Economic Deflation: The Blood on Bernanke’s Hands

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We left off yesterday wondering what stock market investors were thinking. They bought stocks heavily on Monday. Then, yesterday, they sold them a bit – the Dow fell 38 points.

Yesterday was largely uneventful. Gold rose a dollar. Oil climbed to $82.

Maybe stock market investors are not really expecting to get rich. Maybe they’re trying to avoid getting poor. They may figure that the real risk is being in cash…not in stocks.

If so…they may have a point.

Here’s the low-down…

As near as we can tell, the Japanese-style correction is still underway. Consumers are careful about spending because they fear they might not have jobs. Employers are careful about hiring because they fear they might not have revenue. And banks are careful about lending because 1) few people want to borrow, and 2) the banks figure they may need the money themselves.

Meanwhile, Ben Bernanke has staked his entire reputation on being able to avoid a Japanese-style slump. He gave a famous speech about it back on the 21st of November 2002. He called it “Deflation: Making Sure it Doesn’t Happen Here.”

Well, that was when the inflation rate was not far from the Fed’s 2% target. What’s happened since? The consumer price inflation level – as measured by the government – has now dropped down to 0.5%. And many economists think it will go negative soon.

Hmmm… This leaves Mr. Bernanke in a tight spot. It looks like deflation is happening here. And it is happening after Ben Bernanke has already used most of his tricks to stop it. The Fed is lending money at 0.25% interest – effectively zero. What’s it going to do next? Pay you to take the money?

If Bernanke allows deflation to happen…and persist…he will have Congress on his back. The Fed is supposed to be independent. But every Fed member knows which side his bread is buttered on. And no one doubts where the butter comes from – the US Congress and the administration. And everyone also knows that there will be mid-term elections this year.

As it stands, the voters are not too happy. They’ve seen the banks get bailed out. They’ve watched Goldman’s boys make their millions. And they’ve begun to wonder whose interests their elected representatives are really serving – the voters who sent them to Washington? Or the special interests who write big campaign checks? (Goldman gave millions to the Obama campaign…one of the best investments it ever made…)

Unfortunately for democracy, the poor voter has no idea of what is going on or why. If he has a job and his house is rising in price, he’ll likely vote for the clowns already in Washington. If not, he’ll want new clowns.

And right now, his house is likely to be underwater…and probably sinking. As for his job, he’s lucky to have one.

Ben Bernanke must surely feel the pressure to “do something,” right?

Not only that, his reputation is at stake too. What did he say in that remarkable 2002 speech? Oh yes, that “under a paper money system, a determined government can always generate higher spending and hence positive inflation.”

Well, maybe. But so far, it is looking as though it may not be as easy as the younger Mr. Bernanke thought. We have a paper money system, no doubt about that. We also have a Fed that is determined to keep inflation positive. But we also have inflation that is becoming less positive every day…and may turn negative soon.

And more thoughts…

Remember our discussion of prices yesterday? Here at The Daily Reckoning, we have nothing against higher prices…and nothing against lower prices. It’s dishonest, misleading, and treacherously false prices that we don’t like. They send the wrong information. They may tell us that an item is plentiful, for example, when it is actually in short supply. They may cause us to invest our money in the belief that profit margins are increasing when they are actually shrinking. They may also induce us to expand production, when the world already has far too much of what we have to offer.

And unfortunately for the market system, we live in a world of phony prices. Nobody knows what anything is really worth… Let’s take a simple concept like consumer price levels, generally. According to the feds’ calculation they’re barely rising at all. But if you computed them the same way the Europeans do, you’d find the US price level moving up at 3.5% per year.

So, then you’d have to wonder whether Bernanke and company should be concerned at all. If it’s inflation they want, inflation is what they’ve got. Maybe. We don’t know. We can’t trust prices…or the calculation of price levels.

But the Bernanke team probably has to trust its own numbers. After all, if you can’t trust numbers you twisted yourself, what is the world coming to?

Besides, whether the inflation rate is 0.5% or 3.5% hardly matters. People don’t have jobs. They don’t have incomes. They don’t have much desire to vote for sitting politicians. And Ben Bernanke is going to lose his reputation – such as it is – if he allows this Japanese-like slump to continue.

