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Deflation in an inflationary environment

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Speaking from a North-North American perspective. That is Canada and the United States.


I think that we are going to be in a situation where we will have inflation on commodities and deflation on services.  This will lead to an overall measurement of benign inflation and allow loose monetary policies for longer than many predict.


Two reasons for commodity price inflation:

1.  Expansion of the money supply means that if it's priced in USD the price is going to go up.

2. We will be competing with industrialising nations for natural resources and the prices for the energy to attain them will rise.


Reasons for deflation of services:

1. Rampant unemployment will result in more competition for local jobs and this will keep wages restrained or declining. Oftentimes Labor is the largest cost for production.

2. A globalized workforce will see manufacturing and some service jobs going overseas to lower cost labor. This will lead to more unemployment and feed into point #1.

3. A deleveraging consumer will need to decrease spending and be more aware about purchases and will go to the lower cost provider leading to agressive price cuts for anyone looking to keep sales up.

4. Lower profit margins will feed again into point #1 as businesses become more focused on cutting costs to reduce prices.


Without trade barriers I don't see how the above scenarios can be avoided.  (I'm not advocating for them)  Based on these arguments, I think that low interest rates and loose monetary policy may be in place a lot longer than people expect as main street has only just begun to fix their balance sheets and this will in all likelihood take quite some time.  Given that we have service economies this may be very painful and these loose monetary plicies will feed further into commodity price inflation.


Any comments would be appreciated. Perspective is everything.

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Keep in mind that your deflation is too little money chasing too many services, & can only occurr if all NA spending goes down faster than services. Governments can temporarily print money to plug the spending gap, & NA labour has a significant migratory component.


Yes, in the near-term there are too many workers; but farmers aren't going to use pickers if they cant sell their crop, and factories/construction sites aren't going to use migrant labour to do the sh1t jobs if they aren't selling. A migrant still needs to make X$ to live, & if his/her 'in-country' relatives are advising that they can't do it - that person is not going to migrate.


If you have $10 & you can buy 10 foreign widgets - you have a lot of 'stuff' but no domestic benefit as the foreign guy got the work. If you now only have $7 & can buy only 5 foreign widgets, or 6 domestic ones - you'll have less 'stuff' but will buy domestic & some NA will get the work. You bought domestic because the value of your currency fell, & not because the production cost of the widget changed. More jobs, more spending, etc.


Most folks are missing this.







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A migrant still needs to make X$ to live, & if his/her 'in-country' relatives are advising that they can't do it - that person is not going to migrate.



The assumption here is that immigrants don't come in to take the sh1t jobs because they aren't getting compensated to do so.  They may as well stay in their respective home countries. What this means is that native Americans / Canadians are so hungry for work that they are now accepting the sh1t jobs. Work they would otherwise not have wanted for wages they would otherwise not have accepted. For us to be at this point, our workforce would need be in an unprecedented state of desperation.



Put another way, for immigrants to voluntarily choose to stop coming to our countries for work, it means that prospects in our countries for labour are as bleak as in their home countries = domestic poverty = less spending = less demand = deflation for anything with labour as an input cost.

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When our migrant was making $10/hr & working 12 hours/day he was making $120/day & might have spent $60/day on food/shelter/& 'fees'. The migrant took on significant risk to get that opportunity (border crossing/daily 'immigration' police), & most of that net $60/day went home where he was considered a 'rich' man. The risk was deemed 'worth it', & thousands sought the 'better' life.


Our migrant now makes $8/hr & can only find work for 10 hours/day. Rising US hostility has both inceased the 'fee' so that he still pays $60/day, & increased his daily risk significantly, so that he now nets only $20/day - & on most days none of it goes home. The risk is now deemed 'not worth it' & kin are advised to stay home.


Keep in mind that the migrant could also be a 'westerner' taking a 2 yr contract in Iraq/Afghanistan for 120K/Yr.

ie: Invert.


Nothing to do with workforce desperation.









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iTulip argues that deflation will  change to substantial inflation and possibly hyperinflation ("Ka-poom") primarily because of an intentional policy by the US to debase the currency. David Einhorn apparently agrees because he has bought gold because gold is a bet that government policy will continue to be stupid and he has bought deep out of the money options betting that interest rates will rise substantially.


Hoisington and Steve Keen both argue that massive debts will reduce consumption for a long time which leads to the Fisher debt deflation death spiral and low interest rates. Hoisington points out that since imports are a small part of the US economy that devaluation will not likely lead to hyperinflation.


Armstrong says that "It's Just Time", that the cycle can't be stopped, only dampened and that the next turning point (on the downside of his economic confidence cycle) will occur in April 2010. Marty writes extensively about the decline of rule of law and suggests this will result in capital leaving US, currency collapse and inflation, not deflation.


I suggest that iTulip overstates the "intention" because monetary policy alone can't both control interest rates and the currency at the same time. The Fed is controlling interest rates so it can't control the currency. The currency policy at best is neglect. So far the low interest rates have stimulated a recovery just as iTulip predicted. We are even experiencing some asset inflation in places which don't suffer debt deflation (like Vancouver where I live or China). I suspect the low interest rate environment will occur for an extended period because the policy is good for the banks, especially those with large derivative positions. Interest rate swaps are about 70% of the derivatives and I suspect they have bet that there will be a steep yield curve with low rates because that is what has occurred. The attempt to keep this interest rate environment causes the weakening USD. Reckless spending and intentionally using taxpayer present and future monies to support the housing market (through FHA and the like) erodes confidence in the commitment of the US to pay its interest obligations in current dollars.


Hoisington is correct that currency devaluation alone in the US cannot lead to hyperinflation. I agree with your point that competition and debt deflation will restrain wages and that wages are a big component of costs which also helps prevent most inflation. Unfortunately I don't think we face only the risk of currency devaluation. We face the worse risk of a declining trust and confidence in the system.


Confidence is important for this reason. The Birth of Plenty argues that our prosperity is a result of four factors and that the absence of one or more of the factors meant that there was no growth until the 18th century and that growth occurred in each country only when all four factors were achieved. The four factors which cause financial prosperity are: 1. Protection of property rights 2. Support of scientific rationalism 3. Effective capital markets and 4. Fast and efficient communication and transportation. I suggest that trust and confidence are the framework that make the four factors possible. These factors explain well the rapid development in Canada and the US (and elsewhere).


Accordingly I suggest Marty's views are critical to the analysis.  I agree with Marty that there is deteriorating rule of law in the US. The US policies to impose new taxes on foreign owners of US securities and to attack US holders of foreign bank account are particularly ill-considered. I worry about the Copenhagen treaty. Treaties are how voters lose their right to govern themselves.  I believe the proposed Copenhagen treaty is an attack on the post war Washington Consensus which has created so much prosperity. I note that once the treaty is signed, it is difficult for any country which signs to change its mind and back out. The Senate may yet save the US from the treaty but in Canada we have to rely on the PM. So much for democracy in Canada; we face a change in our economic system and we don’t even get a chance to vote. Those who think the treaty is about climate change should better study the document and the science. The treaty erodes all four factors vital to prosperity.


On a positive note the Washington consensus has placed us on the verge of exploiting countless new technologies. The internet has increased the speed at which new ideas are spread and implemented. Will the capitalist environment remain strong enough for these new opportunities to emerge?


Niall Ferguson argues in various books that power and wealth have shifted from Europe to US and is now shifting to Asia. Exactly. China is dancing while the US erodes its power and position by its own hand. China has always complained about US hegemony. Marty is right that we are approaching a turning point. One day China will re-announce their policy to allow the Yuan to appreciate, then there will be a risk-less one way bet fed by the USD carry-trade, which will weaken the USD further if the US continues to have silly economic policies and the borrowed USD are converted and invested elsewhere. Capital flight from the US will result in the lower standard of living in the US, stagflation and rampant unemployment. So yes, it currently looks like we cannot avoid inflation in USD in commodities and deflation in the US in the price of services.


Let’s hope that the US’ capacity to re-invent itself arises. I suggest they focus on restoring the four factors set out in The Birth of Plenty which caused their prosperity from the start.



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