My unpublished (100,000 word) book “The Financial Jigsaw”, is being serialised here weekly in 100 Issues by Peter J Underwood, author
Quote of the Week: “People don’t want to hear the truth because they don’t want their illusions destroyed” – Fredrich Nietzsche
Last week we opened Chapter 9 with a review of the nature of inflation as a mathematical concept and illustrated this with a mind game to test perceptions of maths concepts. Here is the link to last week: Issue 45
Now that Brexit is finally coming to a conclusion after almost three years I will now be providing weekly updates as events progress:
Brexit Update – 5th April 2019
This week happens to be the end of the UK tax year and for Brexit it was merely more of the same prevarication as Parliament continued endless debates all of which ended in no definite decision either way as to how to carry forward the exit strategy.
The week ended with the two leaders, Theresa May and Jeremy Corbyn engaging in a head-to-head discussion in an effort to agree some sort of compromise which could be acceptable to a majority of MPs. To date no announcement has been made and the deliberations continue into the weekend. But on Friday Mrs May announced that she has applied to the EU for a further extension of Brexit to 30th June 2019 but yet to be agreed by the EU.
Yet another ‘indicative’ vote is to be held in Parliament next Monday when perhaps we will get further indications of the final outcome of Brexit bearing in mind that the current deadline for exit remains 12th April 2019 with an EU summit being held on 10th April 2019.
Details can be found here:
Nigel Farage, who was formerly the leader of the Ukip party, has founded a new Brexit Party to fight the European elections should they occur. Here is his latest missive:
Dear Brexiteer
“In her letter to Donald Tusk this morning, Prime Minister Theresa May made it clear that she is seeking a further extension to Article 50, and has ordered the government to prepare for the upcoming European elections.
I thought we had won the battle for independence, but I refuse to stand by and do nothing, after 25 years of endeavour, to watch British politicians roll us over and betray the Brexit vote.
The fightback has begun and I think the establishment are going to be very surprised by the shock we can deliver.
I will be leading The Brexit Party into those European elections as it now looks certain they will happen.” – Nigel Farage
For those of you who wish to follow the Brexit saga each day, you can do no better than follow Dr Richard North’s blog at: http://eureferendum.com/ Please note that Dr North has always promoted his ‘Flexcit’ solution, a 400 page thesis on an efta/EEA exit plan.
Hot Press: Newport (Wales) UK By-election
A by-election was held on Thursday, 4th April and the results are disappointing for Labour with a swing of 2.4% to Conservatives after 9 years of Tory rule. Ukip managed to increase the percentage of the vote (8%) which presages a move to a ‘No-deal Brexit’ as a final outcome.
These local results are not always indicative of a general election outcome but nevertheless the Labour vote is not encouraging. Perhaps Corbyn will have less leverage in his talks with Mrs May over the next few days.
Europe and Inflation
The ECB’s reintroduction of TLTRO is an offer of yet more monetary and credit inflation, despite the evidence that unprecedented waves of monetary inflation in the last ten years have failed in all the objectives for which they were designed, except two: governments have continued to get the funds to spend without meaningful restraint, and insolvent banks have been preserved. The relentless progress of the failed policies of central banks are continuing to influence the (95%) general public, raising more angst against the ruling elite.
https://mises.org/wire/ecb-inflationists-are-crippling-europe
CHAPTER 9
Inflation & Deflation
“There are known knowns; there are things we know that we know. There are known unknowns; there are things that we now know we don’t know. But there are also unknown unknowns; there are things we do not know we don’t know” The original source of this koan may be ‘Landmark Education of Seattle’, Washington;
although generally it is attributed to former US Defence Secretary. – Donald Rumsfeld
“There are three kinds of lies: lies, damned lies, and statistics” – Mark Twain
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value” – Alan Greenspan
Enter ‘deflation’ on the scene, scorned by economists and governments alike
Deflation however was our current concern in 2017 and one of the things most feared by bankers and the powerful financial elite. Most modern-day economists propose that: “a little inflation is a good thing,” and they fear deflation which is well illustrated by Dr. Ben Bernanke, chairman of the Federal Reserve of America.
His studies of the Great Depression have convinced him that deflation was the monster most associated with the drastic economic effects of that day and age. It is true that the Great Depression and deflation were found together in some countries but it is important to distinguish between association, correlation and causation by determining a true basis for the causes of deflation.
A recent study by Atkeson and Kehoe spanning a period of 180 years for 17 countries found no relationship between deflation and economic depressions; rather it found a greater number of episodes of economic depression coincident with inflation than with deflation. Over this period, 65 out of 73 deflation episodes had no economic depression and 21 out of 29 economic depressions had no deflation.
The main argument against deflation is that when prices are falling, consumers will postpone their purchases to take advantage of even lower prices in the future reducing current demand. This is projected to cause prices to fall even further in a self-fulfilling prophecy ending in a deflationary economic spiral downward and thus ‘causation is determined’: that deflation causes a depression; the argument can be found in most introductory economics textbooks.
The St. Louis Federal Reserve Bank recently wrote: “While the idea of lower prices may sound attractive, deflation is a real concern for several reasons. Deflation discourages spending and investment because consumers, expecting prices to fall further, delay purchases, preferring instead to save and wait for even lower prices. Decreased spending, in turn, lowers company sales and profits, which eventually increases unemployment.”