So, what’s he going to do. He has to “do something”…but what? Well, there aren’t many choices. About the only thing he has left is “quantitative easing.” Yes, maybe stock market investors are right. Maybe they don’t really think stock prices are going to rise. Maybe what they’re really worried about is that cash will turn out to be a bigger trap that stocks. After all, if there is one thing a central bank ought to be able to do – if it puts its mind to it – is create ‘positive’ inflation. And it looks as though the Bernanke Fed will go all out to do it.

The Fed’s Open Market Committee meets next week. Most likely, they’re going to threaten to buy more treasury bonds. That’s the way they hope to get more dollars in circulation and raise consumer prices – thus encouraging both “positive” inflation and consumer spending. If that doesn’t work, they’ll have to resort to even more radical solutions – such as dropping money from helicopters.

They’ll keep at it, most likely, until they get the job done. Whether that will take 6 months or 6 years – we don’t know.

In the meantime, the sensible investor may figure he’d rather be in, say, Exxon or Intel or Johnson & Johnson rather than in the US dollar. Many of the blue chips are cheap. They will probably get cheaper. But then, once the Bernanke inflation machine begins to get some traction, they will probably be a much better place for you money than cash.

Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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Comments

  1. I don’t understand. How does inflation help if people don’t have jobs, or if incomes are not rising. Inflation has the same effect as higher interest rates for the mainstream. It retards the ability for an individual to buy things. So if they are trying to stimulate consumer spending by making things mroe expensive, then yes, consumers -will- spend more money, as staples are more expensive…

    … but is the game to rob people of value, to create a country of slaves or to simulate them to stop saving (and shoring up capital reserves in the banks).

    Maybe I’m not afraid of deflation because I don’t have my cash tied up in assets that will lose value? To me, on a good income with no debt, deflation just increases my buying power and makes things more affordable.

    What am I missing?

    Chris in IT
    August 5, 2010
    Reply
  2. Chris: “What am I missing?”

    The value of _gold_ rises in inflationary times, Chris. ;)

    Reply
  3. @Chris,

    yes,you hit the nail on its head. the name of the game is robbing the people of its value. the feds reckon they can reverse the speeding train once the musical chairs of spending and more spending sets into an apparent perpetual motion(it all arises from the faulty flow vs stock in keynesian concepts in la la land)

    Reply
  4. Chris: “What am I missing?”

    Deflation will lead to job losses. Quite possibly not yours. But your salary will be cut. And in a socialist country you’ll be called on to pay very high tax to feed all the unemployed. In the old days the banks would have gone under. But nowadays you’ll get to pay to bail them out as well. There’ll be a bit of credit around for the likes of yourself I guess. But you won’t be rushing to borrow because you’ll be worried about things like a) asset prices falling further, b) your salary being cut further, and c) ultimately, if things get worse, your job going too.

    I wanted to end with a Smiley Face … But couldn’t think of anything much in that scenario to smile about??? :)

    Reply
  5. Here’s the smiley face, Ned. :)

    Deflation in Oz? Highly unlikely. In the NH? Highly likely!!~

    SH’r’Us. Note the small ‘s’. ;)

    Biker Pete
    August 5, 2010
    Reply
  6. I think true values are the thing to watch rather than the dollar denominated. So I think PMs, commods and oil to to increase in value…and high quality farm land but probably the larger tracts. Smaller bits probably will massively deflate and get sucked back in to larger chunks due to oil cost requiring increasing efficiencies. Not sure people will want twenty acres 2hours outa town. As the value of oil explodes the size of govs to implode and globalisation with it. Plenty of jobs though Neddie… for example on farms with renewed emphasis on local product. Maybe manufacturers to come home. The unemployed will work. Some wont…we’ll eat them.. mmm mmm unemployed people with apple sauce ;)
    Not looking forward to driving less :(
    The west is going to have to shift back toward to real jobs.

    Reply
  7. As opposed to NH’is’US – Well large chunks of it anyway!

    I’m with Ross in my hope they can just keep tottering along the ridge line – Without falling off either side. The one thing that concerns me more than deflation is hyperinflation. That’s REALLY nasty stuff from the little bit I’ve heard and seen of it. Bernanke damn well better know what he’s doing – Or no-one could blame the Yanks for making his send off seem tidy compared to what the Italians gave Il Duce. :)

    Reply
  8. errata: ‘tidy’ -> ‘messy’

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  9. So my take on value is that the flations are irrelevant. eg if we had a hyperinflation you might hold stocks to the moon but when you cash out higher up will that cash buy you more or less of various items. Will some of your picks go belly up…total loss. Same for deflationary collapse absent the monetisations.
    How will the relative values of hard assetts/goods stack up/change in the next five years or so…well thats where Im at anyhow.

