Deflation - now?
Very few forecasters believe in the prospect of deflation for Europe and the U.S.A – at the time of writing this article (November 2013 * updates at end of article). Why is this?
Governments on both sides of the Atlantic have erected a smokescreen. It’s called QE (Quantative Easing). QE has the effect of convincing people that central banks have full control over the economy, via gradual expansion of the money supply in order to fend off the credit-crunch gremlins until economic growth returns naturally to keep everyone safe and happy.
But that’s a false picture. Every serious economics student is taught about long term business cycles ending in massive debt liquidation, which causes calamitous deflation. When debt gets so large that it cannot be adequately reduced, true growth cannot take pace again. The debt has to come down somehow. When debt gets to the stage of continuous expansion, which it has been for more than a decade now, liquidation is the only possible outcome.
The reason indescribable quantities of debt liquidation are about to cause a ‘panic’ phase is plain and simple. At the end of a long term business cycle - the period we are currently suffering - credit contracts while unsustainable debt gets offloaded. That’s all there is to it. Credit contracts because overburdened consumers and corporations pay down debt as they are able (reducing outstanding credit) while, at the same time, lenders try to reduce their risk (reducing outstanding credit). Writing off debt just adds to the problem.
QE can at best delay the inevitable coming deflation. It can’t solve the credit crisis. QE does not convince people to take on more debt, which is what’s needed to solve the credit crisis. QE keeps alive, a little bit longer, technically bankrupt organizations (and sovereign debtors). But eventually ‘the piper has to be paid’.
The proof? QE, in the recent round, has been going on for years. It bolsters the money institutions and the Stockmarket indexes but it doesn’t cause growth. Inflation in the EU block and the U.S. has fallen to below 1% recently, - less than half that predicted by Governments - during a period when hundreds of billions of Pounds and Euros (and trillions in dollars) have been scattered around like confetti while interest rates have been close to zero too. If that didn’t cause real growth, what will?
The amount of credit outstanding simply won’t expand, despite all these monetary influences, until debt is reduced to a manageable level. To reiterate, at the end of the long term business cycle debt liquidation, far greater than has already occurred, is inevitable. This is basic economics. Political motives are what cause the Authorities to try to convince themselves, and the public, that they can ‘hold back the tide’. They know the truth but simply can't say, "Let market forces have their way."
Bubbles have to burst. They do so by gradual leakage or by blowing up the bubble further - so enormously that it pops with a big bang. That’s what QE is doing. And we’re very close to the pop right now. Unless, that is, sufficient new money could be printed causing currencies to devalue so much that the existent mountain of debt becomes manageable again. If that amount of money-printing took place there would be hyperinflation and disaster for the economies originating it - a disaster more debilitating than deflation.
What’s the best course of action for individuals if deflation sets in? In my view, getting debt down as fast as possible and keeping away from equity and property investments. Cash will be king but keeping it in banks could be very high risk.
(Note: DISCLAIMER: This essay is based on personal opinion and should not be used as financial guidance. The author has carried out an in-depth study of economic and market forces to reach the conclusions herein but there is no guarantee that the future will pan out as described here. The author can bear no responsibility whatsoever for reader’s investment / economic decisions or activities.)
Update January 2015
Inevitably, as I purported above, everyone's starting to talk about deflation. The EU is in actual minus inflation, pricewise. Some central bank base rates have gone into minus rates too. This means paying people to borrow your money! UK is also slipping perilously near. It's CPI is 0.5%.
Deflation is actually the shrinking of outstanding credit, which has been going on for a long time now. Any drop in prices is the result of deflation in the system, not the cause of it. You can feel deflation all around. Fuel price drops have exacerbated the notion but it's in food and clothing too. Once the price of necessities starts falling, deflation is underscored.
Update May 2015
Deflation in the UK is announced. 'Get it while you can because it won't be around for long' is the immediate Bank of England reaction. Well, we know that what the Bank states is usually changed at a later date! The Authorities obviously don't want the public to imagine long term deflation because they'd put off purchasing things en masse. But the cause of deflation must change to bring back inflation. The cause of deflation is too many goods available for the available funds that people (and organisations) are prepared to spend. The credit crunch didn't come about because there isn't enough credit to use but because folk aren't so willing to use it; the debt pile became too great. A willingness to increase borrowing has to occur all round for the economy to expand. Watch this space. Another round of QE could yet be on the cards - even though it's now clear that QE doesn't solve the deflationary problem; it only delays it.
Update January 2016
The outward signs of severe deflation are easy to see now. Commodities down 55% overall since 2011 including 80% reduction in price of crude oil - the most valuable commodity in the world. Stockmarkets now down 10% to 50% in different nations. The 'Baltic Dry' index is 99% down from its peak (cost of shipping dry goods in bulk carriers). Hardly anyone would have predicted these falls a few years ago because QE disguised the 'deflating balloon'. QE didn't cure anything as, throughout history, money printing never has done. It just delayed the inevitable for a few years while doubling the greatest debt in history for the sake of the big banks. What's next? More QE perhaps. Or, I'm projecting, a drawn out deflation affecting all areas of our lives.
Update June 2017
UK printed another 170 Billion pounds, last year, on the excuse that the decision to leave the EU would be immediately disastrous (which it wasn't). That was enough to keep the banks alive, the stock market moving sideways and an upward bubble within the deflating property bubble. Greece has been bailed once again, by EU money printing too. many more EU countries are in similar positions. Ho hum - on we go - 'same old same old'. I'm watching the 10 year gilt yield chart. The yield has grown from 0.5% last summer to 1.3% now. If that upward growth slope continues interest rates will be certain to rise. (Why? Because when people loaning you money demand a higher return, you can't continue lending money out at a cheaper rate). Then, I believe, the party will be over.
Update January 2019
Is the party over, despite late drinkers insisting it can go on forever? Interest rates have been rising steadily, proving lenders have had enough. Global debt is 250 TRILLION dollars, compared to 100 trillion in 2003, according to the Institute of International Finance. It's unfathomable. .... Chinese domestic property is 20% vacant. British and American property prices have topped out and are falling. 13 Countries still sell their debt at negative rates, attracting safe-haven investment money from those who realise what's coming. The piper has to be paid. When borrowers can borrow no more, accompanied by repayment defaults exceeding new credit, the dominoes are going to fall - in a destructive wave not seen before in history I believe.
May 2020. Can't update on deflation any longer because this predictive page has just reached its conclusion. If you didn't prepare, beware; some prices will drop through the floor because deflation has just taken place (too many goods for the available money & credit) Hyperinflation is still a possibility to follow the current zero growth, zero interest-rate scenario because money printing, unmatched in history, is now the worldwide way forward to counteract the shutdowns due to the covid flu. Watch out for a digital currency to appear. Something has to happen for governments to get more control over people's savings and taxing their income. Otherwise it's impossible for most countries to repay their grossly inflated debts. China has the leverage, being the only superpower to remain solvent, cash-wise. Batten down the hatches!