What plan for the upcoming inflation?

[Machjo]

Last quarter we recorded deflation in the economy. Now certainly is not the time to worry about labour shortages, inflation, high interest rates, and growing government debt, but rather deflation. This, however, is precisely the time when the government should be looking ahead and drawing up a detailed global and long-term counter-inflation policy. Of course we would not expect the government to implement the strategy while we're in a state of deflation, but it is the time to plan for it, while we're not in any state of panic, thus allowing us to plan it in a calm and rational manner. We may be out of deflation by next month, or maybe next quarter, or maybe later still. But whenever it comes, we should be ready for it now.

This I think is the error that the government for this recession. Since we were not in recession, the government chose to lazy about and not do its job and look tothe possibilities. It should have at lesat considered the possibility of inflation and have a rational plan of attack, not the multi-billion dollar knee-jerk reaction it exhibited owing to lack of preparation. I hope the government wont' repeat this mistake for the upcoming boom, and just as it should have planned for the recession before the recession, so it should be planning for the boom before the boom.

But alas, I doubt they can see that far.

[Pliny]

I saw what seemed to be deflation and several economists said we were in a period of deflation but couldn't come to grips with why because the definition of deflation is "a decrease in the supply of money and credit" as inflation is an increase in the supply of money and credit. The drop or rise in general price levels is merely a symptom of monetary increase or decrease.

After doing some more reading I determined we were not in a period of deflation at all and the definitions I just stated were sound.

We were in a period of price adjustment. There was not a drop in the general price level. There was a correction in the prices of some overpriced items such as housing and automobiles. The housing market was of course an economic bubble created by government in its kind attempt "to make housing available" to as many citizens as possible and by creating moral hazard for mortgagers by having the financial industry and government itself, in the entities of Fanny Mae and Freddie Mac, buy up the repackaged derivatives from said lenders. Everyone rode the wave until it broke. It was a big wave and the bigger they are the harder they fall.

The stimulus package was designed to replace the loss in value of the derivatives and was a further injection of money into the economy.

Were banks and financial institutions really not lending? They were certainly being more prudent and the government wasn't able to get them to continue lending in the prolific manner they did during the housing boom. Making what was termed Ninja loans (No Income No job Approvals)

The economy has slowed down because people are saving rather than choosing to spend or invest. Instability and uncertainty as to where the economy is headed is the reason for them making this choice. They are also uncertain about their jobs. The government is trying to get people to spend.

Are we going to see inflation?

By its definition we will. The American government has injected more money into the economy in one year than has been injected over the entire period since the inception of the Federal Reserve including the Bush administration.

Bernanke's plan is to spend their way to prosperity. Inflation in Canada has occurred as well with our stimulus package so we will see a rise in prices but I doubt as steep as the Americans. the Canadian dollar should have surpassed the American dollar in value already, and actually did at one point, but the reluctance of our government to allow it keeps the real value down. What am I saying? Its real value is zero as are all fiat currencies. We have a pretended value based upon the confidence of the citizenry in it's government and because of it's fiat status.

A counter-inflation policy is simply the removal of money and credit from the economy. High interest rates are a tool to counter inflation by curtailing borrowing. I notice the Fed has no interest in raising the overnight interest rates. The banks are slowly edging their long term rates up, much to the consternation of the central bank.

Bernanke thinks that the problem during the Great Depression had to do with not creating enough money and credit to stimulate the economy. He said so much in his eulogy to Milton Friedman who identified that as a big problem.

After the Y2K technology boom burst several economists were calling for another boom to be created, Paul Krugman comes to mind and he even suggested a "housing" boom be started. Krugman works as a columnist for that liberal rag the NY Times. That he won a Nobel prize in Economics is a sad commentary on the state of Economics.

There shouldn't be these boom and bust cycles. They are not a norm for businesses or the economy and are entirely manufactured by the central banks and government monetary policy.

In order to understand their position we must make assumptions. The assumptions being authorities have not learned anything from past depressions or they are stupid or there is some other reason than the stated one for their plans and policies.

The last is rather conspiratorial and I don't adhere to conspiracy. They are not stupid. But the lessons of the past do not seem to have been learned well. I suppose you could call that stupid but I think those lessons are missed out of arrogance and a basic belief in the publics ignorance and necessity for dependence upon the intelligence of our Statesmen.