    Reply
  10. I prefer mine with whipped cream and chocolate topping Lachlan … But each to their own? :) :) :)

    Reply
  11. “…farms with renewed emphasis on local product…”

    It’s a desirable end, particularly as transport costs rise… .

    I’m sure that the period following the 80s plateau in Australia would qualify as hyperinflation. Certainly felt like it; but, looking back I don’t think it could have been anything else… .

    “…my take on value is that the flations are irrelevant…”

    Y’know, I’m not so sure. Deflation means loss of jobs, as Ned points out. Inflation means today’s buck is worth less tomorrow. The ideal is balance.
    Each ‘flation hurts a specific demographic. For example, deflation whacks retail and jobs; inflation whacks OAPs and fixed incomes.

    So the RBA’s stated position, to keep inflation in check, is defensible.
    At the other end of the scale, the lowering of interest rates when deflation appears predictable, is defensible. All very simplistic, of course; but as Glenn Stevens notes: “It’s a blunt tool.”

    Reply
  12. “Smaller bits probably will massively deflate and get sucked back in to larger chunks due to oil cost requiring increasing efficiencies.”

    You don’t think technological change might mean more intensive farming, Lachlan? At one time our production of cherry tomatoes was so successful we could have supplied every restaurant in town. We were too busy with other projects to bother… but, as retirement beckons, I can see a dozen similar possibilities, particularly once our large solar electricity system is up and running. That project alone, selling power back to the grid, means another income!~

    Having watched our ten acres increase to 7.7 times purchase price, I doubt we’ll see small holdings deflate. Sustainability, lifestyle, and intensive farm production (combined with LETS) may mean these smallholdings are, in fact, the real gold… . :)

    Biker Pete
    August 6, 2010
    Reply
  13. good for you Ned, of course these are the little bonuses in our future that the pessimists fail to pick up on

    Reply
  14. “the flations are irrelevant” – Your middle class get wiped out in high inflation Lachlan – Leastways if they are cash savers they do. Of course in severe deflations where banks fail, effectively the same thing happens.

    So it wouldn’t surprise me too much if Japan’s on again off again deflation for 20 years (but with no bank failures being allowed) hasn’t actually been seen as preferable to the inflationary alternative. For them? And by and large I’d imagine China sees it the same way given their savings culture???

    The Yanks didn’t seem to see it that way initially – And were quite happy to see Bear Stearns and then Lehman Bros go under. But someone apparently gave them a hint along the lines of ‘No bankie, no tickie!’

    Not sure where the RBA and Oz guv see us sitting in that? Sure, we’ve got a lot of debt. But we’ve got a lot of cash too.

    Reply
  15. And never forget the packet of chrystallised cherries Lachlan – You can have huge amounts of fun with them! :)

    Reply
  16. “Not sure where the RBA and Oz guv see us sitting in that?”

    Probably as confused as we are about what might happen next, Ned. ;)
    We do know they’ve missed key indicators at times, acting too late; or failing to act in time.

    Easy to criticise, of course, as HMAS Oz is a fairly large vessel to three-sixty in troubled global waters… .

    Reply
  17. BP, I didn’t think you’d see yourself included in what I was saying. But then I was ambiguous. I shouldn’t have issued a blanket statement about small holdings because it wasn’t what I actually was thinking about.
    I think small land with self sufficiency potential will maintain and grow but not where too far from centres.
    When I’m out and about in the countryside I see a lot of small blocks on marginal/crappy land, no water, isolated (maybe in small regional towns but lacking services anyhow). Many of them have appeared in last ten years, often in little groups. They’re either not selling now or discounted. Stock levels are high. In my opinion they wont work out until the oil age is past us and that still seems a way off (but who really knows).
    Actually Biker, when the oil spiked in price two years ago a number of people moved from my small town (700) to a larger centre up the road a bit. My local agents informed me at that time about the effect it had on them.

    Reply
  18. Yes, you’re right… 700 is a small town. We’re seeing the emergence of deliberate shire ‘nodal’ policies, to energise towns that size, at present. Small holdings near these nodes are around a million, even without groundwater. We’ve owned four over the years.

    As far as the oil age, I think that rapid production of EVs will astonish us.
    It may even leapfrog internal combustion to the extent that oil prices plateau, or fall, for some time. Lexus is the latest marque to develop an EV.
    Once cheap EVs become popular, distances may be diminished… .

