commerce for real goods. So they choose collateral that no one “uses” or “consumes” and therefore the change in price doesn’t lead to mass deprivation. Then the “price” of the currencies all adjust to compensate, and it’s rough but not fatal. In a messy way, that’s what Roosevelt did by confiscating and repricing gold. Price inflation in the U.S. started the day after. –But then he did wipe out mountains of banks and their liabilities at the same time. Gold is, or has historically been the contact point, the doorway, between imaginary “financial” reality of human promises and the world of real goods. Time and again that door is bolted shut by different powers, only to be forced open again to serve its purpose of re-establishing balance between financial and economic reality.

    So the debt problem can be re-set several ways. As we hear, the BRICS would like to re-value gold and carry on with having real ecoomies, real trade, and real human progress. The U.S., not so much. But then, since when has any nation or power center ever VOLUNTARILY re-set their economy to give up power? And yet it happens. Over and over again.

    I guess we’ll see.


    Eventually I agree that we will have deflation and then eventually I agree that gold will be a good investment. But the first must happen before the latter. Why? Because during the deflation people will be forced to sell anything and everything they have in order to try and pay their debts and or survive. That means that gold will decline right along with every other commodity as everyone will be trying to sell it for USD (can’t buy a loaf of bread w/ gold – at least not in the US). Now once the deflation ends and inflation begins in earnest then that is when you buy hard assets (including gold) with the dollars you’ve been saving.

    My problem is that this is taking way longer than I ever thought possible. It’s why I rarely visit TAE anymore because the message hasn’t changed for 10 years while very little has happened, at least here in the US. Through my reading here and elsewhere I got out of the markets before 2008 but because I thought the whole thing was going down I didn’t get back in and missed out on doubling my money. Also, my wife told me to buy TSLA at $75 but I thought, that’s already overvalued for a company that doesn’t turn a profit. Look at where that got me. So next time there’s a “correction”, as soon as they announce QE4 I’m going all-in in the stock market. Some may call it picking up nickels in front on a steamroller but that steamroller is moving damned slowly and there are huge piles of cash laying on the road.


    I say let deflation ring. At least all the underemployed youth who own no homes or stocks will have cheaper homes, cars, and gas to buy.

    John Day

    @ Dr Diablo,
    I nominate (again) Depleted Uranium as the new uber-collateral.
    Make it worth 50 times what gold is (whatever that might become).
    The biggest financial powers already have plenty of it, so they wouldn’t have to fight this plan.
    It’s pretty nasty in it’s current default role of a tank-busting munition, which burns on impact, creating uranium oxide, which is water soluble, gets into the food chain, and causes deformed babies and cancer for thousands of years in Iraq, or Gaza, or Afghanistan…
    It’s rare enough, readily identifiable, costs a whole lot to make, and there is ultimately a limited supply. It lasts forever, too.

    John Day

    Oh, all-y’all, look at 2 things in that Dorothea Lange photograph of the woman who never left Mississippi.
    First, she has a truly beautiful look upon her face.
    Secondly, she is holding her withered left hand in her strong right hand.
    I suspect she had a left brachial plexus injury at birth, caused from pulling hard and down to the right, on her head, to get her left shoulder out from under her mother’s pubic bone.
    This injury used to be more common.


    John, I have a second photo of her coming up.

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