The concept of Conspiracy assumes that conspirators know exactly what they are doing. There may be a plan but the most intelligent people in government don't know exactly what will happen when they implement their plans and Obama is the epitome of that.

We are simply at a crossroads in civilization at this point in our history. We will either completely succumb to the central authority of a global government who will manage the global economy with the support of national governments or that drive will completely fail. Americans are the only ones that can ruin things for them by not going along.

All other nations are sort of observers, just spectators.

[Machjo]

Quick reply:

You mentioned we could counter inflation by raising interest rates. Yes we could, but that's but a temporary and partial fix to the problem. I'm not against interest rake hikes as a temporary solution, but they ought to also send the government a message. As soon as we need interest rates to counter inflation, that's a message to the government that there is too much money in the economy. My preferred solution would be for the government to increase revenue and/or reduce spending to actually pull the excess money right out of the economy.

Deflation hurts people, especially the most vulnerable members of society. But what many forget is that inflation is equally harmful, and especially to the same people.

Ideally governments should view booms with the same concern as they view recessions. In fact, I'd go one step further and say that the very reason for recessions is because we glory in booms. If we saw booms with the same trepidation as we did recessions, we'd soon, if not eliminate both, at least ensure that future booms and recessions would be extremely moderate. But unformtuately, when a boom hits, we all become greedy and fail to look to its futrue consequences.

[Pliny]

Quick reply:

You mentioned we could counter inflation by raising interest rates. Yes we could, but that's but a temporary and partial fix to the problem. I'm not against interest rake hikes as a temporary solution, but they ought to also send the government a message. As soon as we need interest rates to counter inflation, that's a message to the government that there is too much money in the economy. My preferred solution would be for the government to increase revenue and/or reduce spending to actually pull the excess money right out of the economy.

What is a natural interest rate or is there one? Why would interests rates go up or down? Does the central bank set the interest rate? If so, should they have the ability to set the interest rate?

"Money" under a fiat paper currency system exists in the form of credit and credit alone. Extending credit is increasing the money supply. The housing boom was created by extending credit and since there wasn't value in the growth of that credit, it crashed. Once it stopped feeding itself and people were not demanding more credit or credit could not possibly be extended any further it collapsed. This was an increase in the "money supply". It was not warranted but the solution was for government to throw gas on the fire by encouraging the banks to lend even more money and get spending happening again. It borrowed 800 billion dollars to "stimulate" the economy. Obama, by the way, did not oppose the borrowing of more money by the Bush adminstration but he likes to blame Bush for his spending. What audacity!

Pulling money out of the economy is deflation. From your following statement you are against deflation. I think what you want is controlled inflation which is what government attempts by controlling the money supply and the rate of interest.

Deflation hurts people, especially the most vulnerable members of society. But what many forget is that inflation is equally harmful, and especially to the same people.

If you wish to escape the cycle of inflation and deflation you have to return to a free economy with real "money".

Ideally governments should view booms with the same concern as they view recessions. In fact, I'd go one step further and say that the very reason for recessions is because we glory in booms. If we saw booms with the same trepidation as we did recessions, we'd soon, if not eliminate both, at least ensure that future booms and recessions would be extremely moderate. But unformtuately, when a boom hits, we all become greedy and fail to look to its futrue consequences.

You can always tell when a recession is coming. It is what inexorably follows a boom. What government is attempting to do is create another boom, "stimulate the economy" they call it. The roller coaster ride is getting wilder and I am not sure the engineers will be able to keep everything on the track.

[Jerry J. Fortin]

The business cycle is the boom and bust cycle we are talking about. Strangely enough, central banks set interest rates and control money supply by doing it. At least they try to control it that way by making it more expensive to borrow and slow down the borrowing or making it cheaper and speed up borrowing. The constant in that equation is borrowing. That borrowing is done with a little interest rate side dish.

The problem with the entire concept is the fiat currencies we use. Those currencies themselves have become commodities to be bought and sold.

[Pliny]

The business cycle is the boom and bust cycle we are talking about. Strangely enough, central banks set interest rates and control money supply by doing it. At least they try to control it that way by making it more expensive to borrow and slow down the borrowing or making it cheaper and speed up borrowing. The constant in that equation is borrowing. That borrowing is done with a little interest rate side dish.