    Reply
  19. Ned maybe I was ambiguous again. Flations have huge and broad impacts…agreed. I was discerning between value and price…where flations arent the “key” issue.
    For mine, if you have tangibles and not exposed to the type of interest rate spikes we could perceivably have (large debts)…you can relax, protected by intrinsic value of your chosen tangible. Relative values may alter a little bit and I see they are constantly doing so but the key issue is you wont be robbed…as many will be.

    Reply
  20. “…deliberate shire ‘nodal’ policies, to energise towns that size…”

    Should have explained that ‘energise’ here means:

    * development approvals have priority

    * provision of mains water and services

    * provision of roads, cycle paths, etc

    This has both positive and negative consequences, as you can imagine.
    The intention of nodal strategies appears to be to promote a village concept, in preference to extending the usual Oz urban sprawl…

    Reply
  21. ” Once cheap EVs become popular, distances may be diminished…”
    Now thats the sort of talk I wanna hear BP :). Just not sure how long till a dual cab 4wd comes out for me?

    Reply
  22. Its incredible BP how easily and grossly the future can be affected by tech…the difference between languishing in the oil age with POO at multiples of current and then a future with EVs. HUGE!! when you think about it.

    Reply
  23. They do mention other production vehicles in the article, Lachlan:

    http://www.carsguide.com.au/site/news-and-reviews/car-news/lexus_plans_plug-in_super_coupe

    (Took our bikes out onto the Nurburgring racecourse, while in Germany, in 2005. More fun than the autobahns… .)

    Reply
  24. Our little town is a bottler but BP with a much larger centre nearbye. Further west many towns of our size or say a few hundred..distance will be a major problem with expensive oil, until technolgy saves us.

    Reply
  25. And you’ll be young enough to get maximum time and distance out of it, Lachlan! I’ll be (a young, fit) 68 when my new EV is delivered!!~ :)

    Reply
  26. “I think small land with self sufficiency potential will maintain and grow but not where too far from centres.”
    So I’m talking about people on net moving into these areas BP but not arguing price. Value should improve with demand as I see it.

    Reply
  27. Value may be there right now, Lachlan. Price will rise with demand.

    For a few years we tried to find some bargains in Special Rurals, on behalf of our sons. We found them, but failed to realise they were bargains. That area is now over 300% higher.

    Off to pick up my new boat. Not really a ‘need’… but a slab of bronzie on the barbie is hard to beat… . :)

    Biker Pete
    August 6, 2010
    Reply
  28. DR’s stooge in Newcastle reporting on the deflationary trends. I stocked up on Kathmandu outdoor gear at the sale last w/e. Most items were discounted 60%, and I was surprised with a further 15% off at checkout. This connected to the report that stock prices for this retailer had fallen. I heard, maybe here, that other major outlets like David Jones etc are only making 1-2% at the moment, less than inflation. So inventory isn’t clearing.
    At the beach you can count the number of coal-loader ships on the horizon on almost one hand. Normally the queue is much longer, say high 20’s.
    The place looks and feels quiet. eg I recall seeing only 1 concrete-mixer all week on my 20km daily commute. “Unusually uncertain”.
    And yet Aussies are still buying property. Someone I know bought a house this week for $480,000 and is looking to negative gear it. Regardless, an awfully big outlay IMO.
    Seems like a good time (as the money supply dries up) to stay cashed up, scan the w/e papers for sales, maybe even stock-pile on some items.

    Bearamundi
    August 6, 2010
    Reply
  29. “my new boat” – Mine will most likely be a secondhand canoe that I do up Biker. No rego or licence costs (I hope?) Reckon I’ll be able to figure out some sort of outrigger setup for crab pots and such like. Yep, I’m looking forward to it too! :)

    Reply
  30. “other major outlets like David Jones etc are only making 1-2%” – Maybe they need to rethink their business models Bear? The last two major electrical appliances I bought both came off the internet – Even including the $20 delivery fee on each item, the store bound retailers weren’t in the hunt.

    Reply
  31. Is it possible that if we had less salespeople and more ditch diggers then our house prices might be a bit cheaper???

