A 5th Economic Condition?

[doodle]

Fascinating show on CNBC tonight about New York bankruptcy issues during mid 70's. The political posturing and issues seem so similar to today.

Medium Tex, how does your position fit with high fiscal deficits and very loose monetary policy?

If Ben Bernanke is willing to drop dollars out of helicopters to prevent deflation, what would the outcome of this policy be? More deflation???

[doodle]

Wow.....watching what New York went through in the Mid 70's my faith in the ability of the United States to recover is slightly renewed. What a hell hole! What a mismanaged mess.

Hopefully we don't have fall to those levels before we pull ourselves together though. I know New York had a bad reputation back then, but I had no idea the extent of the problems. It looks like a war zone.

[AgAuMoney]

Ok even if it's not bonds, let's just look at money-flow.  Dollars in foreign hands can only be used for so many things... the options for that are for foreigners to 1) buy our treasury or corporate bonds, which are always in some sort of equilibrium with each other based on duration and default risk, 2) buy stuff from us to get rid of their cash (our steel, products, tanks, etc), or 3) invest in our stocks, buy some land, open a factory in the US, etc.

To decide whether they'll do option 2 vs option 3, they'd probably try to figure out how healthy our economy is going to be in the future... the foreign investment would not necessarily assume no inflation, but the disastrous mass-divesting of the dollar and collapse of our economy probably wouldn't happen alongside China using their dollars to try to spur on economic growth in the US buy investing here.... kind of like to hedge against disastrous inflation you and I buy gold, not US stocks.

The foreign investment in the US, in a way, is just another form of their consumption of US goods.  Whether China sends $1 Billion to the US to build a factory or $1 Billion to the US to buy our widgets, I'd imagine, are both going to have the same general effect on our macro-economy in the medium-term.

Sort of.  I guess it depends on how big you consider "same general effect" to encompass.

When China (or whomever) buys U.S. Treasuries it keeps the money out of circulation and drives down interest rates on treasuries.  This reduces inflation in the U.S.  Economists sometimes refer to the past 30 years of trade deficits as "exporting inflation."

Any other use of that money will cause inflation (thru both velocity of money increasing and thru supply and demand factors).  When China (or whomever) buys stocks, stock prices will go up.  Same with farms, mines, iron, gold, copper, cement, oil, ships, or whatever.  Even if the very next step is for whomever sold the asset to put the money into a U.S. Treasury, that added step is an added bump to inflation pressure.  Plus it helps diversify for whomever purchased the asset, which China has publicly stated many times that they intend to do.

News reports re. China indicate they are buying and trying to buy everything, from anywhere, everywhere.  Joint mining ventures in Africa, Australia, South America and Canada.  Buying mines and oil fields and farms.  Buying (or attempting to buy) ports and shipping companies and even tech companies.  Buying huge quantities of raw materials like oil and iron ore, and etc, probably not all of it for immediate consumption.  (wikipedia ''In 2007 China announced an expansion of their crude reserves into a two part system. ... The government-controlled reserves are being completed in three phases. Phase one consisted of a 101.9 million barrel reserve, mostly completed by the end of 2008. The second phase of the government-controlled reserves with an additional 170 million barrels will be completed by 2011. Recently, Zhang Guobao the head of the National Energy Administration also stated that there will be a third phase that will expand reserves by 204 million barrels with the goal of increasing China's SPR to 90 days of supply by 2020.'')

[MediumTex]

Fascinating show on CNBC tonight about New York bankruptcy issues during mid 70's. The political posturing and issues seem so similar to today.

Have you seen "The Warriors"?  It captures the way people viewed New York City back then pretty well.

Medium Tex, how does your position fit with high fiscal deficits and very loose monetary policy?

If Ben Bernanke is willing to drop dollars out of helicopters to prevent deflation, what would the outcome of this policy be? More deflation???

It would depend on what people spent the money they collected from the helicopter drop on.

If they used it to pay down debt, I would say no inflation (inflation being defined as a rise in prices of the things people buy).

As far as high deficits go, that is a pure abstraction.  It is hard to project how abstractions will intrude into the real world.  I don't know when that situation will reach a breaking point.  I just don't have a clue.  I would have said it would happen long before now, but it hasn't.

