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“All the perplexities, confusion and distress in America arise, not from defects in their Constitution or Confederation, not from want of honor or virtue, so much as from the downright ignorance of the nature of coin, credit and circulation.”
John Adams

Commentary & Analysis
Once again: It is a deflation problem!

I have continued to watch with amazement that number of people who believe we have an inflation problem. I think it was either Mark Faber or Nassim Taleb, two people who do a lot of talking and throw a lot of stuff on the wall just in case something sticks, told us there was a “100 percent” guaranteeing inflation would spiral out of control, based on the money the Fed was “creating.”

Taleb loaded up on long-term bond puts based on his view, he told us; you can figure out how well that trade is working (may help explain why he hasn’t hugged every camera in sight lately).

Mark said he was buying gold, and nailed that trade long before many others to his credit, and has done well, so who cares his inflation guarantee has gone awry. As traders say, and I say it every day, “I’d rather be lucky than good.”

In other words, I’d rather make money for the wrong reasons, than lose money for the right ones.

This inflation concern still seems to be in the minds of many, evidenced by the email I received yesterday from a nice gentleman, asking me this question:

Economic central planners – whether here or abroad – are obviously control freaks and I would think they would reflexively turn to wage/price controls should inflation start to get out of hand. Do you think they will turn to that “solution”?

My first answer is: those “control freaks” wish rising payrolls were a problem. Bernanke is doing all he can, trying to get a little inflation into the economy. After all, isn’t he the great sage who knew exactly why we entered the Great Depression? And wasn’t he the great seer who criticized Japanese authorities for miring them into a 30-year deflationary box, saying with confidence that of course the Fed has the tools to create inflation at any time? [Note: The answer is yes to both of those questions above.]

Okay, inflation versus deflation question and answer time boys and girls … so simple even a government official could understand [assuming your first name isn’t Joe and you aren’t the Vice President of the USA] …

  1. Is a rise in commodity prices inflationary? Answer: We need more information! Why do we need more information? Because rising commodities prices in the right context can be deflationary?
  2. Rising commodities prices could be the result of a simple decline in the supply of commodities. Remember this great equation from the past that of course policymakers still attempt to refute everyday through their central planning…

    The crossover point of supply and demand equals price [in a perfectly theoretical world of pure competition].

    Thus, if demand stays the same, and supply falls, then prices rise.

  3. Now let us add in a little more information, and try to keep this simple …
  4. Say you are Mr. US Consumer–one of those “angry white male Tea Party types,” according to Legend in Her Own Mind Meredith Whitney; or one of those “Tea Party terrorists”, according to Fumble and Bumble and Plagiarizing V.P. Joe Biden.

    [It’s funny how a group of people whose intentions is to get their country back on the right track are treated by our so-called “elites.” What more do we need to know!]

    And so, you Mr. US Consumer, the one not employed by the Federal government, or some rich hedge fund guy, look at your balance sheet and income statement, i.e. your payroll check. You notice your biggest asset, your real collateral known as your house, is in the dumps still. You notice your employer (assuming you have one), is also struggling in this recession (assuming Steve Jobs isn’t your employer), and he’s not doling out raises and has decided no bonus this year. Then you see the prices of real stuff rising–food, gas, gold, copper wire, etc.–the kind of stuff you need and use for example to fill your car with gas to get to work; heat your home when it gets cold, feed your family when they get hungry, and need air conditioning repair thanks to Al Gore-lioni-type heat waves.

    So what happens now is why rising prices of goods is not in and of itself inflationary.

    Mr. Consumer must shift more of his available income to purchase the stuff he really needs, and by the magic of math, reduces the amount spent on other stuff that he needs less (some call it discretionary spending, but easy for them to say, I know). The point being: the amount of money in the system has not increased to bid up the prices of goods, it has only been redirected to purchase the same goods, but at higher prices.

    Thus, this cannot be inflationary.

    Now, if we add on another layer here, to add to the complexity, we look at how people are reacting now … since the credit crunch. And we see that those that have available income, are saving more of it for the simple reason they need to rebuild their balance sheets, to a lesser degree of course, and are scared of what they see happening in the economy.

    Thus, on a relative basis, their spending has fallen too.

    So, just because the price of commodities has risen, no matter how much Uncle Ben and his “esteemed” colleagues threw onto the banking system (the way money is distributed in an advanced economy), consumers aren’t demanding money and credit. And this is why Uncle Ben was so wrong when he said he could create inflation. And he is eerily wrong when you consider this is almost the exact path the Japanese economy has paved.

  5. We can then layer on the fact that the huge debt overhang created by our government, by spending our money, is also deflationary. We can add on to this fact that austerity measures now biting down across the whole of Europe are also deflationary. We can add to that the fact that China is now using its fire extinguisher, not its flame thrower, and the fall in growth there will also be deflationary.
  6. And let us not forget the powerful deflationary feedback loop from a decline in the stock market. Stocks do represent a lot of things, but at the core they are a reservoir of collateral values for the real economy. Therefore, a falling stock market destroys main street’s collateral values, which we know are already badly impaired from the credit crunch.
  7. We could layer in more economic mumbo-jumbo like velocity of money, disruption in the interbank lending markets globally, etc. But we don’t need to complicate this stuff anymore than it is.

And guess what? A major deflationary cycle is exactly what the world needs in order to rebalance and clean away all those debts and, as our Austrian School friends say, malinvestment. This stuff needs to be deleveraged and that is what Mr. Market is doing despite the continued hampering by our illustrious governments.

So, I think now you can see that Mr. Bernanke’s prior claims that he has the tools to deal with this rising global deflation represented the height of arrogance. But sadly I guess we can expect nothing less from our elites.