Reply from Heinz:
i've actually debated the issue with Steve Saville himself a few months ago.
i think he's right that Mr. Mauldin's PREMISE is wrong. recessions do NOT automatically imply deflation. they only do so in a deflationary era, or the downgrade (winter) of the K-cycle.
i think Steve's mistakes are
1. the assumption that central banks not only CAN, but also WILL, inflate at all cost.
this i believe does not take into account that no modern day CB will risk a complete failure of its currency. during the time when countless countermeasures against deflation will be tried, deflation will have time and opportunity to develop. now i agree that in the modern era, this does not necessarily mean classical inflation in terms of an actually shrinking money supply (although it might - we'll see). but if the CBs money floats about in the money market unused, and velocity continues to plunge, declines in the aggregate goods price level WILL emanate eventually, although they will probably be mild.
2. the second mistake is imo his belief that because consumer and corporate debt have risen for several decades, they will NEVER shrink. it is an essential point that money creation in the fiat system is closely linked with debt creation. you can lead the horse to water, but you can't make him drink. and my opinion is that we WILL eventually see large debt defaults, and a general tendency to pay down debt by those who do not default, coupled with a sharply rising savings rate. i find it almost impossible to conceive of the private sector debt bubble growing much further.
3. although he's not entirely wrong to dismiss global overcapacities as a pro-deflation argument, he overlooks that those overcapacities will be a contributor to falling prices. it is actually more appropriate to refer to overcapacities as malinvested capital. these malinvestments will be liquidated in a credit crunch, but first they will try to survive via price wars. note also that the liquidation entails defaults - so the credit 'out of thin air' that was created to finance these malinvestments will go back to whence it came - into thin air.
4. i don't buy the 'manipulated bond market' argument. yes, it's true that the Asian CBs buy a lot of US treasury debt - but if the conditions for a bond bear market were in place, they could not possibly hope to influence the market to any appreciable long term degree.
leaving aside for a moment the fact that there are still way too many bond bears out there, which is a contrarian buy signal, one must note that the holdings of foreign CBs, while large, represent only a small percentage of the entire market (5% or so). their purchases do of course add to demand at the margin, but if private sector bond holders were convinced that they're trying to manipulate the market out of desperation, they could never ever stem the tide of selling that would result from such a perception. |