[AgAuMoney]

Whoa!  The PP doesn't have home country bias, it has world reserve currency and safest bond market bias.  We just happen to be living in that country, which makes the PP an especially appealing option for the U.S. investor.

Harry Brown said many times and it has been repeated here and on Craig's site, that holding the US$ and US Treasuries and US Stocks is for US investors and that you should own similar things in your local economy if you are not an US investor.

I wasn't suggesting that non-U.S. investors should use treasuries and U.S. stocks.  What I was saying was that the PP only has an inherent home country bias because that's the way it is designed.  For the U.S. investor, though, the PP probably works best, since it is able to use the world's reseve currency and the world's safest bond market for its assets.

That sounds like the definition of home country bias to me.

[Gumby]

Harry Brown said many times and it has been repeated here and on Craig's site, that holding the US$ and US Treasuries and US Stocks is for US investors and that you should own similar things in your local economy if you are not an US investor.

I wasn't suggesting that non-U.S. investors should use treasuries and U.S. stocks.  What I was saying was that the PP only has an inherent home country bias because that's the way it is designed.  For the U.S. investor, though, the PP probably works best, since it is able to use the world's reseve currency and the world's safest bond market for its assets.

That sounds like the definition of home country bias to me.

Let's not split hairs.

Appendix G of Why The Best Laid Investments Usually Go Wrong is a short two page recommendation on Foreign PPs titled, "Permanent Portfolio Alterations for Non-Americans."

Harry Browne says:

Permanent Portfolio Alterations for Non-Americans

The suggestions in this book are made with American readers in mind. If you live outside the United States, some of the suggestions I've made for the Permanent Portfolio can be changed. Whether you should use U.S. investments or use investments of the country in which you live depends on how stable and useful you consider the investment markets in the country where you live.

If you are an American living abroad and you expect to return to the US to live within the next few years, it isn't necessary to make any changes from the suggestions I've made. If you don't know when or whether you will return to the US, consider making the changes.

The purpose of Treasury bills in the portfolio is to provide stable purchasing power through a default-proof investment in the currency you rely on. So, for US Treasury bills, you can substitute the equivalent investment in the country in which you live. That can be bills, notes, or bonds issued by the government and maturing in one year.

The long-term bonds can be bonds of the government of the country in which you live, so that you will have protection if there's a deflation in your country. Use the longest maturity available.

Stock-market investments are meant to provide profit when you country is prosperous and inflation is low. So, in general, you should buy stocks of the companies in your country.

However, you might prefer to use American stock-market investments instead. Usually, the stock markets of the world move upward or downward together. And the US securities markets offer a greater number of alternatives — including such things as warrants and specialized mutual funds.

The decision may depend upon how adequately you believe you can cover yourself with stock investments of your own country. One possibility is to split the stock-market budget between investments of your country and the United States.

There is no reason to alter the suggestions I've made for gold, no matter where you live.

[MediumTex]

Wage growth is per-capita.  And I think 10 years is plenty sustained and even 5 years really hurts.  What definitions do you use?

I assume you mean 10 years of sustained inflation, right?

I would define inflation as an increase in the prices of the things that people typically buy at the grocery store and the mall, plus large durable goods such as appliances and cars, along with houses.

Over the past 10 years some prices have risen and some have fallen.  The prices of houses and electronics have fallen a lot.

For the average person, their two most valuable assets are their home and the personal services that they offer in the marketplace for wages and salaries.  In the last ten years I would say that these two assets have either fallen in value or stayed the same for most people.  When your two most valuable assets are either falling in value or just treading water, the world doesn't feel too inflationary.

Sooner or later we will get some 1970s style inflation, but IMHO we've got a lot more deflationary days to live through before that happens.

[MediumTex]

Harry Brown said many times and it has been repeated here and on Craig's site, that holding the US$ and US Treasuries and US Stocks is for US investors and that you should own similar things in your local economy if you are not an US investor.

I wasn't suggesting that non-U.S. investors should use treasuries and U.S. stocks.  What I was saying was that the PP only has an inherent home country bias because that's the way it is designed.  For the U.S. investor, though, the PP probably works best, since it is able to use the world's reseve currency and the world's safest bond market for its assets.

