Gyroscopic Investing

I tend to agree with the stagflation example.  I think that's exactly what we're experiencing right now.  If we look at monetary aggregates, they are all expanding.  Credit is still being destroyed, but most things purchased at the earliest levels of production are increasing in price and are usually purchased with cash or short net terms.

It is absolutely necessary one of three scenarios to occur:

1. Assets drop to clear malinvestment and bad debt (deflationary)
2. "Money" in its various forms needs to expand and inflate in order to rise to a level that supports assets (inflationary)
3. Some combination of #1 & #2 (stagflationary)

Just the action of suspending mark to market accounting was inflationary by itself to a certain degree.  If we made banks realize market value for their assets, most large institutions holding mortgage paper would be insolvent.  The Fed can openly monetize bad debt via purchasing MBSs from institutions and adding them to their own balance sheet.  What would be deflationary (foreclosure realized at 50c/dollar) can now be inflationary (paper sold to Fed at par).

On the issue of peak oil, I don't think folks should get worked up over it.  Most people don't like change because they can't predict the outcome with certainty.  Back in the late 70s when inflation was rampant and unemployment was high, people were pessimistic.  Who would have thought the productivity gains of personal computing and the internet would be right around the corner? 

We just don't know what breakthroughs are ahead of us.  I would absolutely not be surprised if there are major technology breakthroughs in energy that will drive economic prosperity in the 2020s and beyond.  Nat gas, hydrogen, solar, wind...whatever. 

We will trudge through our current mess as prior generations did with theirs, and then we will move on and make a better life in the future.  That is all provided we don't wipe each other out in a nuclear holocaust...but the PP wouldn't save us then so who cares?

Lone Wolf wrote:

MediumTex wrote: Higher energy prices create demand destruction across the entire economy as people have the same amount of money as before but everything starts costing more.  Faced with no extra money to pay higher prices, demand across the entire economy becomes soft, driving prices lower after an initial upward surge. 

You're making a compelling argument, but isn't something like the 70s "stagflation" quite likely in such a case?  If lots of money gets pumped into an economy in which it can chase fewer goods, why couldn't we see weak economic growth coupled with higher prices?  It seems to match history pretty cleanly.

IMHO, stagflation requires a different demographic profile than we currently have (i.e., an expanding workforce) and more ability to exert upward wage pressure through entities such as labor unions.  We had an expanding workforce in the 1970s and strong labor unions.  We have neither of these things today.

In the 1970s there was also strong appreciation in housing prices in most parts of the country, which was inflationary.  Anyone think house prices are about to start rising again?

In the 1970s there was a tiny fraction of the amount of debt in the system compared to today.  Back then there was no massive credit contraction competing with Fed attempts to reflate the economy.  It's harder to create inflation when for every dollar you print several dollars are extinguished through credit contraction (ask the Japanese).

As a shorthand approach, since we know that Tbills have historically more or less tracked inflation, just watch the Tbill rate.  When it begins to rise, you will know that there is some inflation in the pipeline.

I don't know how it will play out, but I would take the deflation thesis seriously.  The last 20 years in Japan show how that story can play out and how much damage it can do.

An Austrian economist would say that what we are seeing today are merely effects which are following causes that occurred long ago and these effects are not alterable at this point.  The only choice is whether additional malinvestment is going to occur through governmental attempts to short circuit the deleveraging process.  This is what the Japanese attempted to do in the 1990s and 2000s and what the U.S. attempted to do in the 1930s and today, with more or less predictable results.

One of the basic insights of Austrian economics is that it is the malinvestment facilitated by artificially low interest rates during the boom period that causes the depression that follows.  The crash that precedes the depression (and which appears to be its cause) is just the point at which the pressure within the system finally manifested itself.  By 2008, we were far past the point at which something could have actually been done to mitigate the effects we are observing today.

MT,

I can always dig your well measured point of view. 

Best,
Wonk

I have found that it is a good exercise with PP assets to be able to make both a bull and bear case to yourself at all times.  This helps me to keep from getting overly optimistic or pessimistic about any one asset, because I just don't know what's going to actually happen.

Making the deflation argument certainly makes sense to me, but it also makes sense that every fiat currency in history has eventually failed (as has every centralized government).

Perhaps in the short term the deflation argument will carry the day and in the longer term the inflation story will take over.  How long will this take and how will it unfold?  If I knew I wouldn't need the PP.