David Stockman asks - What Deflation?

We have been running several articles here talking about monetary officials concern about potential deflation. We have pointed out that we need to watch to see if we are starting to head into a deflationary spiral and if so, how would officials react? Not everyone buys into the idea that deflation is here. 

Former Reagan Budget Director David Stockman writes this article on his blog pointing out that nowhere in the world is there any deflation yet in the reported statistics. So why all the concern? Let's look at it. First a few quotes from the article, then a few comments. As always, readers should read the entire article to get full context.

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"The Fed’s public relations firm of Hilsenrath & Blackstone was out this morning with the official line on the market’s tremors of recent days. It seems that $10 trillion in freshly minted digital money at the world’s major central banks over the last eight years—-that is, a tripling of their balance sheets to $16 trillion—- is not enough. Not only is 2% inflation still MIA, but it now threatening to enter the dark side:

Behind the spate of market turmoil lurks a worry that top policy makers thought they had beaten back a few years ago: the specter of deflation."

"Never mind that there is nothing close to a sustained run of negative consumer price indices anywhere in the world. The recent modest abatement of what has been 45 years of relentless consumer price inflation throughout the DM economies can be readily explained by short-term oil and commodity price movements and exchange rate fluctuations. Indeed, the money printers are always gumming about inflation-ex food and energy— so here it is."

"During the most recent twelve months, the CPI-ex food and energy is up 1.7%, and that compares to 1.8% in the prior year and 1.9% in each of the two years before that. Indeed, since the turn of the century the CPI less food and energy has risen by an average of 1.9% annually. So now that it has tumbled all the way down to 1.7%——a fractional emission of pure statistical noise from the government data machine—-we are suddenly drifting into a deflationary crisis?"

"And, no, the data is no different for Europe. There is no sudden lurch into a sustained downward price spiral. Instead, European consumers are enjoying a period of only marginal erosion of their purchasing power. Thus ,during the most recent twelve months, core inflation in the euro area has risen by 0.7% and that is virtually the same rate as the prior year. Going back to the pre-crisis peak in September 2007, the average core inflation rate has been 1.1% for seven years running. Again, there is no step-wide plunge in the consumer inflation trend—-just a reasonable approximation of price stability."

"In fact, what possible explanation do the Keynesian money printers have for what they imply to be an economic disease that could be called SODS (sudden onset deflation syndrome). That notion is empirically false as shown above, but by their lights where did it come from all of a sudden?"

"All of this is empirical nonsense, of course. In fact, its a blatant con game. The only reason that there is an appearance of a troublesome “inflation shortfall” is that recent rates have been below the arbitrary 2% “policy” target that has been set by Keynesian central bankers all around the world."

"Moreover, when this 2% target is taken with such literalistic rigor as to rival creationist doctrine regarding the scriptures, it can make trivial differences appear profound; and to cry out for new forms of policy action—which is what the monetary central planners are actually all about."

"In fact, there is no proof anywhere that 2% inflation on the CPI enables extra GDP growth. It’s just a flat-out invention of the monetary scholastics who have seized control of the world’s financial system."

"So here’s the real reason the nonsense of 2% inflation targeting and the specter of deflation is being fed to the compliant financial press by the policy apparatchiks running the central banks, IMF and the major nation treasury departments. In a word, governments have buried themselves in debt, and are desperate for an excuse to inflate away the real burden."

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My added comments: This is a pretty long article and readers should read the entire article because I am going to skip over many of the points in the article. To summarize, Mr. Stockman is pointing out that despite all the media and Central Bank talk about worry over deflation, none exists right now according to officially reported data. So why all the fuss over deflation he asks? He answers his own question by arguing that officials want the public to fear deflation so they can continue monetary stimulus. He says the real agenda is to get inflation up so that they can pay off the enormous existing sovereign debt burdens with cheaper dollars. The underlined and boldened paragraph above is the key paragraph in his article in my view.

I understand what Mr. Stockman is saying and agree that an unstated goal for financial authorities is to deal with the debt problem by devaluing the dollar over time. In fact, this is the very point Jim Rickards has made many times and we have covered here extensively. But I do think that their fear of potential deflation is real and not just a PR ploy as Mr. Stockman suggests. We have to keep in mind that the Central Banks have access to a lot of data that we don't. They see the trends. Also, while no actual deflation has been reported, the very low inflation rates are probably troubling to the Central Banks because they have flooded the system with so much stimulus ( a point Mr. Stockman does make in his article). I suspect there is very real concern that despite the enormous amount of monetary stimulus, the economy is still very weak. And of course as he notes, they need much higher inflation to reduce the debt to GDP ratios around the world due to the overhang of huge sovereign debt (Jim Rickards says their real unstated inflation goal is more like 4-5% per year). If this is true, you can see why only 1.7% inflation would be worrisome to them.

The reason we are watching for signs of deflation here is that we do believe it is a real threat and that the IMF, BIS, and Central Banks see that too. We think they are sincere in the many warnings they are issuing about all this lately. Just because no official deflation is showing up yet does not mean that we aren't possibly headed for some. And the warnings being issued by the IMF, BIS and others about the potential for another sudden crisis due to over valued financial assets indicate this is a real possibility. If debt starts to overwhelm the system (or a sudden rise in interest rates), it can pick up speed very quickly making recent historical data meaningless in real time.

Mr. Stockman's article wants to point a finger of blame at these same officials for creating this condition with their monetary stimulus policies. While that may be true, it does not help any of us deal with the consequences if a major deflation event does unfold. Most of us will just be trying to get by and figure out how to deal with the situation. The Central Banks will probably be in full panic response if this happens. No one should hope this happens of course. Being able to blame the Central Banks won't put any food on the table.

For now, things are still relatively stable despite the recent stock market volatility. All we can do is continue to stay alert and watch things. Low inflation, falling oil prices, stock market volatility, and bond market volatility are all signs of a possible coming deflation event. The financial authorities are clearly worried about it and are issuing warnings right and left. What we have to do is continue to follow events and watch how the authorities respond if deflation does gain momentum. Do they reverse course and ramp up another huge monetary stimulus program for example? If they do, does inflation start to rise quickly? Does another crisis unfold and lead to monetary system change sooner rather than later?

Because there is a gigantic debt overhang on the present system and the system is highly globally interconnected, big changes can happen quickly. A problem anywhere can lead to a problem everywhere. Jim Rickards says an avalanche is building up (the system is unstable) and any new snowflake can trigger it. The first step to being as prepared as possible for whatever happens is to stay informed. That is what we are trying to do here and encourage readers to do.