That sounds like the definition of home country bias to me.

The context in which I was making the comment was that doodle was saying he didn't like the idea of tying up so much of his assets in the U.S. treasury market.  I was trying to make the point that we are buying treasuries BECAUSE they are denominated in our home currency.  We're not buying them because we believe the U.S. is a great manager of public finance, but rather because the store on the corner only accepts U.S. dollars for purchases.

For a U.S. investor, the fact that the U.S. dollar is the world reserve currency and the U.S. treasury market is the safest in the world is just gravy.

If I was setting up a PP in Russia I would be reluctant to buy Russian bonds and Russian equities.  Happily, the U.S. PP investor doesn't have to deal with such a decision because of all the currencies and bond markets in the world, the U.S. dollar and treasuries are presumably the first choice, for reasons that Browne described in Gumby's post above and elsewhere in Browne's writings.

[Gumby]

AgAu,

Just a hunch, but I'm guessing from your avatar, your callsign and your posts that you're somewhat of an inflationista. How far do you go with that? Are you a PP traditionalist? (I am). Or are you heavily weighted to gold and silver?

I only ask because I find the idea of banking on high inflation to hyperinflation of the US Dollar to be fascinating and morbidly speculative for the world's financial markets. To be totally sold on the idea of hyperinflation of the US dollar seems to imply an Armageddon-type scenario for the world's economy. And investing for Armageddon in our lifetime seems like it would be a tough pill to swallow (i.e. you win big if the world falls apart, but then what do you do with all your money when there's no food or clean water to survive on?).

Where do you see this all going? I personally have no idea, but I would love to hear your perspective.

[AgAuMoney]

Let's say we have an economy that produces 10 units of something.

At the same time there are 10 units of money in the system.

In this system 1 unit of money = 1 unit of something.


Lets say that the real economy (production of services, stuff, etc) grows at 2 percent every year, but the units of money grow at 10 percent every year.

Year 2:  11 units of money will equal 10.2 units of stuff.

Year 3: 12.1 units of money will equal roughly 10.4 units of stuff.

year 4: 13.3 units of money equals roughly 10.6 units of stuff.

So in four years you have 30% inflation more or less. If growth of money supply is at 10% and economic growth of products is at 2% doesn't this cause inflation?

In a simplified world, yes.  But your hypothetical totally ignores the velocity of money.

What if of the 10% money growth, 2% was put into circulation and 8% was just vaulted immediately after production and used for the sole purpose of replacing worn out currency?  Then the growth in the economy would be exactly matched by the growth of the circulating money and there would be no price increase.  (Economists could debate for hours whether inflation is a price increase or an increased supply of money, and if the supply of money is only that quantity circulating or if it includes that which is in the vault ready to circulate, and even might include what the printing press is able to manufacture during the next period under consideration and etc.)

That vaulted 8% would be a very slow velocity of money (it does not circulate).  But since velocity does not depend just on the new money supply, inflation can happen even with no increase in the supply simply by increasing the velocity.

Velocity is a bit harder to understand...  Your example assumes everybody settles up (essentially does just one transaction) and is done.  Call that a velocity of 1.  What if the first person to buy purchased twice what was needed, and sold the second half for more to the last person who otherwise wouldn't get any?  That makes one extra transaction (the first person buy is the extra, the last person buy from the first person just changed the parties involved) or a velocity of 2 and a price increase for that last person.  That last person the next time around is going to go out and buy 2x to 3x what they need, very quickly so as not to get stuck paying higher prices, but now somebody else will either go without or pay more.  The natural evolution is that everyone rushes out to buy anything with all the money they get as soon as they get it.  They may even buy on credit (carry me for just a few days Hank, you know I'm good for it) which can act like a temporary increase in the money supply.  Now you have price increases with no net increase in the money supply.

Under this scenario wouldn't interest rates have to rise from present levels?

No.  What would drive the increase in interest rates?  In the most basic sense, interest rates are simply the cost of money.  In your example money seems even cheaper now since there is more of it.  Maybe someone will decide not the pay the higher prices for the widgets and save their money instead, thus conceivable driving down rates.