    Reply
  32. Hi Ned,
    That would depend on the relative salaries wouldn’t it?
    You’re not related to that aussie hero/villain are you?
    Maybe it is not the business model as much as the extent of debt? The Chinese businessman might be saying: “Mr Rudd, he number one, you aussie not smart” well, before FHOBG was removed anyway.

    bearamundi
    August 6, 2010
    Reply
  33. “He was an honest man; Compared to the likes of some!” … As they say Bear. :)

    My guess is that ditch diggers nor salespeople would thank me for my thought – The salespeople will have to go and dig ditches for a living; And the ditch diggers wages will go down.

    Reply
  34. “No rego or licence costs (I hope?)”

    Don’t count on it, Ned!

    I’ve just counted four separate licences: boat, trailer, boat (fishing), fishing. Add my Skipper’s Ticket… and that’s five.

    It’s actually a sweet little hybrid: electric motor and fuel motor, with two batteries… ideal for a little trolling; some squidding; crabbing; coupla craypots and a couple of shark lines.

    Just got it home. Missus hasn’t seen it yet!~ :)

    Biker Pete
    August 6, 2010
    Reply
  35. Oh, and in case there is any confusion, by ‘He’, I didn’t mean Kev – I recently sent all our sitting pollies and their protagonists an email asking if we can have the job category “Politician worth feeding” added to the nation’s critical skills shortage list.

    Reply
  36. “Just got it home” – Excellent news Biker! Us boys always love our new toys!!! (Leastways when they are paid for cash up front!) :)

    Reply
  37. “I recall seeing only 1 concrete-mixer all week on my 20km daily commute.”

    Heartbreaking news!~ ;)

    Reply
  38. They wanted 2% if I put it on Visa, Ned; so I paid by cheque. Yes, I figure we ditchdiggers toil hard for our pennies, so a little punt won’t hurt much.

    I’m saddened to hear that the supply of new homes is dwindling, mate.
    Where will we put the new people?

    I hear we already have half a million Kiwis here in Oz. Guess they know a good thing when they see it?!~ ;)

    Reply
  39. I could imagine you enjoying a bit of trollling Biker!!

    bearamundi
    August 6, 2010
    Reply
  40. Yeah, it’s all the strikes I get from bearamundi I enjoy most!~ :)

    Reply
  41. “we ditchdiggers toil hard for our pennies, so a little punt won’t hurt much” – Amen brother; Amen … :)

    Reply
  42. “slab of bronzie”…you mean bronze whaler BP?
    Fished for sharks as a kid. Obsessed with them actually. Good fun chasing bull sharks in the shallows…not too deep but :(
    you know they might get the upper hand. Its all a mind/confidence game with em. Never ate them. Maybe a waste hey?

    Reply
  43. “Good fun chasing bull sharks in the shallows…not too deep but
    you know they might get the upper hand” – Which is another reason why I want outriggers on my canoe mate! :)

    Reply
  44. “Never ate them. Maybe a waste hey?”

    Brilliant eating, Lachlan. There a quite a lot of BWs reasonably close to shore here. We also catch gummy sharks, school sharks and wobbegongs.
    The latter are ugly-looking brutes, but their cutlets are superb
    poached in a little white wine, wrapped in tinfoil, on a BBQ.

    Gotta stop. I’m salivating and the missus thinks I’m having conniptions drooling over the new toy…. . :)

    Reply
  45. Good on ya BP. I do know people that catch and eat shark…they all seem to go on the BBQ…must be the cooking mathod/shark combo that does it.
    Ned you can fish the Pine River then? Looks alright when I pass over occasionally….little tinnies dotted about, rods over side.
    Bear…run for it mate. Theres bulls and fisherman all over the place ;)

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  46. The Pine – Yep, nothing much to look at but the word is that there’s still a feed in there on occasion.

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  47. “Yeah, it’s all the strikes I get from bearamundi I enjoy most!~”

    Oh reely…

    bearamundi
    August 6, 2010
    Reply
  48. Hey Lachlan, did you catch ‘The Keiser Report No63’ on youtube yet? It’s on (whisper) ‘Ag’….(heads off into weeds)

    bearamundi
    August 6, 2010
    Reply
  49. Not yet. That can be a late night read for me Bear…done a bit of that this week

    Reply
  50. youtube…no reading involved, the funniest commentator around. He’ll have you on the floor sometimes…

    bearamundi
    August 6, 2010
    Reply
  51. “Oh reely…”

    Yes, ya line b*stard…

    Reply
  52. “Gotta stop. I’m salivating” … Yeh, everytime I see that pic of the new baby pygmy hippo at Taronga Zoo I think of BBQ only to then muse on those selfsame politically correct thoughts! :)

    Reply

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