Paul Krugman: The Inflation Obsession. March 2, 2014. New York Times.

[modified: both paraphrased and cut]

Recently the Federal Reserve released transcripts of its monetary policy meetings during the fateful year of 2008. And, boy, are they discouraging reading because Fed officials come across as clueless about the gathering economic storm. What’s really striking is the extent to which they were obsessed with the wrong thing. The economy was plunging, yet all many people at the Fed wanted to talk about was inflation.

Matthew O’Brien at The Atlantic has done the math. In August 2008 there were 322 mentions of inflation, versus only 28 of unemployment and 19 of systemic risks or crises. In the meeting on Sept. 16, 2008 — the day after Lehman fell! — there were 129 mentions of inflation versus 26 mentions of unemployment and only four of systemic risks or crises.

Historians of the Great Depression have long marveled at the folly of policy discussion at the time. The Bank of England, faced with a devastating deflationary spiral, kept obsessing over the imagined threat of inflation.  It turns out that modern monetary officials facing financial crisis were just as obsessed with the wrong thing as their predecessors 3 generations before.

They failed to understand that printing money in a depressed economy isn’t inflationary.

[Since 2008 many still worry about] “the supposed threat of rising prices, despite being wrong again and again. If you spent the last 5 years watching CNBC, reading the Wall Street Journal, or  listening to prominent conservative economists, you lived in a constant state of alarm over runaway inflation, which was coming any day now. It never did.”

At a fundamental level, it’s political — obvious if you look at who the inflation obsessives are. Most conservatives are inflation obsessives, and nearly all inflation obsessives are conservative. Why?  It reflects the belief that the government should never seek to [help the public], because the private sector always knows best.

The flip side of this anti-government attitude is the conviction that any attempt to boost the economy, whether fiscal or monetary, must produce disastrous results — Zimbabwe, here we come! And this conviction is so strong that it persists no matter how wrong it has been, year after year.

Finally, all this ties in with a predilection for acting tough and inflicting punishment whatever the economic conditions. The British journalist William Keegan once described this as “sado-monetarism,” and it’s very much alive today.  We used to marvel at the wrongheadedness of policy makers during the Great Depression. But when the Great Recession struck, and we were given a chance to do better, we ended up repeating all the same mistakes.

April 1, 2011. Comstock Partners There Still Is No Viable Solution To America’s Debt Crisis Businessinsider.com

Our feeling, as long-time readers will not be surprised to hear, is that this enormous debt will not be inflationary but deflationary instead.  If this is the case, the stock market is headed much lower and the economy will either go into a double-dip or have such a sluggish recovery that it will feel like one. There are the two main reasons we are so convinced that we will not be able to inflate or grow our way out of this mess.

1) the massive increase that QE1 and QE2 has generated in the monetary base has not been translated into anywhere near a commensurate rise in money supply (the so-called “money multiplier”).

2) the subdued rise in the money supply to date has not resulted in a big increase in GDP (the so-called “velocity of money”)-.

3) The loose fiscal policies cannot generate the borrowing and spending that is required to get the money supply up enough to drive the economy and inflation higher.

4) The velocity of money is also influenced by interest rates. When rates are low, people hold more money in cash. On the other hand, when rates are rising, they put more money in interest paying investments.  The low rates, as we have now, results in a “liquidity trap”, which is what Japan has also experienced over the past 21 years.

5) Another reason that makes us so convinced that the “debt situation” will be resolved by deflation and not inflation is the political environment that is currently sweeping the nation. The Republicans and Tea Party congressmen and governors that were recently elected ran on a platform of cutting government expenditures, cutting back on entitlement expenditures, and doing whatever possible to pay down the debt. The bipartisan “Debt Commission” that was sponsored by President Obama, came up with a number of austerity measures that would cut the deficit substantially over time. The big problem, however, is that any austerity program implemented now will only exacerbate the ongoing deleveraging of this debt and throw the economy into recession.

6) Another reason we believe the onerous debt incurred over the past 30 years will wind up with a painful deflationary bear market rather than inflation or hyper-inflation is the high cost of necessities such as food and energy is much more deflationary than inflationary. 

7) In order for easy fiscal and monetary policy to result in significant inflation there must be a transfer mechanism, and that mechanism is a rise in wages by an amount at least enough to enable consumers to pay the higher prices. That just doesn’t look as if it is going to happen.

