DEFLATION & INFLATION

Will the Sun Rise in the Morning, or Will it Set in the Evening?

By Jeff Thomas /  January 20, 2014

A feature of the recent Liberty Forum Conference in St. Kitts was a debate over whether the world is headed toward deflation or inflation. The debate proved to be quite a lively one, with the two speakers conceding very little ground to each other. The first speaker made a strong argument in favour of a deflationary depression (including a drop in the value of precious metals), whilst the other made an equally strong argument for an inflationary depression (with a significant rise in the value of precious metals).

Both speakers were well-known to the attendees and both are contrarians, yet they took diametrically opposing views on this contentious topic.

I tend to see this discussion as being akin to, “Will the sun rise in the morning, or will it set in the evening?” As I have presented previously in International Man articles, I believe we will almost certainly see both deflation and inflation. In addition, we will experience stagflation and very possibly hyperinflation.

The Sun Will Rise in the Morning

The argument for deflation centres on the fact that, historically, when a crash occurs (such as a crash in either the bond or stock market, as we anticipate), deflation is a predictable knock-on effect. This is understandable as, with a crash, people instinctively pull in their horns through fear and diminish their spending, especially on big ticket items. Additionally, a crash shifts wealth out of the hands of the average person, limiting even those who would otherwise continue to spend. As a result, demand for (and therefore prices of) assets such as stocks and houses fall. It would not be surprising to see the price of gold fall, as people in trouble tend to sell anything they can to stay afloat.

The Sun Will Set in the Evening

The argument for inflation centres on the fact that the US Federal Reserve has stated, repeatedly and unequivocally, that they consider deflation to be the greatest threat to the economy, and should deflation occur even to a minor extent, they will step in quickly to inflate the deflation away. Fed Chairman Ben Bernanke famously stated in 2002 that, if necessary, in order to get currency into the system, he would drop money from helicopters.

Mister Bernanke’s “solution” is the one most often taken by governments that face deflation. Commonly, in doing so, governments over-inflate, and the inflation takes on a life of its own. Consumers, not wishing to hold a devaluing currency, tend to rid themselves of it, leading to hyperinflation. A concurrent dramatic rise occurs in the price of gold, creating a mania, as it is revealed as being a safe haven for wealth.

The Sun Will Both Rise and Set

Both of the above arguments are soundly reasoned. The trouble in debating them, however, is that each is taken in isolation. As we have previously predicted, both can occur. Here is what I consider to be the most likely combination:

A crash occurs. Deflation is an immediate result. The Fed steps in quickly to counter the deflation, but regulating the balance is not a simple matter. It takes time to reverse the downward trend, and it is difficult to maintain control of the rise. Hence, dramatic inflation then occurs.

Further, it is entirely possible that we shall see inflation and deflation at the same time. We may well see deflation in the value of assets, such as real estate, whilst seeing commodity prices, such as fuel and food, rising—the worst possible combination of deflation with inflation, yet one that I consider not only possible but likely. (Typically, wages do not rise to keep up with the rising cost of essential goods, and the standard of living drops for most people.)

There is no particular danger in projecting the likelihood of either inflation, deflation, or, indeed, both. The danger is in creating the impression that only one or the other can occur.

The Larger View

So, why do we see two contrarian “experts” taking such opposing positions? In discussing the question after the debate with Doug Casey, he commented, “People like certainty. It’s a black and white, headline world.”

Quite so. To be sure, in those countries where the people are continually inundated by the media, it seems to be increasingly difficult for the average person to look at the Big Picture. The attention span becomes short and requires quick, definitive answers to even the most uncertain of situations. The mind has been trained to gravitate only to those “answers” that are simplistic, and the sound-bite becomes central to reaching any personal opinion.

Further, the mind ceases to deal well with uncertainty. We need to be spoon-fed the answer to any given question—to put it to rest, so that it ceases to vex us.

Unfortunately, this trend is exactly counter to what is beneficial to us, as we enter a period of change that will prove unprecedented in its magnitude.

More than at any time previously, we will need to train our minds to be open to possibilities. Indeed, at such a time, it will be important to accept that we actually know very little; that most of what we perceive, we either think or believe.

This principle may well be the deciding factor as to whether we do well or badly in the coming years, as we see the level of change increase dramatically. Our ability to juggle—to keep the conceptual balls in the air—to actually avoid certainty on many questions—will define our ability to flex and even reverse our position quickly when necessary.