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August 26, 2010

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I'm sure I will comment more, but there are two glaring issues with this post. 1. slight deflation is not always bad just like slight inflation is not always good. 2. In theory, Gold as an asset class should under preform in a deflationary environment. It would out perform in a hyper inflation environment, where currency loses value. The current bet with gold is not because of deflation risk.

Quite the opposite.

In the next 10 to 20 years, the single biggest macroeconomic problem facing the US is the massive amount of inflation that will be required to service our existing (and growing) debt levels plus all of the myriad entitlements that the Baby Boomers have claimed via the ballot box.

1. Do you think we are beginning a period of deflation that is at least short-term, if not greater – or are these fears unfounded?

I believe these fears are unfounded. I think I said last year sometime that current deflation fears are more of a result of disinflation than of real deflation (in a truly deflationary environment, we'd be seeing a general drop in both prices and wages. What we are (still) seeing is a slowing of price increases, a stalling of wage increases, some prices going up (food, medicine, gasoline) and some prices going down (cars, electronics, real estate).

Additionally, the Federal Reserve has stated that they will not tolerate deflation. Many question whether the Federal Reserve has the ability to combat deflation, but I can assure you that the Fed can and will (and is in the process of) forestalling deflation with large rounds of quantitative easing. It is impossible to have quantitative easing without having inflation; money creation to purchase government bonds are spent by the government, which in turn places that money in circulation (even if that circulation isn't the general US economy initially, it'll effect US pricing overseas... which is where all our stuff comes from).

Personally, I think the deflation talk is being ramped up not to warn on deflation, but to give justification for the Fed to use the "nuclear option". YMMV.

2. If deflation takes hold of the economy, how would you reallocate your investments? Would you hedge with cash/short-term government debt, gold, or other vehicles?

If deflation truly took control (i.e. - as it did in 1930-1933), I would probably re-weight my portfolio to agriculture, drop my metals holdings a bit and increase my currency (foreign and domestic) holdings. I would most certainly not invest in a government instrument at that point, except possibly for local municipal bonds.

My thinking here would be: shift to an industry that produces something everyone needs regardless of economic conditions (most likely to survive a deflationary environment), cash out some PMs and convert them to dollar (increase transaction unit availability) and foreign (in a delationary environment, chances are foreign currencies will appreciate faster relative to the dollar) currencies and stay away from government debt (if we really hit deflation, chances are any inflationary restarts prompted by the Fed/FedGov will fail - and they will keep trying, which means my investment will only make things worse) except for local munis (in a truly deflationary environment, local economies will be hit the worst, so any help I can give there will return either a montetary benefit or a community benefit - quite possibly both). The good news on this is we already have so very many dollars floating around out there if we begin to see real deflation start, there will be plenty of time to make these changes before the "spiral" phase hits.

I'd like to close by saying that there is/has been a rather heated debate in the economics realm for the last two years on deflation vs inflation/hyperinflation. In many cases, the louder, ruder elements on both sides have gotten to name calling (I have seen respected economists state "if someone thinks that deflation isn't here, they simply don't understand basic economics" and "those who still cling to the deflation argument are either shills for the Federal Reserve or are doing so for personal gain"). There may be opposing viewpoints here - as FMF said, we like to talk about these things. Just be advised there might be strong emotions pop up that seem to come from nowhere.

Oh - a quick note to the author:

I don't think you meant to do this, but you are using "value" and "purchasing power" as if they were two different things. While $1 may become $1.05 due to inflation (via interest or some other method), you still have that original $1 and an additional nickel. The value of that dollar has decreased, even if the number of dollar (and sub-dollar units) you hold has increased. I think you meant to say that dollar holdings tend to increase over time as a result of inflation, even if the value of those dollars decreases over time due to the same inflation.

Or.. I've completely misread what you are trying to say?

I have read all sorts of articles and all I can say is everyone has an opposite opinion of what is happening in the world today to the point of I really don't think anyone has a grasp of what is really happening. I have heard fears of inflation, deflation, stagflation, unemployment, underemployment, double dip recession each having there time in the spot light.

I think part of this is due to the avalibility of information is so vast and contradictory that there is no sense of order. No one theory can explain what is happening completely because it is too complex with global influences.

Just hold on until the roller coaster comes to a complete halt.

