Worse than a Depression
By Monty Pelerin
AmericanThinker.com
As the economic
crisis approaches the two-year point, it is apparent that "this time is
different." Few analysts believe that we are going to recover from this
Great Recession in a fashion that resembles prior recoveries. Most argue
about how long it might run (Japan's recovery is now two decades old), and
whether inflation or deflation results. Two years into the problem, these
issues are still unclear.
It is understandable why the
duration of the recovery might be moot. Less clear is why economists
cannot agree as to whether there will be deflation or inflation. After
all, these outcomes are polar opposites of one another and critical
knowledge:
"I believe that
getting the inflation/deflation story right is the single-most
important investment decision that needs to be made. It will
determine the investment outcome of portfolios over the next
decade."
- Jim
Puplava, FinancialSenseOnline, July 24, 2009
Inflation and deflation proponents have
intelligent, reasoned arguments. Both have some representatives that
were not "surprised" by the events of 2008. How is it possible that
intelligent people can forecast such opposite outcomes? The differences,
in my opinion, arise from two primary sources:
- 1. The schools
of economics themselves
- 2. The time
horizon
Schools of Economics
Each school is complex, and not as simplistic
as this short treatment might suggest, but here are the basics:
The Keynesian school of economics believes
that aggregate demand is the driver for economic outcomes. If aggregate
demand is too low, an "output gap" (the difference between current
demand and demand necessary for full employment) is said to exist.
Because demand is "insufficient," upward price pressures are claimed to
be not possible.
Monetarists and Austrians believe, as Milton
Friedman was fond of stating, that "inflation is always and everywhere a
monetary phenomenon." While these schools otherwise differ tremendously,
both understand money to be the driver of inflation.
Virtually all Keynesians, as a result of the
output gap, believe that deflation is the likely outcome of our current
situation. Keynesians did not believe the stagflation of the late 1970s
was possible. That period had "insufficient demand" but high inflation,
theoretically an oxymoron in the Keynesian system. Their continued
insistence on more stimuli suggests that their notion of "output gaps"
still plays a central role in their thinking.
Monetarists and Austrians disagree with
Keynesians on virtually everything and frequently disagree with each
other -- except on the critical role of money in the economy. Their
methodologies and monetary processes differ, but both monetarists and
Austrians recognize the possibility of an "output gap" coexisting with
inflation.
The Time Horizon
Current data support the deflationist
position. Money supply is shrinking and there is no inflation, at least
as measured by the government's CPI calculation. There are few signs of
economic recovery despite the "green shoots" melody sung by government
and their media minions.
Monetarists and Austrians would agree that
price increases in a deflationary environment are impossible. (The
original definitions of inflation and deflation were in terms of
inflating or deflating money supply.) Those who expect inflation,
therefore, also expect a rising money supply at some point.
Reconciliation of the different positions
becomes tractable if one allows for different time horizons. In fact, I
would argue that both sides of the debate are correct -- i.e., we will
have deflation followed by inflation.
Argument for Deflation
Throughout the
financial crisis, policymakers have focused on keeping things afloat
until the storm passes. They've spent vast
sums of taxpayer funds trying to jumpstart growth
until the economy is back on track. They've
encouraged people to keep the faith until
businesses start hiring again.
Servicing existing debt is impossible because
income levels are not high enough to do so. The economy cannot grow
large enough fast enough to offset this problem. Debt will be liquidated
by default/forgiveness.
Government has been unwilling to accept a
downturn, adding more debt in hopes of generating a miracle that cannot
arrive. The danger, as expressed by Financial Armageddon, is that the
presumed "untils" do not happen:
But what happens if all those "untils" turn
out to be wide of the mark? What if the carnage we've experienced so
far is structural, not cyclical? If that's the case, then Americans
are going to find that instead of experiencing better times ahead,
they are going to be much worse off than they were -- or are.
Additional debt is of little
value. Debt's
marginal value,
with respect to creating additional GDP, has gone negative. The
government has fired all of its bullets. It has nothing left that will
affect real output on any sustainable basis.
As the economy continues to devolve,
deflationary forces grow stronger. The private sector continues to shed
debt. The public sector attempts to offset this with greater deficit
spending and more stimulus packages. The private sector is contracting
faster than the government can expand.
How We Get Inflation
Our government is
bankrupt many times over (see
Spiraling to Bankruptcy),
as are the democratic socialist states of Europe (see
Welfare States - R. I. P.).
For political reasons, none of these countries is either willing to cut
back on its spending or accept a recession.
Mish provided
a description of both the U.S. and Europe (my
emphasis):
For Europe, $1
trillion is not enough, nor would $10 trillion.
There is no plan that can possibly work. But that will not stop
politicians from trying. Politicians do not care about math or
logic, or the fact that piling on more debt cannot possibly be the
cure for a problem of too much debt with no possible way to pay it
back.
We are witnessing the death of democratic
socialism. No politician wants it to happen, but none can prevent it. We
are at the point where the Ponzi concept of "extend and pretend" has
been extended beyond social commitments and banking systems to entire
economies. We are approaching what Ludwig von Mises described as "the
crack-up boom":
There is no means of avoiding the final
collapse of a boom brought about by credit [debt] expansion. The
alternative is only whether the crisis should come sooner as the
result of a voluntary abandonment of further credit [debt]
expansion, or later as a final and total catastrophe of the currency
system involved.
Political cowards around
the world have chosen Mises' second outcome -- "a total catastrophe of
the currency system involved."
None of the countries
have the resources to continue to fund current programs. As their
economies deteriorate, they will "print money" in order to continue
meeting obligations and stimulating. At some point, the money supply
will explode vis-à-vis the goods available.
We have seen many "impossibles"
in the last couple of years. Be prepared for the next --
a hyperinflationary depression. It is not
impossible, it is not an oxymoron, and it should surprise no thinking
economist. It is nearly upon us.
Your lifestyle will depend on how prepared you
are to meet this newest, biggest, and most horrific Black Swan. This
beast will destroy economies, overthrow some governments, and alter the
nature of the world.
Wake up, people! Your politicians have no
intention of heading this off.