Some comments on Deflation/Inflation. And some stuff…
I agree with Dave Lewis on this, It is the experience of inflation following the first leak in the flow of funds that leads people to shift funds out of the banks and into hard assets. That is, just as night follows day, the oil rally of 2004 will begat the inflation of 2005 and the eventual rally in Gold... Now that the monetary authorities have lost control of the flow of funds, something noted recently by Martin Wolf of the FT; The US is now on the comfortable path to ruin. It is being driven along a road of ever rising deficits and debt, both external and fiscal, that risk destroying the country's credit and the global role of its currency, the writing is on the wall. BUT, the rally in OIL may last longer than Lewis thinks, causing Inflation to start later than he thinks. My basic premise seems to be the same as his in that I consider high OIL and low GOLD to be Deflationary and, until the cycle turns, i.e. when OIL is close to topping and GOLD is close to bottoming, we're in a Deflationary environment.
So, I agree with Puplova on the issue of Deflation. And on where we're going, and when...
From Jim Puplava 03.01.2004 Collision Course The Perfect Financial Storm In the world of finance (besides guessing where the stock market will end up this year), a topic that dominates front page news is the issue of inflation or deflation. The financial world is divided over this issue with the deflationist dominating the debate. The Deflation Argument The deflationists cite the historical levels of debt overhanging the economy and the enormous asset bubbles in stocks, bonds, mortgages and real estate. In a levered economy and financial market any increase in interest rates would cause the whole debt bubble to implode. This would lead to a deflationary spiral as debts are liquidated contracting the supply of money. In an economy and financial world, this leveraged rise in interest rates would devastate the financial markets and the economy leading us back into a recession. Rising interest rates would also usher in the next leg of the secular bear market which has yet to begin. Collapsing asset prices, debt defaults, and bankruptcies would surely contract the money supply and this would be deflationary. Another argument made on the deflationary side of the debate is the world is awash in excess capacity. Global competition is keeping a lid on prices, so therefore we live in an environment whereby prices continue to decline. Here again the same mistake regarding prices as a symptom rather than a root cause obscures the deflation debate as it does the debate over inflation. Defining Deflation I refer to Webster’s definition of deflation: a lessening of the amount of money in circulation, resulting in a relatively sharp and sudden rise in its value and a fall in prices. As mentioned in a previous essay, inflation and deflation are both sides of the same coin. They are both a monetary phenomenon. A rise or fall in price is more of a symptom than it is a cause. Once again we have confusion here regarding monetary terms with deflation usually thought to be synonymous with falling prices. Historical evidence points to falling prices as a consequence of productivity and economic progress that result from increasing production and the supply of goods and services which lead to lower prices... What Brings Deflation? What brings about deflation is a contraction in the money supply. This reduction in the amount of money in circulation or the volume of spending in the economic system causes prices to fall. With less money circulating within the economy there is less money that can be earned, and thus there is less money available for the repayment of debt. This leads to monetary contraction and is the only real form of deflation that exists... Deflationary Storm Front Closing In Within the next 12-18 months I fully expect a deflationary storm front to hit the financial system and the economy. The debt overhang will begin to implode with rising interest rates causing financial asset prices and real estate prices to fall. This will be deflationary. What the Fed and the government will do to counteract this deflationary storm front will be to expand the supply of money and credit within the system and the amount of money spent within the economy. This will bring about inflationary forces that will counteract the prevailing deflationary headwinds of a collapsing financial system... Seven Headwinds of Inflation... financialsense.com
And, I agree with the basic premise of this article on the relationship of Inflation and high OIL prices...