Rod - What I meant was a dollar today has less purchasing power than the same dollar one year from now, assuming inflation. Example: it costs $1 to buy a cup of coffee today, but you may need $1.05 to buy the same cup coffee in a year, due to inflation. Your original dollar has less purchasing power because it can't buy the cup of coffee anymore, by itself.

You had some insightful thoughts on this topic. And yes, I'm aware that some folks may have strong opinions on this issue as you suggested.

I'm really interested in seeing everyone's opinions to those 2 questions (which you thoroughly answered):

1. Do you think we are beginning a period of deflation that is at least short-term, if not greater – or are these fears unfounded?

2. If deflation takes hold of the economy, how would you reallocate your investments? Would you hedge with cash/short-term government debt, gold, or other vehicles?

There are clearly divergent views on this topic. With respect to #1, none of us has a crystal ball (if we did, we would be basking in our wealth right now). With question #2, I'm curious what folks think would be a good hedge IF they thought deflation would be occurring. Not saying when, but if.

Rod - ok, one last clarification. Sorry. I meant a dollar today has MORE purchasing power than the same dollar tommorrow, assuming inflation. Got the words mixed:) Connecting this to the coffee example, I'm sure you see it.

The Fed can halt deflation whenever it wants. It simply needs to flood the system with dollars and purposely cause inflation. An explicited stated target for inflation and drastic continuous actions to meet that target via adding more and more dollars into the system will eventually kill deflation. I just don't know that I think the Fed has the stomach to do this. It would probably involve something like buying massive quantities of govt bonds with new money thus putting that money into the system. The fed has already tripled it's balance sheet and many people are upset about this. Doing what I propose would increase their balance sheet even more, and I just don't know if I believe they will do it.

Despite what Helicopter Ben has said about dropping money from the sky, to me they don't show evidence that they are willing to go beyond the minimum of trying to keep inflation at zero rather than trying to re-inflate. If they don't re-inflate we could risk Japan style stagnation and despite what Tyler says, I have never heard of a good example of minor deflation. Japan has had minor deflation and dis-inflation for 20 years. It hasn't worked so well. Perhaps there are examples of minor deflation being good but I don't know of any.

The thing is with the debt problems we are facing a moderate level of inflation (in the 5%+ range) would be very good longer term in growing our way into our debt problems. If we don't, we face drastic fiscal problems that involve either govt default, big benefit cuts, big tax increases or likely some of all of the above.

It's a near given that the Fed can re-inflate if it wants to. Yet the fed continues to hold to its stated 2% inflation target and frankly, trying to hit that target from here leaves me unconvinced they have the will to take the steps that would kill deflation as it would likely lead to inflation of greater than 2%.

Of note I am not claiming we have deflation right now. Likely just dis-inflation.

I believe there was a discussion here a year ago about impending inflation and someone was predicting it was imminent. Rod, I know that you have commented on this topic in the past so I don't know if that was you but I know I had a discussion with someone where I said inflation was a potential problem but the current conditions made it highly unlikely that it would occur in the next few years. So far that has been correct and I still hold to that. Inflation could definitely re-heat if the economy starts a real recovery. Currently there is no evidence that the economy is recovering at all and until such time and with only weak efforts by the Fed, I don't see any near term risks of inflation.

A good post and really good comment by Tyler and Rod.

As for myself, I think we are on the doorstep of deflation but in the end we won't cross the threshold. The housing market will have a lot of bearing on this. Wages have started to go down around here. The governments where I live haven't given raises to non union employees in 3 years. The same employees are being required to take 24 unpaid days off (that a 9% cut). Still, I believe the Fed will do everything possible to prevent this.

As for me, my money is going now to cash instruments, checking accounts earning 4%, fixed account getting 4%. But I can't bring myself to avoid equities totally. I don't know enough about commodites. And gold has never appealed to me. If I was going to own gold, it would be something I intended to hold for 20 years or so. Otherwise what's the point? Can't buy anything with it, you have to turn it in for paper. (Hyperinflation a la Weimar is a different story)

So I contradict myself somewhat. I don't think deflation is coming other than a short period. I preparing in case it comes and stay longer than I expect.

Bill,

Would love to know where you are getting 4%.

The US Government has signalled that it will work to avoid deflation at all costs. As another posted pointed out, if all else fails they can print money like there is no tomorrow. In their zeal to do so, I think we have a better chance of inflation rather than deflation.

