Hyper-inflation vs. Deflation - A Struggle for the soul of the Misesian people

Economics Economics Questions
1

My question is a very simple one: which camp of the Austrian Economics is right: Hyper-inflationistas or deflationistas? Or are we entering a deflation anyway because even the most wide money aggregates slowed their growth rates drastically. I believe that most of the people here are familiar with this debate, so I make only a very brief summary on the subject.

The debate is very much about the best money supply aggregate. The hyper-inflationista camp includes such people as Peter Schiff and Stefan Karlsson. They believe that the most broad money supply figures (MZM or M3) reflect reality and we are in fact in a stagflation. The deflationist camp believes that narrower money aggregates are correct and that the US economy is in a Japanese style deflation. Members of this camp include Frank Shostak and Gary North. Most of them seem to think that the FED is incapable to increase money supply because banks go bust or are unwilling to lend any money. Some deflationistas like Gary North claim that deflation is intentional and that the FED changes federal funds rate only to reflect changes in T-Bill interest rates. I heard Robert Prechter making this same claim some months ago.

The most widely read deflationista is of course Mike Shedlock. He writes very much and he writes well too. But here is my problem with this guy: he seems to change his theories too easily. About a year ago he was very enthusiastic about his finding that the real growth rate of M Prime (M1+sweeps) goes negative almost always before a recession. But recently he wanted to show that real interest rates are actually quite high, so he came to the conclusion that the inflation rate is only 1.3 %, because he substracted changes in Case-Shiller index from the CPI. If the CPI really needs that huge revisions, then that demolishes his first finding, because it rests on the assumption that the official CPI number is roughly correct.

The whole debate may seem a little trivial, but this has huge implications on your investment strategy: Peter Schiff and Stefan Karlsson are very bullish on commodities, but Gary North and Mike Shedlock prefer long-term government bonds. North and Shedlock are bearish on commodities, but Shedlock seems to think that gold could increase its value in deflation.

What is your take on this debate, fellow Misesians? I am no economist, but still interested in this subject.

2

If Fannie and Freddie get bailed out, it will be hyperinflation.

3

Bob Hoye is another person who doesn’t think the Fed/Treasury can really do anything to avert the coming deflation. You can hear his argument here (it’s part 2 of the Inflation vs Deflation debate. The first part is also pretty good, it includes James Turk and Mish Shedlock). I think the deflation argument is particularly strong currently. I’d consider myself part of the deflation camp for the time being, but I do think the end game is hyperinflation. We’ve been on an inflation/credit binge for over 30 years, and derivatives and leverage are enormous–I don’t see how it’s possible not to have deflation when these things unwind. And the signs are pretty clear that they’re finally unwinding. At the same time, the government is so much in debt, I don’t see how the end game of our empire and fiat regime, like all empires and fiat regimes, can be anything but hyperinflation.

4

I take it you aren’t holding any dollars then? After all, you would have to be a fool to still have dollars if you are certain they will become worthless in the near future.

5

Was there supposed to be some point in that?

6

Yes. If you are very confident that the U.S. will soon experience hyper-inflation, your actions should reflect this belief. If they don’t, I would question your confidence in that belief.

7

Ah, so you didn’t have a point. Very good then.

8

Hi Aragon,

I have been very interested in this question as well. As far as I understand it, much of the credit contraction–>lower commodity prices–>lower gold price argument relies on the assumption that the trusted position of the dollar as reserve currency will not change. Another assumption is that a

I have no problem with the argument that the Fed will not be able to ‘push on the string’ and inflate us out of a serious bust before it has played out a good bit more. If we were in an completely isolated market then this might well result in prices for everything going down, (but even this suggestion is one which relies too greatly on aggregation, something that Austrians frequently give Mainstream economists a hard time for doing) after all if people are not borrowing, and reserves are getting wiped out, the multiplier effect can’t kick in. But the Fed and Treasury can make problems simply by TRYING to liquefy the economy: consider the effect all this bailing out has on foreign perceptions of the strength of the dollar. If the bail out of Fannie and Freddie increases the Debt by several Trillion dollars do you think foreign governments will still in the stellar strength of the dollar to back up the value of their respective currencies?