The problem with the entire concept is the fiat currencies we use. Those currencies themselves have become commodities to be bought and sold.

I agree fiat currencies are a problem.

While businesses do go thorough cycles on their own. On the macro-economic level, that is; all businesses in the entire economy, booms and busts are created by government economic and monetary policy.

[msj]

The thing with planning the "upcoming inflation" is also planning for what to do if it doesn't arrive for a very long time:

Deleveraging the U.S. Economy

[Pliny]

The thing with planning the "upcoming inflation" is also planning for what to do if it doesn't arrive for a very long time:

What's a long time?

[msj]

What's a long time?

Well, if you were to read the article, it is decades.

[Pliny]

Well, if you were to read the article, it is decades.

I read the article. It seems deleveraging is what people are doing while government works to counter that with stimulus packages, bailouts and low interest rates.

It doesn't take decades to react to changes in the money supply which is all that inflation and deflation is about. Changes in pricing on the aggregate are symptoms of inflation and deflation of the money supply. There is no other common tie that would explain it.

Edited August 12, 2009 by Pliny

[msj]

I read the article. It seems deleveraging is what people are doing while government works to counter that with stimulus packages, bailouts and low interest rates.

It doesn't take decades to react to changes in the money supply which is all that inflation and deflation is about. Changes in pricing on the aggregate are symptoms of inflation and deflation of the money supply. There is no other common tie that would explain it.

Oh, so you don't understand the article then.

Deleveraging effects the money supply because we are talking about banks/people sitting there looking at all that printed money but not doing anything with it.

It has to do with velocity of money.

Something you continue to ignore as you stress out looking at that big pile of printed money (which is still just sitting there doing nothing).

When money starts to move then we can be concerned about the size of the pile.

If the savings rate in the US continues to go up, and if Americans prefer to witter away at their debt pile, then it certainly can take decades to deleverage.

If it happened in Japan then it can happen in any economy.

[Pliny]

Oh, so you don't understand the article then.

Deleveraging effects the money supply because we are talking about banks/people sitting there looking at all that printed money but not doing anything with it.

It has to do with velocity of money.

Something you continue to ignore as you stress out looking at that big pile of printed money (which is still just sitting there doing nothing).

When money starts to move then we can be concerned about the size of the pile.

If the savings rate in the US continues to go up, and if Americans prefer to witter away at their debt pile, then it certainly can take decades to deleverage.

If it happened in Japan then it can happen in any economy.

Who has all that "printed money" just sitting there? A pile of money that has not been distributed cannot be considered part of the money supply until it is distributed. Besides I think what the government is peddling is credit, not currency, and people are not borrowing. There is uncertainty in the economy regarding employment and there is some downward price correction. During this period saving is preferred over spending. The government is attempting to counter the "deflation" (which is actually price corrections, mostly on housing but other things as well) with easy credit and low interest rates (basically making money available), to get people spending. The government is doing a lot of spending itself with billions of dollars on bailouts, handouts, stimulus programs, work projects and whatever. What the government spends goes into circulation. The government and it's friends get first right to spend before prices are inflated. I would like to say that the "velocity of money" (a term you like to use) is a symptom of inflation and deflation, modified somewhat by confidence or lack of it, just as prices are a symptom of inflation and deflation. By those terms I mean inflation of the money supply alone is inflation. And deflation of the money supply alone is deflation. Increases in the general price level or decreases in the general price level are symptoms of inflation and deflation. The velocity of money in the aggregate is dependent upon the aggregate perception of prices increasing or decreasing but there is generally no perception by the public of the fact that the money supply has changed.

The problem about talking about the velocity of money is it is a generality. It conjures up the concept of circulation of currency in an economy and sounds like a giant wealth redistribution scheme the government fails to mention. In actuality, the amount of money available in the economy (not what hasn't been distributed yet) is what determines it's value and thus it's velocity and the general price level.

You would probably call saving a "slow velocity" but saving is when people value the money more than the things they could buy with it. The opposite is I'm sure just as easy to see, spending occurs when the money is less valuable than what can be bought with it. This explains individual reasons for saving and spending but what causes saving and spending in the aggregate, where people in general will prefer one over the other? The common denominator in the aggregate is the "amount of money" in circulation modified by "confidence" in the future economy. This determines velocity and price level.