Whether we move into inflation or deflation we will have plenty of time to re-evalute our investments - such moves take quite a lot of time to develop. I feel that as long as I continue to operate under the guideline I believe in which is "Let your profits run but cut your losses quickly" my investments will be fine.

Since inflation is usually caused by too much money chasing too few goods I don't think we have much to worry about, now and for the foreseeable future.
Credit Card debt is now the lowest it has been in 8 years.
Eight million workers are unemployed and many more have given up looking. Since both existing and new home sales have really slumped and loans to small businesses are very hard to get it's hard to see where the demand for goods and serv ices will come from. People are building up their emergency funds not rushing to the stores and showrooms to spend the money they just got from a new HELOC because their home just jumped in value. Instead they are worried and concerned about their future. I see half empty restaurants, closed banks, and lots of signs saying "Retail Space Available" everywhere I look.

@JimL
My bank has a checking acct that pays 4%. The deal is : online statements; direct deposits; and 12 debit as charge events per month. Oh yeah, up to 10k. MB bank.


My 457's has fixed accts' yielding 4%. I 've heard on this site other banks doing the same. If you give your state, maybe someone can point out a bank there. MB is at least in Illinois.

Hope this helps.

Question 1: Do I think we are entering a period of deflation?
Answer 1: I don't know. No one knows. It is a unlikely but not impossible.

Question 2: How should you reallocate your investments?
Answer 2: You should not. Unless you are a professional investor, you should not be thinking about macroeconomic issues when you allocate your personal investments. Money you plan to spend soon should be in short-term instruments such as cash, short term bond funds, CDs, etc. It really doesn't matter which. Money you plan to spend in the distant future should be primarily in equities. Money you plan to spend in the intermediate term should be balanced between the two.

Don't let yourself think about anything else and you maximize your chances of reaching your goals.

I am also earning 4% like BillV in Arizona. Deal deal: DD + 12 debit transactions/month. Totally worth it as I set up automatic 10-cent "donations" reoccurring every two days

@Doug,

Fixed income and Equities. Those are the only 2 viable investment options? That's a little narrow.

You should never consider macro economic issues in your investing choices? So you were happy to recommend buying a house in 2006 regardless of values drastically exceeding all historical norms.

That's not to say the market can be easily timed, but taking some precautionary diversification as a result of global and macro economic issues seems fairly prudent. But if I wanted to be advised to put my head in the sand and buy stocks (exclusively stocks for long term investment) regardless of what is going on in the world around me I would just go ask a full service broker what he thought I should do.

http://www.guardian.co.uk/business/2010/aug/26/ben-bernanke-pressure-rescue-us

Here is an article from today that discusses exactly the kind of quantitative easing that I discussed above. It talks about the Fed potentially buying government bonds from banks and expanding it's balance sheet exactly as I had suggested above. Unfortunately it suggests a high likelihood that Bernanke will not have the nerve to admit to such a plan given the high percent of people who are not behind such a move and that he will face a lot of opposition if he tries to carry out a direct and large quantitative easing. There are people quoted in the article who do not believe it will help the recovery and they think its a waste of resources to do it.

This is why I said I fear they won't have the nerve to do it if they need to. Make no mistake if they do it and do it large enough it will eventually cause inflation and as inflation ramps the economy will start to grow in nominal terms even if not in real terms and eventually that growth will lead to hiring. The problem is there is no easy way to make those correlations happen quickly and that's why everyone will say it's not working.

Let's hope we can grow out of this without massive QE cause I am still not convinced the Fed has the stones to do it and be blamed for causing inflation and then initially having it not create any jobs. The Fed does still have a double mandate of jobs and inflation and they seem to be pretty set on not causing any inflation even now.

It is difficult to predict short-term events. Companies cannot increase prices when demand is weak, so it is quite possible that we may have a short period of deflation - possibly a few years.

However, I am convinced that the dollar has to weaken over the longer term to reduce the real size of the federal debt. Either the US government will deliberately weaken it, or other countries will gradually bail out of dollars, pushing down their value.

If the dollar weakens, then imports will become more expensive. The key factor behind the inflation of the 70s and 80s was oil prices. A weak dollar will cause higher oil prices, and this will flow into the price of all goods and services.