Since wages have been static for years, the high cost of these necessities acts to reduce real disposable income. This, in turn, reduces what the average consumer can purchase with his or her disposable income. More money spent on energy and food simply means less money to spend elsewhere.

Unless we escape this “trap” there will be massive deleveraging by the sector that drove us into this mess. Household debt rose from 50% of GDP in the 1960s, 70s and 80s and eventually doubled to close to 100% of GDP presently. This debt will either be defaulted on, or paid down until we get back to the norm of around 50% of GDP again.  This will bring household debt down below $10 trillion from $13.5 trillion now.

Nov 15, 2009 DEFLATION Robert Prechter of “Conquer the Crash”

In 2008 when credit contracts, dollars disappeared, the dollar went up in value. Now market, gold, etc way up, but next downturn, dollar will go up even more in 2010 than 2008 crash.  At least for 5-7 years you’ll be able to buy a lot more stuff with the dollar.  deflation will rule. once we have enough defaults and stabiliziation, the system can start over, and anything can happen. Printing press, gold std, gold illegal — who knows.  But meanwhile the debt market is so huge, that only deflation is possible. unemployment will go way up. companies should cut salaries in half instead. you can profit, it’s the greatest opportunity in your life. be leveraged on the down side, though avg person isn’t a speculator and just wants to hang onto their money. So stick with treasuries only. downturn downside: more conflict, don’t be in the centers of this activity. People will sell stocks, won’t lend or borrow, politics gets polarized, real risks, angry at neighbors, states telling fed gov’t to back off on drug laws, etc.

Aug 12, 2008. 8 really, really scary predictions. Fortune spoke to eight of the market’s sharpest thinkers and what they had to say about the future is frightening.  CNN Money.

Nouriel Roubini, Known as Dr. Doom, the NYU economics professor saw the mortgage-related meltdown coming.

We are in the middle of a very severe recession that’s going to continue through all of 2009 – the worst U.S. recession in the past 50 years. It’s the bursting of a huge leveraged-up credit bubble. There’s no going back, and there is no bottom to it. It was excessive in everything from subprime to prime, from credit cards to student loans, from corporate bonds to muni bonds. You name it. And it’s all reversing right now in a very, very massive way. At this point it’s not just a U.S. recession. All of the advanced economies are at the beginning of a hard landing. And emerging markets, beginning with China, are in a severe slowdown. So we’re having a global recession and it’s becoming worse.

Things are going to be awful for everyday people. U.S. GDP growth is going to be negative through the end of 2009. And the recovery in 2010 and 2011, if there is one, is going to be so weak – with a growth rate of 1% to 1.5% – that it’s going to feel like a recession. I see the unemployment rate peaking at around 9% by 2010. The value of homes has already fallen 25%. In my view, home prices are going to fall by another 15% before bottoming out in 2010.

For the next 12 months I would stay away from risky assets. I would stay away from the stock market. I would stay away from commodities. I would stay away from credit, both high-yield and high-grade. I would stay in cash or cashlike instruments such as short-term or longer-term government bonds. It’s better to stay in things with low returns rather than to lose 50% of your wealth. You should preserve capital.

Jim Rogers. the commodities guru predicted two years ago that the credit bubble would devastate Wall Street.

We are in a period of forced liquidation, which has happened only eight or nine times in the past 150 years. The fact that it’s historic doesn’t make it any more fun, of course. But it is a pretty interesting time when there is forced selling of everything with no regard for facts or fundamentals at all.

Bill Bonner. Aug 6, 2007. thedailyreckoning.com 

[Written BEFORE the 2008 meltdown]

Bill Bonner argues for deflation.  He thinks the Fed is wrong about the risk of inflation. Here’s how he sees the crisis evolving:

1. Liquidity dries up
2. Lenders don’t want to lend
3. Spenders don’t want to spend — they want to hang onto what they have.
4. It’s a downward spiral, the more prices fall, the more consumers are reluctant to spend because they might get a better deal if they wait.  Basically, they turn Japanese and hoard money.
5. Takeovers and leveraged buyouts came to a stop.