inflation and oil prices Introduction How strong is the relationship between changes in crude oil prices and inflation? In theory the causal relationship is fairly clear. An increase in oil prices such as that seen in the second half of 2000 causes an inward shift in short run aggregate supply and puts upward pressure on the price level – in other words a sharp jump in the price of crude oil causes an exogenous inflationary shock and the impact will be greatest when a country is (a) a large-scale importer of oil and (b) has many industries that use oil as an essential input in the production process. Research suggests that a $3-4 rise in oil prices can be expected to add directly about 0.1% to UK consumer price inflation after about two years. This is not in itself a major contributor to higher prices. Of greater impact are the knock-on effects of increased costs through the supply-chain. The second-round effects on inflation are more complicated, as businesses pass through higher costs. Analysis from economists at the Bank of England has estimated that a $1 rise in oil adds a further 0.1% to inflation after two years (including the petrol effect). A doubling in oil prices would have many other inflationary effects: increasing the cost of heating oil and aviation fuel, plastics, chemicals, as well as raising the material costs of all firms (which would likely be passed onto consumers). But other factors might help to limit the inflationary impact of this exogenous shock. Consider the impact of higher oil prices on aggregate demand. Firstly, an increase in inflation acts to reduce the growth of real incomes putting downward pressure on consumer demand (the main component of AD). Higher inputs costs will also squeeze company profit margins which together with a slower growth of demand will lead to cutbacks in planned investment spending. The monetary policy authorities might respond to rising oil prices by increasing short-term interest rates which acts to dampen down spending. A rise in interest rates is by no means automatic, because the Bank of England for example takes a full range of inflation indicators into account when setting interest rates. But if policy is tightened, we would expect to see slower economic growth, a possible rise in unemployment and a diminution in the ability of workers to ask for pay increases that keep pace with inflation. Deflationary policies designed to control cost-push inflation will have the effect of reducing real national output below potential (creating a negative output gap). Indeed if a slowdown becomes a recession, then the demand for oil will decline putting downward pressure on international oil prices... tutor2u.net
And, this piece on Deflation, Rising Prices, GOLD & OIL seems to make a lot of sense relative to debt...
Deflation and Rising Prices? Memo To: Martin Wolf, Financial Times From: Jude Wanniski Re: Gold and Oil March 7, 2001 I'm delighted to have your question about how we could be experiencing deflation when price indices are still rising. You are easily my favorite economic commentator at the Financial Times or Economist, the two publications I regularly see from England. The deflation began in December 1996 when the demand for liquidity began to increase as a result of the anticipation of supply-side tax cuts in 1997, which did take place that summer. Gold was at $385 when the deflationary process began. In our classical framework, inflation begins with a rise in the price of gold and deflation begins with a decline in the price. There is no such thing as "disinflation," the term modern Keynesians have developed to account for a mixture of prices falling in one area and still rising in another. A balloon inflates, as the influential British economist A.C. Pigou advised early last century, or it deflates. That's it. We are most definitely in a monetary deflation, although prices are higher for the moment because of the disturbances in oil caused by that deflation. Bear with me: We have been experiencing deflationary polices that could be felt in early 1997, when gold was at $360. If we would have been on a gold standard, the Fed automatically would have had to increase liquidity to prevent gold from falling in price. I'd urged U.S. Federal Reserve Chairman Greenspan, whom I have known since 1973, in December 1996 that this was going on and that he had best begin talking about it to educate the political class so there could be a change in the Fed's monetary target. When he did not do so, I asked for a meeting with the President to warn him of what was ahead. The White House instead had Deputy Treasury Secretary Larry Summers call me. I met with him in April 1997, but while he treated me with respect, said he could not buy my gold argument. I'd told him we could expect a decline in the oil price, then farm prices, just as we had been warned in January 1972 by the 1999 Nobel Prize Winner Professor Robert Mundell to expect a rise in oil prices and other commodities. You know what happened...I took it upon myself to reckon that the optimum price would be exactly at the center of gravity between debtors and creditors. As that center changes all the time, I now believe it may be as low as $300 and as high as $325. Mundell told me yesterday he would like to see the dollar/euro rate fixed at a parity of 100, which would mean the price of gold would have to rise by 10%, to $300. If you agree, we can help change the history of the world, for the better. Mundell, who helped inspire the revolution in monetary thinking that brought about the fixed-exchange rate system in euroland told my client conference in Florida Sunday that it is insane to advocate a floating currency or flexible currency in this world...
wanniski.com
Some other stuff at Cheers marketswing.com which will resume regularly scheduled programming when my schedule permits…
IMHO, the FED tried to reflate, and failed. OIL is the wild card, and dictates the current trends. The Bear case is based on Deflation. And the extent and impact of whatever Deflationary forces are in play are unknown. I read an article many moons ago about how Deflation in the US could be managed in about 18-months to wring out all the excesses in the system rather than follow the path of Japan's multi-decade fiasco. IF so, with a lot of pain in a relatively very short period of time, the cycle could be over -- meaning a top in OIL and a bottom in GOLD -- in-line with the 4-year cycle-lows around October 2006. And then we get to play the game all over again as it may in fact take several such cycles of rinse, lather, and repeat to truly make the turn...
Anyway, a VERY Bullish read on OIL. IF correct, the party's only just begun...
Norm
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