Do I understand the article? I know certain basic things about Economics and I know some of the fallacies that are carried forward by mainstream economists. Most neo-economists deal in Keynesian concepts of aggregates, mathematical models and econometrics. So I have done a little bit of reading, a lot more than the average person. But I am not an expert. Frankly, the article was worth reading (and I just re-read it) some of the things I have said here myself. Some I disagree with, which I have also stated. Unfortunately, I have not read much about Japan's economic situation other than it has been rather stagnant over the past decade and a half. That part of it I will have to admit I am lacking information and can't claim to fully understand it.

If the savings rate in the US continues to go up, and if Americans prefer to witter away at their debt pile, then it certainly can take decades to deleverage.

If the savings rate goes up price levels will drop until they are too much of a bargain to pass up and people will start spending. The government doesn't like falling prices because they signal a drop in revenues along with unemployment. They won't allow prices to drop. The fiscal policies of government creates a boom by increasing the money supply, this causes a general rise in prices, eventually, the boom cannot sustain itself because of inflated prices. Wage and price controls are what's attempted next. This creates shortages in the supply of those goods. The government then invokes tight fiscal policies of high interest rates, deflation of the money supply and tight spending.

The private sector has already deleveraged quite a bit and is trying to deleverage even more but the actions of government are attempting to stop the deleveraging. So you are basically saying the government wishes to drag out the deleveraging for decades. It wouldn't take long if the government just let the proper market corrections occur. GM should be gone, Goldman-Sachs, Chrysler perhaps, many more banks, Fannie Mae, Freddie Mac - all should be history like Worldcom and Enron - that would complete the deleveraging and healing in the economy could start.

[msj]

Pliny, other than some terminology differences I think we are on a similar wave length.

People like to point at one graph in particular where the Fed has "created" all of this money and how it is prima facie evidence of the coming inflation.

The problem with that graph is that it does not consider velocity.

Velocity of money is a very important concept and I can really do no more than point out my links above and in the past.

Look up John Mauldin - he has talked about inflation/deflation many times and is very good at explaining the arguments for and against inflation and deflation.

I think the arguments favour deflation on the basis of delevaging going on in the credit markets.

As for it affecting prices - that is a symptom (an interesting symptom) rather than useful information.

More useful to people is the knowledge that credit has been contracting for months, the savings rate is going up which introduces its own pressures (or lack there of), and wages have been doing nothing in real terms.

That is a recipe for continued deflation.

[Machjo]

Of course as long as deflation continue, we should continue with a counter-deflationary policy. All I'm saying is that a counter-inflationary policy should be established and ready to be implemented at a moment's notice when inflation kicks in, even if it is in a few decades.

In like manner, we should plan for the next recesion immediately after this one is over. We should always be ahead fo the game and never be taken off guard like we were this recession.

[msj]

Of course as long as deflation continue, we should continue with a counter-deflationary policy. All I'm saying is that a counter-inflationary policy should be established and ready to be implemented at a moment's notice when inflation kicks in, even if it is in a few decades.

The US Fed already has a plan in place although it is doubtful how successful it will be.

The plan is basically to unwind what they have wound up. In fact, if one were to read the FOMC report from yesterday one would see where they discuss winding down one phase starting in October, 2009.

As for Canada, well, I guess we can hope the Federal government will stop spending like drunken sailors (recession or not the Federal government is terrible at controlling their spending regardless of who is in power - probably the nature of minority governments).

The Bank of Canada?

Well, I don't have a clue on them.

I think they have a moron at the helm who makes Greenspan/Bernanke look like geniuses by comparison.

[Machjo]

The US Fed already has a plan in place although it is doubtful how successful it will be.

The plan is basically to unwind what they have wound up. In fact, if one were to read the FOMC report from yesterday one would see where they discuss winding down one phase starting in October, 2009.

As for Canada, well, I guess we can hope the Federal government will stop spending like drunken sailors (recession or not the Federal government is terrible at controlling their spending regardless of who is in power - probably the nature of minority governments).

The Bank of Canada?

Well, I don't have a clue on them.

I think they have a moron at the helm who makes Greenspan/Bernanke look like geniuses by comparison.