Bonner asks “What can the feds do?”  They can print more money, but how are they going to get it into the hands of people who will spread it around?  The Fed would prefer inflation – they’re already printing too much money.  But they won’t be able to inflate their way out of the economic crisis, because the Feds won’t be able to get the money into the hands of the people who need it most, so we’ll eventually end up with deflation. Once deflation kicks in, people won’t borrow because they’re not sure they can pay it back.  Prices fall, so money paid back on a loan is more valuable than the borrowed money.

Bonner says that Ben Bernacke, who is fully aware of the dangers, thinks the Fed can get around it with “a technology…called a printing press…”, and if need be drop dollars from helicopters to get money into circulation (this is why Bernacke is called “Helicopter Ben” at thedailyreckoning).  Of course Bonner says, Ben was being fanciful, the Fed won’t actually do this or the dollar would inflate faster than in Zimbabwe, where inflation is over 5,000% a year.

When Japan’s real estate and stock bubbles popped, everyone had a lot of savings, the country had a huge trade surplus, and there was no subprime lending problem.  But in America the average person is in debt.  Bonner asks “Can America afford a liquidity crunch…a credit contraction…a deflation? We don’t know…but if we were Ben Bernanke, we might want to make sure the printing presses and helicopters were in good running order.”

 

May 1, 2008. Investable Capital – And Why It Matters. By Karl Denninger.  The Market Ticker.   [Written BEFORE the 2008 meltdown]

Long article.  It ends with:  “Nothing goes in a straight line folks, but the inevitability of what is coming down the road is a simple matter of mathematics. Our politicians do not want to listen, but the fact remains that they created this Ponzi Scheme at the request of the banks and other financial institutions and were warned that it would turn out like this.  They ignored those warnings, and now that day is here.  I have several times warned people to raise cash. I still mean it – raise cash, and do it now. Use this “rally” to prepare, because at the moment you are in the eye of a hurricane – and the other side of the eyewall is coming.  Soon.”

Dec 9, 2008. Chris Martenson interview.

I’ve excerpted the part about how credit affects businesses

I think there’s probably a 50% change that we are going to see a banking holiday before this year is out. And the reason that this would happen is that everything is chaotic right now. And the banks actually, they may not even know if they are solvent themselves. But they certainly don’t know if their banking partners across the street are solvent. And so what that does is it causes the banks to not want to trade with each other. We’re seeing this already, the interbank lending rates are very high and there’s a lot of fear and banks aren’t even talking which each other in a good way around this right now. And so, if the banks really just stopped and the credit stopped, this is actually a pretty big blow to our style of economy, because we have a credit based economy.

What I mean by that is that even if your local store decides to order more food from a distributor, they’re going to do that on a credit basis of some kind. They’re going to place the order, no cash is going to go from one account to another. They might have 30, 60 days to make good on that. The distributor is doing the same sort of stuff with whoever they’re getting their product from. And all the time they are using the banks as a cash flow mechanism, as they operate on credit. If the credit goes away, and we don’t have a credit based economy any more, then we go back to a cash based economy. And we don’t have a cash based economy anymore. We could figure it out again, but trust me, it’s going to be a little bit weird for a while.

JB: Yeah, do the groceries still arrive to the store, does the power stay on, does payroll still get made?

CM: All of that, most of that is happening through credit mechanisms. We live in a just-in-time society where pretty much everything, from your medication, to your food, to your gasoline all arrive on a continuous rolling basis when it’s needed. If that credit mechanism breaks down, our system literally freezes up.   To prepare for a potential banking holiday, take some cash out of the bank, 1 to 3 months living expenses. Think about like in Katrina: Katrina hit and all of a sudden ATMs didn’t work and people weren’t taking checks and credit cards, the whole thing kind of didn’t work for a while. And so for people who had cash, you could still go out and conduct business. So part 1 is to get some money out of the banking system. Make sure you’ve got a really safe place to keep it if you choose that option.  Also make sure that whatever bank you’re with is the safest bank you can find.   I use three banks, none of them big nationals exposed to the derivative crisis. All of them are banks that are very highly rated by independent rating services. And of course, nobody should have a bank account with more than the FDIC limit on it at this point in time.

JB: Well, what about that, instead of just having stashes of money, you create some buffer in your food and your medical system at home?

CM: I think that’s just plain out prudent. It doesn’t cost that much and if you took somebody from 100 years ago and teleported them to today and showed them our system, they’d be aghast, because it would be unthinkable that you would ever go into October without knowing exactly where all your food was at that point in time.