December 05, 2011

Deflation Draws Near

"If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered." -- Thomas Jefferson

Whether it is Europe or America or any of the other dominoes in this hopelessly entangled financial network that falls first, there is little doubt that the worldwide economic system will follow in a swift cascade of implosions in very short order thereafter - the 'shock and awe' debacle of this very decade. Most people have no idea how to survive in such an environment, having been brought up on the past reality of continuous expansion, with temporary pauses. The future though will look totally different!

The featured article takes an upfront and personal look at this phenomenon, last experienced more than three generations ago - though this time is more likely to resemble the disastrous depression that came out of the South Sea Bubble almost three centuries ago! It is a well-written, if somewhat lengthy piece detailing the build-up to that time and some actions that can be taken to get through it. Here are a few extracted highlights for those who may not find the time to read all the way through:

[This is - the proper definition of - inflation : an increase in the supply of money plus credit relative to available goods and services. In times of speculative mania, when people no longer care what they pay for something on the grounds that someone else will always pay more, and money is being created with abandon in order to satisfy the acquisitive impulse, credit hyper-expansion constitutes inflation on a massive scale.

Expansion is the only reality many of us have known, hence it is no wonder we imagine it can be a permanent condition.

In the process of credit expansion, we borrow from the future through the creation of debt. Our focus on virtual wealth has very significant real world effects, as it distorts our decision-making in ways that guarantee bust will follow boom. We bring forward tomorrow's demand to over-consume today, frantically building out productive capacity in order to satisfy that seemingly insatiable demand.

As money supply increase leads the development of productive capacity during this manic phase, increasing purchasing power chases limited supply and consumer prices rise. Increasing virtual wealth also drives up asset prices across the board, strengthening speculative feedback loops that inevitably strain the fabric of our societies, all too easily to the breaking point.

However, concern about the inflationary trend continuing into the future is misplaced. That is where we have come from, but it is not where we are going. Simply extrapolating past trends forward is tempting, but does not constitute meaningful analysis and has no genuine predictive value. It is far more important to be able to identify coming trend changes and to understand where these will lead.

Decades of inflation lie behind us. It is deflation - the contraction of the supply of money plus credit relative to available goods and services - that lies ahead. The threat we are facing is the rapid and chaotic extinguishing of the myriad excess claims to underlying real wealth created during our thirty years of credit hyper-expansion.

Here is another illustrative parable of financialization run amok, looking this time at the real world consequences that follow. Whereas credit expansion pushed up both demand and prices, creating the perception of great wealth in the process, the inevitable bust crashes prices and ruins businesses. The artificial demand boost disappears, but rather than return to its previous level, demand crashes and remains depressed for a long period of time.

The greater the scale of the credit expansion, the greater the effect of bringing demand forward during the boom years, and the greater the crash thereafter. With little demand, there is no price support at anything like previous levels, so prices also fall and remain low, potentially for years, as we saw in the depression of the 1930s.] (see full article below)

Monday, December 5, 2011

December 5 2011: Look Back, Look Forward and Look Down. Way Down.

WPA Federal Art Project poster from New York, 1936

Ilargi: At the start of a week that has been dubbed "historical" and "one of the most important moments in Europe's history", I can't seem to forget the statements by Merkel and Sarkozy sometime mid-October, when both solemnly pledged that by the end of that month the euro crisis would be resolved.

We know where that went. And we also know that establishing stronger fiscal ties across the continent, the somewhat vague "plan" that seems to be worked out in all haste, even if it can be accomplished, which is by no means guaranteed, will take a lot of time. Time that Europe almost certainly won't be allowed.

Merkel, Sarkozy, Monti, Draghi, they've lost all credibility in the eyes of the markets. The only thing they still trust them to do is throw more of their people's funds and future funds as free money at the fire, which the markets can then lap up. At some point, though, the free money will run out.

Satyajit Das has some nice quotes:

The Sovereign Debt Train Wreck
The US is in serious, perhaps irretrievable, financial trouble. Peter Schiff, president of Euro Pacific Capital, identified the state of the Union with characteristic bluntness:

"Our government doesn’t have enough spare cash to bail out a lemonade stand. Our standard of living must decline to reflect years of reckless consumption and the disintegration of our industrial base. Only by swallowing this tough medicine now will our sick economy ever recover."

There is a lack of political or popular will to take the action necessary to even stabilise the position. The role of US dollars and US government bonds in the financial system mean that the problems are likely to spread rapidly to engulf other nations.

As John Connally, US Treasury Secretary under President Nixon, beligerently observed: "Our dollar, but your problem."

Connally's observation is about to be thrown right back into the face of America: "Our euro, but your problem."

Europe doesn't have the means to save itself. It will look to the rest of the world, especially the US, to do it instead. The same US that "... doesn’t have enough spare cash to bail out a lemonade stand. Nice dilemma.

As former broker Ann Barnhardt observes: Europe is mathematically impossible. It cannot be saved. [..] You even want to make a start at trying to bail out Europe we are talking $25 trillion just to start. [..] if you were going to bail out the entirety of Europe - you would now be talking about hundreds of trillions of dollars.

Whatever concocted statements or plans come out of the EU summit on Friday, December 9, it doesn't really matter anymore. The best the Europeans can do is extend and pretend the can down the road for a few more days or weeks. So how about it, America?

Here's Stoneleigh with our 1000th post on TAE:


Look Back, Look Forward, Look Down. Way Down:

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