In the real fiat money world, devaluation of money by an increase in the supply and current or near-term interest rates are orthogonal concepts.  The connection is only between the rate that savers demand as a return on their savings and that connection can be totally ignored using fiat money creation (who needs savers? just print more!) and has only a slight coupling when using fractional reserve banking (don't need very many savers, and instead of raising rates we can just reduce the reserve).

[MediumTex]

Where do you see this all going? I personally have no idea, but I would love to hear your perspective.

I'm curious too.

I only argue strenuously for the deflationary scenario because it is the one people seem to have the most trouble taking seriously.  

I think that part of being a happy PP user is being able to easily make the case for ANY of the three volatile assets being a good place to be at any given point in time.  

I see people cheating on the LT bonds in the PP imagining that they are limiting their risk when they are actually increasing it.

The inflation case is, in many ways, almost too easy to make.  It would be like arguing that we're all going to die some day.  Of course we're all going to die, but the harder prediction is determining when exactly someone is going to die, just like it's hard to predict when a fiat currency is going to die.  

Just like people can have decades of good health before they die, a whole lot of deflation can unfold before a fiat currency finally expires.

[doodle]

Good article to add to current perspective: http://www.lewrockwell.com/north/north74.html

Seems like a similar debate was raging in the mid 70's.....why would that environment turn out inflationary...and this deflationary? What are the differences? What are the similarities?

[Lone Wolf]

Have you seen "The Warriors"?  It captures the way people viewed New York City back then pretty well.

Heh, quite true.  New York is just not the same anymore without the Baseball Furies, the Turnbull AC's, and a charismatic Messiah asking the gangs of New York, "Caaaaannn youuuuu dig it?"  Fun film with a style all its own, that one.  Did you know that was based on Xenophon's "Anabasis", the account of Greek mercenaries cut off and alone in Asia Minor trying to fight their way home through hundreds of miles of hostile territory?

I agree, MT.  Also, I think a neat stimulus project would have been a switch to the metric system.  I often hear how difficult/expensive the initial plunge would be.  What better time to put engineers & sign post pounders alike to work?

The EU, in turn, could do a stimulus in the form of switching from the metric system to feet, inches, yards, miles, pounds, gallons, etc.

No, no, this isn't nearly wasteful enough!  Paul Krugman is very disappointed with the puny, stingy ideas this board is coming up with.  Think how much more we could waste, er "stimulate ourselves" if these workers all had to do this with only abacuses and charcoal pencils.  Instruct them to wield these tools with nothing but their butt cheeks.  Free yourself from the Paradox of Thrift!  Let's add a few more zeroes to that national debt!

[MediumTex]

Good article to add to current perspective: http://www.lewrockwell.com/north/north74.html

Seems like a similar debate was raging in the mid 70's.....why would that environment turn out inflationary...and this deflationary? What are the differences? What are the similarities?

The major differences are that in the 1970s:

1. The economy was not reeling from the popping of a credit fueled asset bubble.

2. Households and government were not up to their eyeballs in un-repayable debt.

3. The nation's demographic profile was such that the number of people entering their peak earning years was rising.

4. Labor unions were still a strong enough force that they could demand higher wages in response to rising prices, which set the stage for an inflationary spiral.

5. There was still the belief in some political quarters that price controls were an effective tool to counter inflation.

The biggest difference, though, was the debt issue.  Today there is debt at all levels of society that simply cannot be repaid.  Widespread defaults and attempts to service un-repayable debt is not inflationary.

[Lone Wolf]

Yeah, that $25k-$50k business is nonsense.  Cash on hand depends on the size of the bank and bank policy.  And yes, some branches will have different amounts on different days depending on deposits and on payroll habits of nearby businesses -- some people and especially those doing certain kinds of work do seem to prefer cash on payday.

Thanks for sharing that information.  That helps flesh it out a bit.  That $25k-$50k number wasn't making a lick of sense to me.

[doodle]

This just have a tough time imagining this as deflationary...