This is another issue. While I have no issue with a counter-deflationary policy, did the government take into account how it would fit in with a later counter-inflationary policy to make sure the two work together? Had the government planned for this recession years ago, ready to implement it as soon as deflation strikes, we could have had plenty of time to debate it, discuss it, plan it, etc. Of course we could never know when the deflation would strike, but at least we'd know we had a good plan in place ready to implement.

But instead, the whole thing ws ad hoc, government governing by the seat of its pants, and I thik that's why our current stimulous package proved to be a fiasco.

Now had the government planned ahead for this recessio, not only would we have had a well-dezigned non-partisan plan to execute, but woudl then have had plenty of time during the recession to discuss plans for the upcoming inflation, whenever it should strike. Instead, the government is now too busy fumbling over the recession.

[Pliny]

Pliny, other than some terminology differences I think we are on a similar wave length.

Perhaps. I am always in search of a greater understanding and generally find that explanatory concepts that lead to simplicity as opposed to complexity are of most value.

People like to point at one graph in particular where the Fed has "created" all of this money and how it is prima facie evidence of the coming inflation.

The problem with that graph is that it does not consider velocity.

Velocity of money is a very important concept and I can really do no more than point out my links above and in the past.

I understand that "velocity of money" is an observable phenomenon. I do contend however it is not a phenomenon unto itself but a symptom of other things.

Take Gresham's law as an example of something that may affect the velocity of money. In the old days the King in order to pay for his wars needed more gold in his coffers so he would collect his taxes from the citizens melt down their coins and alloy the precious metal with a less valuable metal thus debasing the coinage.

The citizenry, upon wising up to what he King had done would hoard the old coins and spend the new coins but of course the prices would rise because the new coins were not as valuable. The old coins would become more valuable and it would seem the price of things would have dropped when using them because everyone wanted to collect and hold the old coins.

Inflation of the money supply, making it more plentiful, makes it less valuable and would thus increase velocity as people would be more willing to trade the money for other goods. Continuing to inflate the money supply would continue debasing it and the velocity of money would increase as people attempted to divest themselves of this ever increasing devaluation of the purchasing power of the "money".

Deflation of the money supply, making it scarcer, makes it more valuable and increases it's purchasing power. People choose saving it over trading it. Continuing to deflate the money supply would make it become more and more valuable and the velocity of money would decrease. People would become very frugal in their spending habits.

Do you see it differently?

Look up John Mauldin - he has talked about inflation/deflation many times and is very good at explaining the arguments for and against inflation and deflation.

I think the arguments favour deflation on the basis of delevaging going on in the credit markets.

Deflation is something the government doesn't like because it means less revenues for them.

The lowering of wages and prices makes their taxation burden a more obvious problem and people become concerned about the level of taxation and spending of government. The people become more focused on the economy and the fiscal problems they are experiencing. The government doesn't want this kind of scrutiny.

Inflation tends to keep people spending as their money loses purchasing power over time.

So inflation is not good for the people but serves governments interests well.

As for it affecting prices - that is a symptom (an interesting symptom) rather than useful information.

More useful to people is the knowledge that credit has been contracting for months, the savings rate is going up which introduces its own pressures (or lack there of), and wages have been doing nothing in real terms.

That is a recipe for continued deflation.

I agree prices will continue to fall. However, as I have said, in my understanding falling prices are not the phenomenon defining deflation and the phenomenon must, in order to fit the definition, include a fall in the general price level. Food, clothing, household goods, and other goods and services have to be included. But in fact, people are currently afraid of rising prices in essentials which indicates, not a period of deflation but a period of price correction in overpriced or speculatively driven goods and services.

We will not be in a period of deflation unless deleveraging is allowed to take place. Government is not encouraging that, it wants and needs an expanding economy all the time - especially if it wants to keep the same spending levels it unwisely reaches in a vibrant economy. It's main problem is that it thinks it can control an economy. The booms and busts it's created over the last century proves it can't. Either that or I will have to endorse conspiracy theorists who think there actually is control over the economy and society.

[Machjo]

I'd see both inflation and deflation to be equally harmful. Inflation promotes borrowing and spending in a race against price increeases. Of course this promotes debt wich chan only come crashing down sooner or later. Deflation promotes excessive savings and even selling off of assets before prices drop, which likewise is unstable. A long-term maintenance of an average rate of inflation of 0% would neither encourage spending nor saving, essentially leaving such incentives to other economic factors, thus ending busts and booms.