The most devastating thing, arguably, for the value of the dollar is if Americans begin to spend less on foreign goods and services. When foreigners receive dollars they find their way eventually into the hands of the respective country’s central bankers, who usually purchase US treasuries with them. With fewer new dollars going abroad, there will be less demand for US treasuries and the Federal government will not stop spending or borrowing so they will have to look elsewhere for financing. As they seek to borrow domestically there will be upward pressure on interest rates and downward pressure on the dollar. Should foreigners take the next step and diversify out of the dollar, even a little bit, the situation will get even worse. Additionally as a recession deepens here at home, US government tax receipts will shrivel quickly, this will put further pressure on the

This is really not a question of what will happen to the current money/credit supply (no matter measurement is used) but of what actions the government is likely take in the future, and what effect these actions will have on foreign trust and confidence in the usefulness of the US dollar as the one and only, good as gold, reserve currency. Based just on the bailout actions of the past year I think it is safe to say that this high time preference government of ours will burn down the dollar barn long before it stops spending on guns and butter.

This is just how I have been able to make some sense of the whole situation for myself, but I could be very wrong. I would be very interested to hear some more takes on this issue. About 10 months ago I wrote to Dr. Shostak asking him some similar questions on this issue, (I have always found his daily articles some of the clearest explanations of complex issues related to booms, busts and the real pool of savings), I was disheartened not to get a reply but I didn’t want to intrude so I didn’t send it again.

Ethan

PS In addition to my reading at Mises.org much of the credit for the above explanation goes to Jim Sinclair over at jsmineset.com. I have read his board pretty closely for the past few years, and much of the above analysis closely follows the arguments Mr. Sinclair makes.

9

I am putting all my money in bullionvault.com so it better be inflation.

10

I don’t pay attention to doomsayers that don’t put their money where their mouth is.

Thanks for the link. That website looks very interesting.

11

I think those betting on deflation are underestimating the incompetence of the fed and congress. I am willing to bet there is no limit on the amount of bailing out they will do.

12

And so you still didn’t have a point.

13

It seems to me Murphy and Callahan are also inflationists.

14

My impression is that Reisman is also among the deflationists. I don’t entirely understand this view, but it strikes me as very optimistic. Deflation (understood as falling prices) is the best thing that could happen amidst a dramatic downturn. Murray wrote that falling prices was the best thing about the Great Depression.

15

Call me a rebel but I doubt we’ll have either. Essentially, the government will print enough money to have inflation, but not the hyperinflation necessary to make commodities profitable investments.

My guess is that we’ll see a gold and silver comeback some time soon, due to a temporarily better economy, but then the prices will crash again when we enter a recession.

16

It could have gone either way, right up until Freddie and Fannie were “re”-nationalized. If they get bailed out, it will be gasoline on the fire. I don’t see any other possibility should there be a bailout–especially a complete bailout.

17

It seems to me that both sides have a pretty good chance of seeing their predictions come true.

If they manage to come out of this current crisis basically intact it will be at the expense of massive inflation to fund all the bailouts.

If they fail and the banking sector goes titsup then the only ‘money’ left will be what is on account at the Fed and the hard currency floating around.

I guess if you think they can pull out of the tailspin in time plan for inflation or else plan for deflation.

Personally, I have given up on the banks and just carry around a big wad of cash while also thinking about how to convert this cash into something more tangible before it becomes too devalued. But, then again, my wad is pretty modest in the Grand Scheme of Things™ and chances are pretty high I’ll just go blow it in Mexico…again.