[MediumTex]

Paul Krugman is very disappointed with the puny, stingy ideas this board is coming up with.  Think how much more we could waste, er "stimulate ourselves" if these workers all had to do this with only abacuses and charcoal pencils.  Instruct them to wield these tools with nothing but their butt cheeks.  Free yourself from the Paradox of Thrift!  Let's add a few more zeroes to that national debt!

My all time favorite make work program has to be FDR hiring photographers to drive around the country in the 1930s to take pictures of pathetic looking people to help convince everyone that the government ought to hire people to do things like drive around and take pictures of pathetic looking people.

If I was one of those pathetic looking people and a person drove up and said they were from the government I would ask if they were there to help me.  When they said that they hadn't brought any food for my empty stomach or soap to clean my dirty face, but that they would like to take my picture I might have a pretty pathetic look on my face too. 

[doodle]

I understand that we should be facing deflation from the bursting of the credit bubble....but what if the FED won't let this happen and the graph above continues? What are the ramifications of this? What happens if we wont let deflation happen because we continue to print money? So the credit multiplier and velocity decline but the expansion on the government side more than makes up for this.

Doesn't this eventually cause a currency crisis?

[MediumTex]

This just have a tough time imagining this as deflationary...

Unless you add in private sector credit and consider velocity that chart isn't helpful at all.

Here is part of the money that disappeared in the form of credit contraction:

[Lone Wolf]

If I was one of those pathetic looking people and a person drove up and said they were from the government I would ask if they were there to help me.  When they said that they hadn't brought any food for my empty stomach or soap to clean my dirty face, but that they would like to take my picture I might have a pretty pathetic look on my face too. 

Too funny!  I must apologize in advance because somewhere, somehow I'm sure to steal some variant of this joke.  Don't worry.  I'll be sure to give credit to the person I heard it from.  (Ash Williams, natch.)

[AgAuMoney]

Just a hunch, but I'm guessing from your avatar, your callsign and your posts that you're somewhat of an inflationista. How far do you go with that? Are you a PP traditionalist? (I am). Or are you heavily weighted to gold and silver?
...
investing for Armageddon in our lifetime seems like it would be a tough pill to swallow (i.e. you win big if the world falls apart, but then what do you do with all your money when there's no food or clean water to survive on?).

Where do you see this all going? I personally have no idea, but I would love to hear your perspective.

Indeed.  I usually consider myself to follow the Austrian school.

I do have a fairly traditional paper (no physical) PP composing of about 40% of my liquid assets.  (Non-liquid assets include primarily myself and family and neighbors; a large lot in the suburbs as my primary residence; a couple of old cars; chickens but no cows this year means I need to mow the pasture; about a year's worth of food and water; tools; etc.  With like-minded neighbors I can call on, a few of which are local police possessing toys^H^Hols few have seen, and nothing short of a mad-max scenario would be catastrophic.)  My PP is limited by having only about 10% of my liquid assets in treasuries.  I just cannot convince myself to buy more.  The other 90% is roughly 17% cash, 33% gold and silver, and 40% stocks.  That means 40% is PP (25/25/25/25) plus 60% as VP (50% stocks, 12% cash, 38% PMs).

As for inflation...  Inflation is the supply of money (Austrian school).  Inflation is sometimes evidenced by price increases.  I know we have inflation, and I expect we'll continue to have price increases no matter what the CPI says (housing is a major component of the current CPI and has been swamping increases in other segments).

I hope the price increases continue to be relatively slow like they have been the last 25 years (only lost 50% of our purchasing power IF you believe the CPI).  However when I look at the graph of the past 100 years it does not project favorably.  Nor does history.  (Great book currently reading:  This Time It's Different, Either Centuries of Financial Folly; by Reinhart and Rogoff)

Given what I know, I fully expect the U.S. dollar to collapse.  Every fiat currency has since the first one documented hundreds of years ago in China.  I just don't know when it will happen to ours.  Everything is in position that it could be now.  But we've been on the brink like this before (maybe not as bad, but who can tell?) and pulled it out so it might not happen in my lifetime.  I want to prepare either way.  The consequences elsewhere have always been really ugly.

And this post was way too long.  Now it is just too long. 