Many of our imports come from China. If the Chinese currency strengthens, then dollar-based imports prices will rise. If more Chinese people demand a higher standard of living, then Chinese production costs will increase and be passed on. China also has a one-child policy, so their labor force reduces in size every generation - which will ultimately lead to labor shortages and higher wage-costs in China.

To the person who said that Japan's inflation/deflation cycle hasn't worked so well: What exactly about Japan hasn't worked? Are ordinary people struggling any more than they were 20 years ago?

"To the person who said that Japan's inflation/deflation cycle hasn't worked so well: What exactly about Japan hasn't worked? Are ordinary people struggling any more than they were 20 years ago?"

That's a fair question and I honestly don't know the answer to that.

However it is generally accepted that from an economic standpoint deflation is bad for an economy and thus overall bad for its citizens on the whole.

Here is an article today about Japan's deflation.

http://www.google.com/hostednews/ap/article/ALeqM5jmfkCQFvxtt6IXRmfAjmFGTya2yAD9HRP6JG2

An excerpted paragraph says the following:

Meanwhile, the country's core consumer price index, which excludes fresh food, fell 1.1 percent from a year earlier. Lower prices may boost individual purchasing power, but deflation is generally bad for an economy. It plagued Japan during its "Lost Decade" in the 1990s, hampering growth by depressing company profits, sparking wage cuts and causing consumers to postpone purchases. It also can increase debt burdens.

Squirrelers:

We're only human; we all make mistakes :)

Apex:

Yes, that was me, and yes, you were right. I hadn't considered the possibility that we'd create all that money to give to the banks for credit stimulation/loans but not actually require that they issue credit or loans as we had done in the past (we were "controlled economy" right up to the point where we gave them the cash, then went "free market" with how that cash was handled.) It just goes to show that as long as you have people making decisions about how money is created, you can never really predict what will happen. (And, not to hijack the conversation or anything, but it's that same lack of confidence in a currency - unpredictability - that creates the foundation for hyperinflation.)

On another note, I have a slightly different take on the Fed's actions to halt deflation: I think the Fed may realize how close we are to rapid inflation and doesn't want to stoke the fire *too* much for fear they will not be able to control it. Over the years, we've become sloppy in our monetary policies; a result, I believe, of being the reserve currency which enables us to bend the rules where other nations have no such luxury. Dollar hegemony has been under attack for a decade, our debts are compounding at a faster pace than ever before, we're currently in a "recession" and greater demands for stimulus are being voiced. Rock - meet Hard Place. The Fed is still engaging in QE; the call is for the Fed to do much more QE in larger quantities (hence the "nuclear option" I referred to.) I think Ben, being an academic and a student of the Depression, is merely coming to understand that theory is all fine and good when that theory stays in the classroom or the peer journals but when that theory must be tested - by you - in the real world with the fate of the US economy riding on the outcome... well, let's just say he doesn't want to rush headlong into anything at this point.

And, speak of the devil:

http://finance.yahoo.com/news/Bernanke-Fed-will-take-action-apf-4107566310.html?x=0&sec=topStories&pos=main&asset=&ccode=

Covering what both of us are saying :)

There are different types of inflation and deflation. Debate often ensues because parties are talking about different types of inflation or deflation. You can have momentary inflation, while having asset price deflation, while having consumables inflation, while having wage inflation, while having high unemployment. Looking at one aspect fails to paint an accurate picture or allow one to accurately assess risk.

The Fed can print all the money it wants, but if the system is deleveraging it can’t inflate. The printing of the money is offset by the reduction of the money multiplier/ velocity of money in the system as savings increase and availability of credit decreases. If I lent you $1mm at .5% and you had to lend it out, would you lend it to a new home buyer with 5% equity? Would you lend it to a new business? Or would you buy ‘risk free’ treasuries at 2% yield and make your 1.5%? If you choose Treasuries, the money going into the system (inflation) went right back out.

You could see the CPI stay flat or increase while your assets decrease in value- especially if the value of the asset was partially derived from leverage. By adding leverage, I could magically increase the value of a company because the multiplier stays the same while the rates of return increase. Unfortunately, I also increase the risk of default. Did asset prices rise because of fundamental supply and demand or were low costs of capital and reduced standards a major factor?