18

There is an old saying. Individuals are destined by their choices, but systems are destined by circumstance. In this case you have a central banking system, and everybody in that system gets paid and compensated if and only if the amount of credit in circulation is expanding. In addition, you have zillions of dollars worth of misallocated capital that has been loaned out. If they don’t cover those bad loans with new bad ones (or govt money), every financial institution in the USA will go under in a matter of months. Global currency markets trade over 2 trillion per day … once the monetary heroin is taken away, the pain will be shocking and almost instaninous. Therefore they won’t do it. Finally, there is the Federal Government. I do not see one person at any level of government anywhere, (well xcept Ron Paul) talking about reducing spending. They simply can’t. Just as the bankers can’t drop the monetary heroin, the US govt can’t drop the government bonds heroin. Even the concept of going without seems shocking and foriegn to them. Just listen to Obama and McCain and all the other members of congress. They can’t even comprehend reducing spending, no less do it. They just can’t, and they won’t. Finally we have “Helecopter” Ben in there. This guy specializes in one thing and one thing only … finding “creative” ways to expand the amount of money in circulation. Also, there are countries all over the planet with trillions of dollar based reserves in their central banks … they are eger to get rid of them, and eventually it will be a mad dash to the exits. They are destined by circumstance too, and the bottom line is that sooner or later they will dump that money to save their own asses.

In sum, we will not only have hyperinflation. But when the dam gives way …it will GIVE WAY. With 500 Trillion in derivatives out there that need to be covered, foriegn reserves out there everywhere, mis allocated capital everywhere, bankers and government bureauocrats unable to stop - it will likely make the german hyperinflation look slugish once it hits the global electronic marketplace. It will happen in a matter of weeks, not years. You could literally wake up one morning and find every bank closed, and every store, gas station, etc … charging 1000% markup - cash only.

Edit: Don’t let anyone fool you. Hyper-inflation is the only option. The more they talk about deflation … the more they will be trying to justify hyper-inflation. There is no other option. It’s inflate or die!

19

“When the facts change, I change my mind. What do you do, sir” - Sir John Maynard Keynes

Thanks to everyone for their fruitful comments.

After reading your comments, I realised that this debate is actually about three different things. I think that two first ones are more easy to debate than the last one:

  1. What a hell has been going on this year? Are we currently already in a deflation? Oil and other commodities crashed. House prices are falling. Equity market stagnated and almost all money supply aggregates favored by deflationistas have stagnated also during last months. But how are we simultaneously facing the largest price inflation since the early 1990s? Is this just a time lag or does the CPI overestimate real life inflation? Or is this deflation theory simply wrong at least in this particular issue? Anyway in the 1970s stock indexes remained stagnated while the CPI tripled.

  2. What is the most relevant money aggregate? Now we have quite unique situation when the most used money aggregates are goint to different directions (YOY M1 stagnating, YOY MZM soaring).

  3. What is the future outcome of all this chaos? This one is the most difficult to know, and here we have very little actual knowledge, but mostly more or less wild guesses, and that makes this issue a very difficult one to debate.

I got first interested on this issue because this inflation/deflation debate is really sexy especially in the Austrian oriented investment circles. There is hardly a day when Bill Bonner, Adrian Ash or someone else doesn’t write on this subject. The variety of opinions about this issue is simply amazing. I have a really strong feeling that this ongoing crisis can be a watershed (or “The Holy Grail”, like Ben Bernake described the Great Depression) event for the whole Austrian movement, when we find out whose positions were right and whose wrong. Already some more “revisionist” Austrians like Mark Skousen have been moving towards the mainstream, and I was almost saddened when he cheered bailing out banks (in his Forecasts & Strategies newsletter) etc. and became almost bullish on stocks (maybe he took Jeremy Siegel too seriously). On the other hand, some mainstream economists have been showing Austrian leanings in their writings.

I am more in the inflationist camp, but everyone should keep their minds open for new ideas. Even inflationista Stefan Karlsson said that “If the facts change, then I would have no problem changing my outlook”. I still don’t hold my breath hearing Peter Schiff or Gary North changing their opinions about this issue[:)]

20

Skousen, though a good economist, cannot seem to stick to one position and defend it. If anything. I’d attribute this to a weak will. In his book, Vienna & Chicago I did not see a single debate going to Chicago - where he was informed on the topic, he gave the victory to the Austrians. Only on methodology did he declare a Chicagoan victory - and, in this section, I can argue that his understanding of Mises’s methodology is terrible, so it is an undeserved victory. Why he isn’t fully Austrian baffles me. Perhaps because it isn’t hip…

-Jon