[MediumTex]

I understand that we should be facing deflation from the bursting of the credit bubble....but what if the FED won't let this happen and the graph above continues? What are the ramifications of this? What happens if we wont let deflation happen because we continue to print money? So the credit multiplier and velocity decline but the expansion on the government side more than makes up for this.

Doesn't this eventually cause a currency crisis?

Irving Fisher wrote a great piece on this topic back in 1933 entitled "The Debt Deflation Theory of Great Depressions."

Here it is:  http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdf

He argued that when you get into cetain types of deflationary processes, there is little that can be done about it by the government, central bank or anyone else.  As I recall, he suggested abandoning the gold standard as one thing that might help break the deflationary spiral.  I don't know if he appreciated the longer term consequences of this step.

[MediumTex]

Given that the U.S. government is the largest owner of gold in the world, to what extent does anyone think that this backstops the U.S. dollar in some roundabout way?

[MediumTex]

If I was one of those pathetic looking people and a person drove up and said they were from the government I would ask if they were there to help me.  When they said that they hadn't brought any food for my empty stomach or soap to clean my dirty face, but that they would like to take my picture I might have a pretty pathetic look on my face too.  

Too funny!  I must apologize in advance because somewhere, somehow I'm sure to steal some variant of this joke.  Don't worry.  I'll be sure to give credit to the person I heard it from.  (Ash Williams, natch.)

A baloon over her head would read:  "That's right kids, she's going to help us by taking our picture.  No, she didn't bring any food.  I know, I'm not very happy about it either."

[AgAuMoney]

Sustained inflation has been supported when the society experiencing inflation has no or even negative wage growth, but sufficient buyers in other societies increase spending sufficient to support prices.  (weimar)

Sustained inflation has been supported by consuming savings and by increasing debt.  (weimar, argentina, brazil, zimbabwe)

Sustained inflation has been supported by declining standard of living (fewer and then no luxuries and even descending into starvation).  (weimar, argentina, brazil, zimbabwe)

Sustained inflation has been supported by people working multiple jobs and/or putting more people to work (women then children instead of school and/or partnerships and co-ops) instead of supporting idle hands.  (argentina, brazil, zimbabwe)

Sustained inflation has been supported thru the support of family and friends in other areas.  (zimbabwe)

These are reality and have been experienced dozens of times in the 20th century, and innumerable times before that in countries of every size and stage of development.

Don't count on wage growth to warn of or as a requirement for sustained inflation.  It may happen, it may not.

In the U.S. people have little to no savings to draw down and credit is contracting, so the basic tool to respond to rising prices here will be wages. 

If wages are not rising, I don't know where the money will come from to pay higher prices.

Official savings stats are just the bank deposits.  They do not include other assets like brokerage accounts, IRAs and 401(k)s.  Also given it takes 18months on average for the bank to kick you out after you quit making payments many people in the U.S. are spending by not paying their house payment (increasing debt).  (My next door neighbor missed his october payment, hasn't paid since, has had renters in the place since last summer, foreclosure auction first scheduled for september and could be pushed out as many of them are.  If that ain't livin...)

Once those avenues are exhausted (if they had them at all) the next place is usually sacrifice and decreased standard of living.  Such as by moving from the house with a $3000/month mortgage to a rental at $1000/month.  OK, that's $1000/month additional if they weren't paying their mortgage anyway, but it is a $2000/month savings if they had to integrity to pay until they moved out and it is definitely a cut in lifestyle.

And wages do not include unemployment benefits, welfare, food stamps etc. which attempt to track cost of living so that demographic will continue buying in spite of price increases.  You could probably lump those in with support coming from friends and family elsewhere (that either aren't affected by the inflation or are more prepared to handle it).

All those ways I mentioned originally and elaborated on above are ways that rising prices could be paid without increasing wages.

In general, how do you see a period of deleveraging accompanied by economic contraction leading to a sustained upward spiral in prices?
...
As far as women and children going to work, in an economy that already has 9%+ unemployment, I don't know how much success these groups would have entering the workforce.

I'm not talking about "work that pays something like my old job" or even "work that will pay the bills".  I'm talking any work you can find.  Even shadow employment -- join or replace the illegal immigrants and other undocumented workers just like desperate people always have.  Anything to bring in a little extra cash (to buy that six pack over and above the food stamps).