I manage assets. Except for its pressure on other parts of the economy, I don’t directly care about consumable price inflation. I can offset that inflation with different assets. I can make very cheap bets/insurance that can protect most assets from price inflation. Unfortunately, protecting assets from asset deflation risk is far more difficult. Its hard to know what will happen if parts deflate.

Personally, I believe assets are over priced using almost any valuation metric. I believe leverage is still a major factor and deleveraging is incredibly risky and in most cases painful to the system. People are deleveraging while large firms are leveraging with long dated debt. Firms adding debt are not adding it to spend; they are adding cheap cash to survive. This could change.

I have no idea what is going to happen. The risk of deflation has increased. The current risk of massive inflation seems very low. Play some defense. Reduce risk. What’s your cost if everything is fine two years from now? What’s your cost if you’re wrong? One should seriously look at their portfolio and their investment strategy and consider different scenarios. (for example, if you lose your job you wont be able to average into that fund you own, and you will be forced to sell to pay the bills.) Just be careful.

Japan has been trying for 20 years to re inflate its economy without any success. Their cost? They have gone from being the one of the most powerful economic forces in the world to the least (G7). Their economy has done nothing for 20 years. Asset prices were crushed. No yield on debt. No economic activity. Yeah starting your career in Japan 20 years ago would have been great. Living there has been a ton of fun.

@Rod,

I think you may be right that Ben is scared of over-inflating. Run away inflation is hard to stop. That's why I suspect he will do what it takes to prevent outright deflation but not sure he will do enough to actually re-inflate.

I don't think we are that far apart. I probably just think we are farther away from inflation starting to run away from us.

@Rod,

I am curious on what you think would be the best outcome. Our government debt situation being what it is, I happen to think the best situation would be for us to start running regular inflation of over 5% to inflate away the debt, slowly devalue the dollar which makes imports more expensive and will lower the trade deficit over time.

What is your take? Do you think 5%+ inflation is desirable, bad, will lead to hyper-inflation thus bad, something else? Do you prefer deflation, dis-inflation, mild inflation, higher inflation?

Someone asked why deflation is bad. Some specific's:

1. Tyler's point on Japan's relative decline as an economic power is a good example of the negative impact of deflation.

2. Japanese deflation has forced a major change in the Japanese workforce. Over a third of all workers are now temporary, with no job security and few benefits.

3. Deflation has also triggered numerous, subtle, side affects. For example, deflation has been blamed for Japan's declining birthrate. The population - according to the CIA factbook - has begun to decline. Returning immigrants have reduced this impact, but this is a limited resource.

To quote from the Japan Times (Japan's current population is about 127M):

"The National Institute of Population and Social Security Research estimates that Japan's population will dip below 100 million in 2046, below 90 million in 2055 and down to 44.59 million in 2105. If this trend continues, the labor force and consumer markets will shrink, having a strong impact on the economy. Social security costs for medical and nursing care services and pensions will exert great pressure on people."

As for the comments that the Fed can simply print more money to defeat deflation, it's not that simple. If the Fed did simply "drop money from the helicopter" the value of the dollar, as perceived by foreign investors, would fall dramatically. All import prices - including oil and goods from China - would increase. The result, as Japan shows, is not necessarily inflation. The results are more subtle and widespread, with the most likely case being economic stagnation, employment disruption and massive financial upheaval.

What I believe - opinion here - is that Bernanke realizes he is very close to the end of his effective bullets against deflation. He desperately wants the fiscal authorities (Congress) to take over the fight against the economic malaise. I believe Bernanke would love to have the economy begin to grow again so unemployment would go down and he could raise interest rates to fight inflation. The difficulty is that it seems increasingly likely that Congress will be deadlocked after the November elections. I predict that two years from now - the late summer of 2012 - will look remarkably like the late summer of 2010...

My $.02 worth

Deflation can be very good for certain groups. Deflation is great for those who are in a position or a stage of life to purchase assets/goods. Its bad for holders of assets. It can be good for savers and lenders but its bad for borrowers/ people in debt.

People wrongly assume the Great Depression was horrible for everyone. It wasnt. Fortunes were made. Companies were created. Creative economic destruction occurred. Ford survived, Cord, Auburn did not. The depression killed off the weak in the herd . (I am not in the "we are on the verge of another Great Depression camp, but it is often used as an example of deflation.)

On a separate note- dont forget the demographic shifts of a society and its potential effects on the economy.

Yes Deflation is good for those who have saved up all their money and want to live off them. It is not good for anyone trying to get ahead or grow wealth. So if you already have it made, have lots of cash, and don't want to grow your wealth, welcome deflation. It's a boon for you. Now let's talk about the other 99% of us.

@Tyler:

"There are different types of inflation and deflation."

I will respectfully disagree. Inflation/deflation is always a monetary event; categorizing the effects of inflation/deflation on market segments is a bit disingenuous, but I do understand it's common for Keynesians. I, too, use Keynesian language and models when discussing our current situation, as we're under a Keynesian system, but when looking at fundamentals, I tend to borrow from whatever school of thought is applicable to the situation. In this case, I believe the Austrians are correct. I am not discounting leverage in the slightest here, btw - it kind of makes my point. It's false "money" created by leverage that mucks around with the indicators; your example of the velocity of money in reverse - as it speeds up, false inflation occurs and as it slows down, false deflation occurs. The money supply (M0-M2) hasn't been affected because the Fed didn't create that money, but the effect of that money is still out there; it's why we can have over 1 quadrillion in derivatives, yet only 20 trillion (?? - hard to know these days without M3) in dollars on the books. So, housing prices inflated due to easy credit and since the credit bust are now deflating. A monetary phenomenon.

"If you choose Treasuries, the money going into the system (inflation) went right back out."

I again disagree. The newly created money goes to banks, who then buy Treasuries - transferring that money to the government. The government then spends that money, which puts it back out into the economy. The problem with the bailout money is the banks are letting it "sit in thier vaults" and not circulating it; most likely to hedge bad derivatives.

"You could see the CPI stay flat or increase while your assets decrease in value- especially if the value of the asset was partially derived from leverage."

I agree completely. That's why I tend not to look at specific market segments for inflation/deflation indicators, but look at money supply and distribution.

"I manage assets."

Out of curiosity, what assets do you manage?

"Personally, I believe assets are over priced using almost any valuation metric."

Have you seen this one?: http://pricedingold.com/charts/CSXR-1987.pdf

"Just be careful."

I completely agree. I'd like add - do your own due diligence as well.

@Apex:

"I probably just think we are farther away from inflation starting to run away from us."

I, too, have no crystal ball. I tend to look to history to see likely outcomes; inflation and hyperinflation are the extremely likely outcomes (one other outcome is we're conquered and occupied by some invading nation, eventually being subsumed into that nation. Not that I think it's likely, but it's there.)

"Do you think 5%+ inflation is desirable, bad, will lead to hyper-inflation thus bad, something else? Do you prefer deflation, dis-inflation, mild inflation, higher inflation?"

I think all inflation is bad :) What I prefer is that we'd stop accumulating debt and start taking the steps to bring our fiscal house back in order by raising taxes, slashing spending and eliminating everything the government(s) spend money on that isn't essential; the party is over and it's time to pay the tab (and someone ran up a HUGE tab). However, we won't do that, so looking at the options available to us, I would say higher inflation to inflate the debts away, arresting that inflation to 0% once that is achieved (with an inflation rate that will have a short/medium term date where our debts will be eliminated; no raising the inflation rate to just spend more to make that the "new normal") and freezing all spending at current levels to ensure we do not accumulate more debts. Again, I do not see us doing this (if we inflate at, say, 5% for 10 years, the "old" $3.5 trillion dollar budget won't get us a cup of coffee - which will be painful). That's the inflation trap, and one of the reasons I do not think inflation is good under any circumstances. Still, we could do it, and it should work... as long as we stick to both sides of the equation.

And, just for fun, I ran some numbers. Let's say we inflate and halt new spending, but do not cut any program currently in place. We'd need (roughly) a monthly inflation rate of 15% for 17 years to inflate our way out of the total debt obligation we have. To put that into perspective, a $4 latte at Starbucks by the time we get to the "dropping inflation to 0%" part, would cost about $50 and gasoline would run around $35 a gallon. The really funny thing is, that wouldn't even be considered hyperinflation - just rapid, sustained inflation.

Growing wealth only matters on a relative basis.

Ill say it again, wealth has been and can be, created in a deflationary environment.

40% unemployment is catastrophic, but it still means 60% have a job. Deflation is not bad for everyone. Those who buy assets with debt will lose everything. Those who didnt make the mistake of adding debt risk will be fine.

I'll second Tyler on that - wealth can be accumulated, in some cases easily, in a deflationary environment. Those with debt, however, will suffer. Which is most everyone, including the federal government, unfortunately.

Rod- re case-shiller vs gold: unless I am putting on a gold housing trade it doesnt really matter to me because I dont buy a house in gold. Its an interesting chart, but I am leery of using it to value housing. Housing could be over valued and gold could be really over valued and I would get the same chart. I could produce the same chart using other things- google stock, oil etc. Not saying its wrong or foolish, in fact I find it interesting, but not incredibly useful.

If I had to pick a group I agree with most in principle, it would be Austrian school. gotta run.

"I'll second Tyler on that - wealth can be accumulated, in some cases easily, in a deflationary environment. Those with debt, however, will suffer. Which is most everyone, including the federal government, unfortunately."

The key is on the unfortunately part.

Those with debts will suffer
Those with hard assets like houses will suffer
Those with investments or business assets will suffer

Those with no debts and lots of cash will find opportunity.

Does the theoretical fact that it's possible to profit in deflation even matter when almost everyone would be hard pressed to name a single person they know who fits into the category above where deflation is beneficial?

@Rod,

I agree with you that it would be best to have minimal inflation with no debt and balanced federal and personal spending. We both agree that has zero chance of happening in our lifetime.

I also think inflation will come with increased govt spending instead of the fixed spending you advocate. However not having inflation also comes with increased govt spending. The sun rising in the East comes with increased govt spending so to me that all irrelevant.

From here if we don't inflate we have to default or raise taxes like crazy or cut benefits like crazy. I have no belief that the last one is possible which leaves us with default or raise taxes like crazy.

Thus given where we are and all the possible places we could go. Inflation is the only remotely palatable choice to me.

@Apex:

"Does the theoretical fact that it's possible to profit in deflation even matter when almost everyone would be hard pressed to name a single person they know who fits into the category above where deflation is beneficial?"

Oddly enough, I know a lot of people who meet those criteria, and every single one of them is dirt poor. They have no debts (never could qualify for credit as their scores hang out in the 500's), no hard assets (can't afford any) and no business assets or investments (again, can't afford any). I'll have to do some thinking on this; deflation might be good for the poor, or at least not bad (prices would drop first, then wages, so at least for a short time, the poor would gain... hmmm..)

"Thus given where we are and all the possible places we could go. Inflation is the only remotely palatable choice to me."

Yeah. I wouldn't use the word "palatable" (as I'd still choke a little on the prospect), but aside from default it's our only chance. No matter what happens, pain in one form or another is the outcome.

@Tyler:

I was just pointing out that there are numerous ways to determine value - using dollars is just one of them. Then again, I stopped using dollars as my primary wealth indicator a long time ago, so I tend to not think of dollars that way. Dollars to me are transaction/accounting units and nothing more.

@Rod,

My list of conditions to be helpful includes a hoard of cash and you left that out (obviously the poor do not have a hoard of cash).

Deflation may not hurt the poor but without a hoard of cash, I don't see how it helps them either. I suppose the government would not be inclined to cut their welfare payments, but if they actually have a job their wages will go down with the deflation. Without the cash or a fixed subsidy, inflation isn't going to help them either.

the last line of my last post should have said deflation not inflation.

Quite a discussion squirrelers! Here are my answers to your questions:

1. Near term deflation is a distinct possibility. I'm not sure how long it will last, but there is the potential for it to go Japanese on us. Having said that, I can fully appreciate the arguments for inflation, hyperinflation and stagflation as well. That's what makes this investing climate so difficult to navigate.

2. I am playing my deflationary thesis near term by holding mostly cash with a small position in an inverse ETF as I think the market will head much lower at some point as the global deleveraging process plays out. I will be on the lookout, however, for any signs of inflation. The idea of holding cash is as follows: It's the best place for your money if deflation takes hold. If I'm wrong, I lose the potential gains of other investments and possibly take a few percentage points hit from inflation. If I'm right, I avoid significant losses to my principal. There are too many uncertainties out there for me to risk our hard-won savings.

I'll have a detailed post on QE up on Monday. Thanks for initiating a great discussion!

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