[Jerry J. Fortin]

The US Fed already has a plan in place although it is doubtful how successful it will be.

The plan is basically to unwind what they have wound up. In fact, if one were to read the FOMC report from yesterday one would see where they discuss winding down one phase starting in October, 2009.

As for Canada, well, I guess we can hope the Federal government will stop spending like drunken sailors (recession or not the Federal government is terrible at controlling their spending regardless of who is in power - probably the nature of minority governments).

The Bank of Canada?

Well, I don't have a clue on them.

I think they have a moron at the helm who makes Greenspan/Bernanke look like geniuses by comparison.

We are heading into a new financial age. The current system of central banking is becoming to say the least problematic. I can see where the nations of the world are going to start to make noise about the stability of the financial industry, because the cross border issues with differences in regulations and policies make their operations more complicated and that translates into more expensive. We will see a shift from the current mix of operational methods into a single minded bean counter approach. An international agreement if you will.

The line has been crossed folks, things are beginning to change.

[msj]

We are heading into a new financial age. The current system of central banking is becoming to say the least problematic.

The system was problematic years ago due, largely, to an incompetent at the helm (Greenspan) and thanks to a political philosophy that is negligent.

By the time anyone really began to notice (called conspiracy theorists or worse back in 2002), however, it was already too late.

So, no, it is not "becoming" problematic.

The horses left the barn a long time ago and people are just starting to notice the failed results.

[Pliny]

I'd see both inflation and deflation to be equally harmful. Inflation promotes borrowing and spending in a race against price increeases. Of course this promotes debt wich chan only come crashing down sooner or later. Deflation promotes excessive savings and even selling off of assets before prices drop, which likewise is unstable. A long-term maintenance of an average rate of inflation of 0% would neither encourage spending nor saving, essentially leaving such incentives to other economic factors, thus ending busts and booms.

Your suggestion is precisely the status quo and was the promise of the central bank, however, as you see busts and booms have not been eradicated but exacerbated.

[Pliny]

We are heading into a new financial age.

True.

The current system of central banking is becoming to say the least problematic.

It's been a money maker for banks. It fiscally untied the hands of government and is agreeably problematic for economies and the general public. It was laughably passed into law in the interests of the "common good".

I can see where the nations of the world are going to start to make noise about the stability of the financial industry, because the cross border issues with differences in regulations and policies make their operations more complicated and that translates into more expensive. We will see a shift from the current mix of operational methods into a single minded bean counter approach. An international agreement if you will.

The line has been crossed folks, things are beginning to change.

Is it "change we can believe in"?

[Machjo]

We are heading into a new financial age. The current system of central banking is becoming to say the least problematic. I can see where the nations of the world are going to start to make noise about the stability of the financial industry, because the cross border issues with differences in regulations and policies make their operations more complicated and that translates into more expensive. We will see a shift from the current mix of operational methods into a single minded bean counter approach. An international agreement if you will.

The line has been crossed folks, things are beginning to change.

I believe that the shift to a common world currency is only a matter of time. Multiple currencies in the modern age is paramount to welfare make-work jobs for currency traders.

In fact, the trend has already begun with the Euro.

[Machjo]

Your suggestion is precisely the status quo and was the promise of the central bank, however, as you see busts and booms have not been eradicated but exacerbated.

We haven't had anything like the depression for awhile. I think it has more to do with governments not planning ahead in good times and then taken by surprise in bad times.

[Pliny]

The system was problematic years ago due, largely, to an incompetent at the helm (Greenspan) and thanks to a political philosophy that is negligent.

By the time anyone really began to notice (called conspiracy theorists or worse back in 2002), however, it was already too late.

So, no, it is not "becoming" problematic.

The horses left the barn a long time ago and people are just starting to notice the failed results.

The system was problematic "many" years ago. Division of the populace, wide swings in voting patterns to elect the lesser of evil rather than the best leaders to govern. These are a few symptoms. Obama, Bush II, Clinton, Bush I - each one elected to avoid the consequences and fill the holes left by the earlier administration.

It is an historically myopic view to be blaming recent administrations for what can only be termed systemic rot, the onset of which coincides with governments increasing intervention in the economy and it's dream of omnipotence.