I have a neighbor who in 2007 thought he was going to be rich.  He'd sold his business and put $1.4M into buying his house, a cabin in the mountains and a chunk of land to develop.  He had the roads built, lots surveyed, test wells, power, telephone all ready to start selling lots.  He and the lenders were into it about $4M but those lots were going to bring in at least $12M and more for him if he could build some nice custom homes.  Then the bottom fell out.  For the past two years he has been driving around the country in an old toyota pickup repairing roofs (mostly) and other repairs and construction after storms and other natural events.  He still has his house and his family is still here.  He has been forgiven over $1M in debt and the other lenders have quit threatening to take the land because they don't believe the threats any more themselves.  They are now being very cooperative hoping that he'll somehow be able to start selling lots and make back something on their investment.  He hasn't taken unemployment or any gov't aid, his wife is working stocking shelves and two teenagers have found work around town.  And some of us have helped out a bit with a meal or a bag of groceries or $50 to take his wife out when he is able to get back to visit.  That's what I'm talking about.  Five years ago I didn't know what kind of man he was.  Now I do.

With every sustained inflation some prices go up and some prices go down.  For example we have had sustained inflation in the U.S. for about 100 years and the rate is accelerating with the last 50 being far worse than the first 50.  Yet computers are much cheaper than they were 50 years ago.  And the gov't says automobiles are much cheaper as well (hedonic adjustment) even at 10x the price.  I know phone calls are much cheaper, and even the cost of having a phone is less.

The austrian school definition of inflation is much less complex than trying to define inflation by its effects. 

You claim increasing wages are necessary for sustained inflation.  What do you believe is the causal relationship between inflation and wages that makes increasing wages necessary?  Higher wages cause inflation?  Must precede inflation?  Must catch up with inflation?  Or what?

If rising wages are necessary, how can the U.S. have had sustained inflation in excess of wage increases?

Can you point to a prior experience with a modern industrial economy in which a credit fueled asset bubble burst and created basically deflationary economic conditions in which there was a sustained upward spiral in prices?  I am not aware of any, but you may know of one.

Not offhand.  Very few "modern industrial economies" in the world have completed their experience with a "credit fueled asset bubble burst."  Even fewer have done when the world is resource constrained and when it was a global credit bubble taking down a large portion of those "modern industrial economies".

What would it take to convince you that we are in a multi-year deflationary period in which there is likely to be lots of slack in the economy and not much pricing power for anyone?

When I don't see prices increasing and when actual money supply (not just claimed derivative values) is decreasing.  Today food, fuel and all sorts of other commodities are in an increasing trend.  Sure we had a bit of a pullback in oil last month, and copper and steel dropped a bit earlier in the year, but the trendline is clear.  Increasing prices.

The CPI swamps this effect by the imputed rent and hedonic adjustments.

In light of those facts, what would it take to convince you that inflation is currently happening?  Ok, you admit "inflation is happening in some areas."  Close enough I suppose.

Obviously if it is happening, it can happen.  We have had decreasing wages and increasing prices.  How do you explain it? Why do you think we have inflation happening in those areas given the massively deflating credit bubble?

What would you say are the key economic differences between the U.S. and Japan today and the U.S. today and the U.S. in the 1930s?  I'm trying to rationalize how we would get inflation in the U.S. today when Japan today and the U.S. in the 1930s encountered deflationary conditions following the bursting of their respective credit fueled asset bubbles.

I'm not familiar with what happened in 1930's Japan.

I also don't think it valid to limit comparison to those countries conditions then and now.

I think a key difference is the world.  In 1930 resources were not as constrained world-wide as they are now and much of the world was still reeling and in recovery from WWI.  The U.S., relatively undamaged, had been booming, not just credit bubble and speculation, but solid industrial growth feeding pent up internal demand as well as world-wide post-war demand.  Suddenly when the credit bubble burst all that demand went away.  Supply didn't, at first.  Huge deflation right there as the first widget/bushel or what have you costs a lot (already paid for during the boom), but the 2nd one costs very little (lots of room to drop prices in the bust).