This argument can be challenged using several sound economic principles. Economies in the developed world have evolved from manufacturing-based production to a consumption-based one in which 70% of UK (and USA) Gross Domestic Product (GDP) derives from spending by the general public on consumable items such as leisure, technology, gadgets, housing, food and power.
This has been caused by the shift in production methods using more automation, out-sourcing manufacturing to developing countries (globalisation) and has reduced employment opportunities in much the same way that agricultural labour transferred to factories during the industrial revolution.
Our society has become so dependent on ‘consumerism’ that it is almost impossible to project a significant reversal in spending habits regardless of how low prices of consumer goods fall in a deflationary environment. Apple has been able to sell its latest iPhone, whilst people expect the same phone to be cheaper in the future, in spite of their propensity to wait for cheaper prices.
Consumer debt replaces the lack of disposable income
Economists argue that if we are consuming less, we must be saving more. But this notion relies on the fact that we can actually maintain our standard of living on less expenditure. This has not been the case because consumer debt has risen and taken the place of our reduced purchasing power; our earnings and savings have in fact fallen in the meantime.
Moreover, economists postulate that increased savings can lead to deflation but it is clear that deflation does not reduce aggregate demand but simply alters the composition of demand. The demand for consumption goods could decline but be replaced with demand for other kinds of goods even capital goods.
The result of this might even lead to growth and more consumption goods in the future, since the economy has more capital with which to work. The period of the greatest growth in the U.S.A. during the nineteenth century, was from 1820 to 1850 and from 1865 to 1900, and was associated with significant deflation when prices were halved. To illustrate these trends we can use the thought experiment in our previous ‘apples’ examples in previous Chapters.
A thought experiment to illustrate the effects of deflation and inflation
Suppose, in a ‘closed market system’, there are 20 apples and £10 stock of money. The market would eventually set the price of apples at 50p each which would match the supply or as economists would say: ‘rendering the market in equilibrium’.
If the price of apples were set higher, at say £1, there would be surplus apples after the £10 had been spent leaving the market to reduce the price to zero for the remaining apples. If you could not give them away they would perish and the next time apples came on the market the price over a short time would be set lower to match supply.
People tend to have long memories where money is concerned, for example, do you know anyone who has ‘forgotten’ a debt? Suppose that the supply of apples increases to, say, 40 apples, the market would eventually adjust the price down to 25p each, again matching supplies, with all other things being equal including the stock of money.
This is how a market adjusts for supply and demand and which some economists equate to deflation, because of falling prices, when in fact the culprit in this case is the ‘supply’ (‘inputs’ in economic terms) which has changed and is reflected in the price.
Next we can make another change assuming that the supply of apples stays constant at 20 apples; the stock of money is increased to £20 this time around. Using the parameters of the last experiment the market will seek to equalise and set the price of apples at £1 each, twice the price in the last example.
Here we see inflation in action in its simplest form; change the stock of money and, so long as supply and demand stays level, prices will increase given enough time. It is important to note the ‘time factor’ as there is always a lag in the market between changes in supply and changes in demand and these are not easily discerned in a short time interval.
We can now see the interaction of money supply with the demand and supply of goods and services but these are only two factors. There are many influences on the economic models for which we need to account and makes economic forecasting so uncertain to the chagrin of politicians and economists everywhere.
To be continued next Saturday
Thank you, AP. Don’t be discouraged by any dearth of comments. The Atkeson and Kehoe study is interesting as well as the “apple” thought experiment regarding supply and demand.
You wrote:
I’m always amazed at how financial headlines are so often at odds with actual “man on the street” reports, so to speak, at any given time. Take for example the automotive industry. National headlines report the top of a retail wave just as dealers and manufacturers express concerns over growing inventories, slowing sales, or similar anxieties.
For the marginally engaged, it makes spotting trends confusing. Therefore, when in doubt, look to where the rubber meets the road instead of the past vanishing in the rear-view mirror. Where they’re at now determines where they’re going. Still, in the end, the road is made of paper, ether, and hot air.
Thank you Uncola, for your kind and supportive words. I am far away from disappointment as my 75 years has given me resilience to weather the storms of fractious seas. As you say the MSM are generally at odds with what the general public know and feel. I love your illustration of the current auto business, so true and an example to us all; and your metaphors are stunning, puns included!
I prefer to think that the MSM merely parrot the government lines without thinking or questioning. They too are under pressure to perform and so take short cuts which do them little justice. I rely on websites and programmes that don’t have agendas and thus offer the truth as they see it, then I check out and research to confirm my findings, but I get it wrong too sometimes.
I expect food to inflate. Cars need to simplify. Welfare needs drastic reform. The Public System is a failure and parents should be given Vouchers only for schools that can pass Standardized Academic Tests. Vote Fraud must be investigated and punished. The FCC must prosecute MSM political bias.
I agree cars need to simplify. Have you seen the chassis for the new 2020 i-car? It’s getting ridiculous.
Looks like people became simplified too.
All so true Robert, thanks, and I support your angst. Perhaps this article will give you hope: