The Confrontation Between The Inflationists and The Deflationists*

The Confrontation Between The Inflationists and The Deflationists

The battle lines have been drawn for quite a while between The Inflationists – who believe that economic forces are pushing the world into spiraling inflation – and The Deflationists – who believe that entirely different economic forces are pushing the world into ever deeper deflation. Both believe that there’s nothing that Central Bankers can do to control those forces …, although there is a third perspective – that the world’s Central Bankers have discovered the Rosetta Stone of economic balancing and that both inflation and deflation are being adroitly pushed into a distant future (a subject explored in “The Dismal Science” and “What if There were No More Recessions?” in the December 4th and November 26th TLRs). TLR earlier this year addressed the inflation-vs-deflation conflict in “Whither Inflation?” and noted that the U.S. Federal Reserve, the Bank of Japan, the European Central Bank, the Bank of England, the Reserve Bank of Australia, the Bank of Canada and a broad coalition of additional Central Bankers have been working tirelessly for the past 10 years in an effort to generate inflation …, and stave off deflation. They’ve printed enormous amounts of fiat currencies and, as a result, the world has been awash in paper money. For better or for worse, that money hasn’t found its way into hoped-for consumption and production and has not led to the expected level of merely 2{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} inflation. Instead, that money has found its way into global equity and bond markets, increasing the wealth of the already-affluent.

There are multiple possible causes of inflation, each depending on a variety of complex economic factors. In short, no one really knows. It’s a mystery (to quote from Shakespeare in Love.) Classically, inflation is triggered when the aggregate demand for goods and services in an economy rises more rapidly than an economy’s capacity to produce those goods and services – a demand-supply imbalance. This can happen when a central bank increases the supply of money and, in doing so, revs up an economy’s consumptive engine causing demand to outstrip supply. Although Central Banks most certainly have increased the supply of money, that money hasn’t found its way into consumption. It has, however, caused another form of inflation. Central Bankers have used a portion of that new money to buy bonds, inflating their value, and investors have used the bulk of the remainder to buy stocks, inflating their value. That’s asset inflation! Meanwhile, goods and services, from wages to agriculturals and natural resources, have been unaffected … or, more accurately, their prices have been declining due to productivity gains largely attributable to technological advances (discussed in “Is this Time the Same” in the August 21st TLR).

The Inflationists believe we’re always at a tipping point. They highlight a number of economic sectors where supply is becoming restricted, leading them to conclude that, cumulatively, inflationary forces are building. Since labor historically has been the primary source of inflation and since U.S. unemployment is at historic lows, they note that workers are starting to use their bargaining power to attain higher raises. Coupled with minimum wage law increases and healthcare inflation, they posit that labor costs will soon start to impact the costs of services and finished goods, especially since the U.S. has become a services-oriented economy. They also point to energy, particularly to the suppression of crude oil and natural gas prices due to the shale revolution which has often resulted in loss-making, uneconomic production, a situation that is now beginning to reverse as wells are abandoned and leading producers reduce their expenditures. They further point to the reversal of globalization, the major cause of product price-deflation. With proliferating trade wars, increasing tariff barriers, the imminent death of the World Trade Organization and its dispute resolution system (the U.S. is refusing to make mandated appointments, eliminating the necessary quorum to adjudicate claims), supply chain disruptions, and the embracing of “our country first” economic policies, globalization and its consequent cost savings are being put into reverse. Such a reversal, say The Inflationists, will unleash an inflationary backlash. The Unicorn phenomenon similarly is spotlighted as having created loss-making industry leaders like Uber and WeWork and Slack, each of which has crushed competitors by driving down prices. Each will soon have to raise prices in order to become sustainable. Doing so will be inflationary. Moreover, a massive amount of infrastructure will need to be replaced, requiring both more money-printing and greater demand on an already-saturated labor market. And then there’s the complacency of a population that hasn’t experienced inflation in over 40 years. Those with only a single decade of economic experience cannot understand that the last decade of money-printing and deficit spending is not the norm. When inflation begins, they will overreact. There are consequences to money-printing and excessive deficit spending, and the pressure of those consequences is building.

And, yet, there are no signs of inflation today …, even though Central Bankers have printed money with abandon. When Germany printed Deutsche Marks with abandon in the 1920s, the result was hyperinflation. When Zimbabwe printed dollars in the early 21st Century, there was hyperinflation. When Venezuela printed Bolivars during the current decade, there was hyperinflation. That hyperinflation resulted from an inability of those nations’ citizens to purchase necessities produced in other countries – an oversupply of cash chasing an undersupply of goods. In essence, the money-printing nations’ currencies became worth-less in comparison to the value of the currencies/products of other nations that were not printing their own fiat currencies …, or not printing them at the same intense rate. These were each single-nation, internationally-uncoordinated money-printings. There are no examples of hyperinflation in a coordinated, globalized economy … like the one we’ve had for the past decade. In fact, there are no examples of inflation of any sort in a coordinated, globalized economy. The reason is that there never before has been a coordinated, globalized economy. Never before have products and services been interchangeable on a global basis. Never before have nations coordinated their currencies, their production modalities and their money-printing.

No one has witnessed a similar confluence of complex economic interrelationships. Economic history reveals no precedent.

The Deflationists are in a similar position. They are unable to rely on economic history, and instead count on the persistence of existing trends. Globalization and technological innovation have decimated the middle class, resulting in fewer high-paying middle-class jobs (for example, in utilities, oil and gas, manufacturing, delivery services and retail (the so-called “Amazon effect”)). This has reduced, and The Deflationists believe it will continue to reduce, wages and wage growth. At the same time, the global economy is slowing, leading to weaker energy and commodity prices and creating a negative feedback loop by reducing jobs and economic activity that, in turn, results in weaker commodity prices and a further negative feedback loop. Pouring water on the deflationary cold embers, technological innovation/ automation is significantly deflating costs. The Deflationists add that, historically, inflation in any event is a wartime phenomenon where heavy government spending on top of a fully-employed economy creates excess demand. They argue that productivity-driven supply always will overwhelm demand …, and the fact that massive global money-printing hasn’t led to any real level of inflation proves that monetary policy alone can’t cause inflation. As further evidence, they offer Fed Chairman Jerome Powell’s lament that, despite the best efforts of Central Bankers, long-term inflation expectations remain “at the lower end of their historic ranges.” Examine the trend in brokerage commissions, they say. Fidelity, Schwab and Vanguard for years bragged that each of their brokerage rates was the lowest until, recently, they effectively eliminated all such commissions! Meanwhile, capital investment remains in the doldrums and wage growth remains depressed despite unprecedented unemployment rates. And, because wages haven’t risen and retirement benefits are in jeopardy, Americans continue to work well beyond historical retirement ages – the supply of workers therefore remains abundant, especially in America’s service-oriented economy. With the also unprecedented aging of the Baby Boomers and the reduced earnings and savings potential of the Millennial generation, The Deflationists add that consumption is likely to be suppressed for many years to come. If demographics indeed are destiny, the fact that surveys indicate that 52{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} of American households most likely will be unable to maintain their living standards in retirement speaks volumes about America’s future. In fact, Americans age 65-74 have twice as much debt as Americans in that age group held in the 1990s. Pressure on American postwar babies to save therefore will continue. Meanwhile, there aren’t many big-spending Millennials. Demographics consequently favor increased saving …, which is deflationary … except for stock and bond prices.

The Inflationists argue that commodity and agricultural shortages will lead to inflation, with The Deflationists countering that, despite human beings’ ever-increasing needs for food, energy and natural resources, history makes it clear that human ingenuity will find ways to overcome any and all shortages. Since the mid-1800s, for example, inflation-adjusted commodity and agricultural prices have been declining. Prices have increased only when there were wars. They conclude that there is no reason to assume that the future will be any different.

The Inflationists also point to already too-high and ever-rising medical costs. The Deflationists reply that the Trump Administration has proposed that hospitals and medical insurers will be required to reveal their secret negotiated rates starting in 2021. If that increased transparency comes to pass, prices will quickly begin to fall and further innovation will multiply the deflationary pressures.

Many feared that Central Bank money-printing and government deficit spending would lead to a vicious inflationary spiral, driving up interest rates and choking off economic growth … or worse. Despite the best efforts of Central Bankers and their free-spending governments, there is and has been little inflation and only modest economic growth. It may be true that the current U.S. federal debt of $23 trillion cannot possibly be repaid out of revenues. It certainly seems correct that at some point – whether at $23 trillion or $50 trillion or $100 trillion or $1 quadrillion – the only way to wipe out the U.S. deficit will be by a U.S. government bankruptcy … or perhaps by coordinated national bankruptcies … or perhaps by hyper-inflation (Whatever that might mean? Who can know? It’s a mystery!). How many years might it take for the global economy to get there? One? Ten? Fifty? A hundred? No one knows. It’s a mystery. Nevertheless, as long as GDP growth continues, even at the currently low rate, and as long as there’s general prosperity, there will be no reason to concern ourselves with potentially unsupportable deficits and possibly unrepayable debts, no reason to pause in stop the money-printing, no cause for concern about inflation or deflation. The Japanese don’t care about their unsupportable deficits, unrepayable debts and deflation, and those who view the Yen as a safe-haven currency certainly don’t care. Massive U.S. deficits and an unsupportable a huge national debt are not currently troubling either Democrats or Republicans either.

We’re in uncharted waters.

The Inflationists will concentrate on Central Bank money-printing and government deficit-spending, the artificial creation of excessive fiat currencies. They will be encouraged by America’s embrace of Modern Monetary Theory. The Deflationists will continue to focus on demographics, technological innovation and the stability of international relations to support a Japan-like global economic malaise. In short, paraphrasing Stein’s Law, the current level of uncertainty, the current push-pull of inflationary-deflationary forces, and the current fiscal environment each will persist … until they all end … hopefully not with a bang, but with a whimper.

Finally (from a good friend)

*┬® Copyright 2019 by William Natbony. All rights reserved.

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