Industry copes, corrects and continues.  I think that would have been the end of it, and by 1932 we'd have been well into recovery but for Hoover stepping in and trying to fix it.  Previous bursting bubbles had been short term like that, even with larger initial corrections and Hoover and the economists of the day expected the same.  But they also expected the gov't stepping in was going to help.  I, along with the Austrian school believe it hurt.  Then FDR continued and amplified those plans and drug us deeper and deeper into the morass of central planning with production quotas, production limits, price controls, fudged economic reports and all the associated political uncertainty and high tax rates.

US today vs Japan...  Japan started with huge savings.  We start with a huge debt and a consumer culture.  Japan still keeps saving, but we'll drag ourselves to the market to buy the latest big screen and stop for a super big gulp or a big mac on the way (my MCD thanks you).  Our gov't actually encourages this, but I don't know why since many of us get depressed if we can't buy something, and so that will be the last thing to go.  And when we cannot buy for ourselves, we get the gov't to buy for us.  Maybe that will be the very last thing to go. 

OK, but as for what is different in the U.S. today vs 1930's...

Today we have a debt nearing 25% of GDP (if you believe GDP numbers) and liabilities reaching at least 4x and as much as 8x that amount (from many of the programs started in the 1930's).  The U.S. has been "borrowing" money like a mad man (created in large part out of nothing so it really isn't accurate to say borrowing, except we're going to owe interest payments on it to the Fed, hmm) and spending it on all sorts of stuff while promising to spend even more in the future.  That can cause and sustain inflation, and has in every previous instance (typically during wars).

Today we have a very hungry middle kingdom that was before the bubble burst and still is consuming everything produced.  China and other countries have a surplus to spend and are spending it to buy food and other commodities and assets.  I propose that as long as they spend it, we'll continue to see inflation in those things they are buying.

Today (if you believe it) we have passed the point of peak oil, and definitely inside the U.S. we rely on the kindness of strangers to provide oil at whatever price the market will bear.  In 1930 we provided our own oil and the supply was bigger every day plus we did not use near as much of it.  From oil comes prices changes on all other goods.

And then there is the Austrian/monetarist viewpoint... In the 1930's FDR had to confiscate gold and change the dollar value to create more money to fund his programs.  That was inflationary, but according to Bernanke, not inflationary enough.  So today BO and the Bernanke Fed conspire to have the Fed backstop treasury auctions to 1) lower interest rates, and 2) ensure the gov't has money to spend.  Bernanke has published many ideas for how to be more inflationary so as to correct the past Fed mistakes.  Who's to say he won't use them and create the inflation he thinks we need?

Today we have a gov't that wants us to turn food (corn) into fuel (ethanol) and so is subsidizing corn ethanol to the tune of 40c/gallon for millions of gallons while driving up the price of corn (2x in the past few years) and the acres planted in corn instead of other crops.  Hows that for wrapping monetarist and supply/demand inflation into one neat little package?

Today we have a gov't that supports the price of sugar (2x world prices) both by import tariffs, import restrictions and by purchasing and destroying tons of sugar (good years) and subsidizing the cost of sugar (bad years) for US producers to guarantee a minimum price.  (Another depression-era program, btw, which is why we use so much corn syrup.)  And why can't we use sugar in ethanol?  Because then you have to pay the inflated sugar price and plus won't get the ethanol subsidy which means your ethanol is going to be priced higher than corn ethanol.  Oh, but we do import millions of gallons of sugar ethanol from brazil, where they make it from weeds that grow naturally (sugar cane) and can ship it to the U.S. cheaper than we can produce subsidized corn ethanol.  How far are sugar prices going to fall?  Not much!

Today we are spending billions of dollars fighting wars and maintaining hundreds of military bases around the world.  In the 1930's the U.S. gov't was directly spending under 5% of GDP.  Today it is over 10%.  Gov't spending is inflationary just by supply and demand (it increases demand and decreases supply), or by the Austrian perspective of increasing the money supply.

Spending by the U.S. consumer is important, but is dwarfed by everything else going on both US gov't and foreign spending.  And never forget that Bernanke and the gov't want inflation and they hold all the cards.