Thursday, February 11, 2016

A Climactic Battle

Rickards, The Death of Money

The world is witnessing a climactic battle between deflation and inflation. The deflation is endogenous, derived from emerging markets’ productivity, demographic shifts, and balance sheet deleveraging. The inflation is exogenous, coming from central bank interest-rate policy and money printing. Price index time series are not mere data points; they are more like a seismograph that measures tectonic plates pushing against each other on a fault line. Often the fault line is quiet, almost still. At other times it is active, as pressure builds and one plate pushes under another. Inflation was relatively active in 2011 as the year-over-year increase reached 3.2 percent. Deflation got the upper hand in late 2012; a four-month stretch from September to December 2012 produced a steady decline in the consumer price index. The economy is neither in an inflationary nor a deflationary mode; it is experiencing both at the same time from different causes; price indexes reveal how these offsetting forces are playing out.

This dynamic has profound implications for policy. It means the Fed cannot stop its easing policy so long as the fundamental deflationary forces are in place. If the Fed relented in its money printing, deflation would quickly dominate the economy, with disastrous consequences for the national debt, government revenue, and the banking system. But deflation’s root causes are not going away either. At least a billion more workers will enter the labor force in Asia, Africa, and Latin America in coming decades, which will keep downward pressure on costs and prices. Meanwhile a demographic debacle in developed countries will put downward pressure on aggregate demand in these advanced economies. Finally, technological breakthroughs are accelerating and promise higher productivity with cheaper goods and services [..]

In short, the world wants to deflate while governments want to inflate. Neither force will relent, so the pressure between them will continue to build. It is just a matter of time before the economy experiences more than just bubbles, but an earthquake in the form of either a deeper depression or higher inflation, as one force rapidly and unexpectedly overwhelms the other.