Inflation-Driven Boom Will Be Followed By Deflationary Meltdown

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We got this note the other day, “You say in part, ‘In markets today, to get along, you have to go long. And if you don’t, well you’re out of luck.’ Are you no longer worried about a melt down in the short term? How long is long? One year or two?

“Your past words of imminent doom had me very worried with its effect on my investment actions, (or inaction ) are you now changing your timeline? I am a daily reader of your investment letter and look forward to your response.”

We answer that a melt-down must be preceded by a melt-up. Or in economic terms, a deflationary bust characterised by over production and capacity surpluses must be preceded by an inflationary boom.

We are in the boom phase. And like it or not, related to real value or not, prices are going to rise as global money and credit creation booms. If you’re in the markets, you’ve got to make a choice with your money. So we’ll be choosing assets with tangible value that are in economic demand as well.

Dan Denning
The Daily Reckoning Australia

Are we in the middle of an inflationary boom? Leave a comment below.

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Yes, we most definitely ARE! Prices of everything are being driven to otherwise nutty levels. I’m a stamp collector; it’s true even in my field. Ditto Ebay coins, PM stocks, and base metals. But some things have been so beaten down that they will have value even after a general stock melt-down, I suspect. Search junior miners carefully! Some of mine are doing well and, moreover, can be bought at reasonable prices. What about gold? On one hand, some say it is somewhat overpriced considering weak (current) investment demand. But in a world of constantly increasing asset prices, don’t you think something which HASN’T boomed over the last year or so (like gold) might just be worth looking at?

    One day soon the general melt-down MAY begin. My stuff will melt down too. But the key question is: what holds value? And…what may bounce back or lose the least as a result of holding value? Paper assets will be out of business for YEARS! But I would suspect even a (today) slightly overpriced Rolex will do better when the blood starts running!

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  2. Even people with a ‘balanced’ portfolio have purchased some portion of it with current cheap credit, if our national savings rate is any guide. They will initally at least sell things of value that they actually own to pay the interest/margin call. No asset will be immune, but some may move through the trough of disillusion faster than others.

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  3. There are a number of contributing factors to a deflationary “outcome”. Two key aspects for Future Watch is “over-indebtedness” and “structural change”.

    In support of the first aspect, Irving “permanent plateau” Fisher, Professor of Yale University, an optimism in 1929, who did not see the coming correction, “examined the depressions of 1837, 1873 and 1929, identifying a number of common factors, but he found these played a subordinate role compared with two dominant factors, namely over-indebtedness to start with, and deflation following soon after” (Max Walsh, Inflation: No joy, only depression, SMH, January 30, 1992, p.23).

    It has taken a technology-driven stockmarket boom followed by a housing and resurrected stockmarket boom to bring consumers, business and government close to the debt-saturation point in this financial cycle. Total American credit market debt for the 4Q 2006 was at 336% of GDP. The high in the previous cycle was 270% in 1929.

    “The United States’ economy has been in recession only nine times in the last 60 years, or roughly once every seven years. Before the last recession in 2001, the economy even expanded for a full ten years. And the average recession has only lasted for about four quarters” (Joachim Fels, Recession 2007, morganstanley.com, November 18, 2005).

    Joachim Fels points out that the US economy has experienced a recession roughly “once every seven years”. This is in keeping with the Biblical “Year of Release” where at the end of every sixth year of seven seven-year cycles, in a 50 year financial cycle, short term debt was cancelled. Long-term debt was cancelled at the end of the 49th year. The fifth year was known as the “Jubilee year”.

    To prevent debt-liquidating depressions and the misery that accompanies them, a financial cycle based, and enforced, on the “Year of Release” and “Jubilee Year” is required not a gold standard per se.

    In regard to the second aspect, Michael Berstein’s premise regarding contraction of the 1920s, and for the 1970s, is relevant for the future, as it was also for the nineteenth century:

    “I want to suggest in this study that the difficulty experienced by the American economy in the 1930s was an outgrowth of secular trends in development. By the 1920s, the economy had entered an era characterized by the emergence of dramatically new demand patterns and investment opportunities foreshadowed and indeed encouraged a shift in the composition of national output. But such a qualitative transformation created impediments to the recovery process in the thirties. These impediments derived from the difficulty of altering technology and labour skills to meet demands for new investment and consumer goods at a time of severe financial instability. In this sense, long-term growth mechanisms played a major role in the cyclical problems of the interwar period” (Michael A. Bernstein, The Great Depression, Delayed recovery and economic change, 1929-1939, Cambridge: Cambridge University Press, 1987, p.20).

    We see a glimpse of the future from The Economist:

    “We are in the early stages of the creation of a new industry, reminiscent of computing in the early 1970s when companies began to adopt it in earnest. There was plenty of resistance. The systems were difficult to operate and seemed to be set up for nerds. The economic benefits were questioned. There were privacy and regulatory worries. Yet in time the rough edges were smoothed and everybody benefited” (Telecoms – The hidden revolution, economist.com, April 26, 2007).

    The Economist in “Telecoms – A world of connections” states that the ‘structural change’ ahead “will be tricky” and “it will not be easy”.

    Future Watch argues that the coming deflationary depression will be the labour pains to the Information Age proper just as the Great Depression of the 19th Century – “a depression of prices, a depression of interest, and a depression of profits” (Alfred Marshall) – was the birth pangs of the Industrial Age.

    Any model for viewing the future needs to incorporate the financial, technological, social, and war cycles with the hegemonic cycle.

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