Deflation or inflation? Don’t let yourself be fooled!

It is fairly remarkable that apparently everyone and his brother including some former inflationists and Amanita subscribers are convinced that a large deflation is approaching. Sentiment analysis with the aid of Google Trends suggests that the crowd has recently started to google for "deflation" like a scalded cat (http://www.google.com/trends?q=deflation&ctab=0&geo=all&date=all&sort=0). This is a good sign because the crowd is almost always wrong if a clear consensus is present. The last deflation debate was triggered in May 2003 after a remark by the false god Greenspan, no surprise that oil as a key benchmark for inflation rocketed by +100% in the following year... The more people are obsessed with deflation (and google for it), the more likely inflation becomes.

In contrast, the search term inflation was an insiders' tip until 2007, in spite of exploding prices search and news reference volume remained constant (http://www.google.com/trends?q=inflation&ctab=0&geo=all&date=all&sort=0). Oddly, in late 2004, late 2005, late 2006, and late 2007 the search volume dropped sharply, precisely near major oil lows (by and large one can say: oil = inflation). However, the sudden rise in the spring of 2008 was a sign of overheated sentiment and a warning sign, was well as the launch of the hyperinflationHyperinflation is inflation that is getting totally out of control. I define global hyperinflation in the broader sense as US$ inflation rising to a new all-time high at 20-30% each year and hyperinflation in the narrow sense of the word as 20-30% inflation each month. certificate DE000MS0JY60 2 months ago.

In addition, the bond market is pricing in deflation (link).

Due to questions I'd like to discuss the 7 most popular fallacies concerning inflation/deflation, as usually the mainstream media spread a mixture of half-truths and utter nonsense:

fallacy #1: "Deflation has already arrived"

This is the most absurd rumor, in reality we have only seen a marginal pullback of inflation, the growth of US M3 (reconstructed) declined from the all-time high at +17% to +13%, Euro M3 also fell by about 4%, from +12.3% to +8.6% (http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=117.BSI.M.U2.Y.V.M30.X.I.U2.2300.Z01.A). So far official euro inflation has fallen from 4.0% to 3.6% (http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=122.ICP.M.U2.N.000000.4.ANR), true inflation beyond the rigged numbers around 100% higher.

In addition, only a handful of 'experts' understands the meaning of intra-inflationary cycleA cycle is a recurring event in the marketss: the two basic forms of inflation are asset-price inflation and consumer price inflation (CPI), i.e. the expanded money supply can either flow into the markets or to the consumer goods. 2007-8 party saw the pendulum swinging back from asset price inflation to consumer price inflation.

Money creation (M3) follows an 11-year cycleA cycle is a recurring event in the markets, the M3 growth top is also the top of the sun spot cycleA cycle is a recurring event in the markets (last instance: 2000-2001). Then we have an half-cycleA cycle is a recurring event in the markets of 5.5 years which did top out in late 2007/ mid-2008, that's why we are experiencing the largest correction in the time frame +/- 5 years. Both the sun spot cycleA cycle is a recurring event in the markets and the M3 cycleA cycle is a recurring event in the markets are currently delayed: Euro M3 growth topped in October 2007 (= stock market high) and US M3 growth topped in July 2008 (= commodities top). The next 11-year cycleA cycle is a recurring event in the markets crest due with the solar maximum 2012 should be the top of the hyperinflationHyperinflation is inflation that is getting totally out of control. I define global hyperinflation in the broader sense as US$ inflation rising to a new all-time high at 20-30% each year and hyperinflation in the narrow sense of the word as 20-30% inflation each month..

fallacy #2: "The situation is bad, that's why inflation should drop or we should even expect deflation"

This rule only applies under a metals standard, in the final stages of the fiat money Ponzi scheme this natural and meaningful role is turned upside down and the principal rule is: the lower GDP growth, the higher inflation. The very weak and difficult late 1970ies through the early 1980ies were coined by very high inflation while the lowest US inflation in the past 35 years (2-3%) was seen in the mid-1980ies when the US economy enjoyed the highest GDP growth (7-8%!) of the past 35 years, see http://www.shadowstats.com/. The reason is that during bad times the economy has to be sedated with a drug called liquidity. At present inflation is going back because we are near the bottom and can expect the last (very weak) economic boom through 2009 within the capitalistic system as we know it. Afterwards, the depression is getting severe again, accompanied of course by inflation going through the roof.

Inflation always means impoverishment and pauperization of the bigger part of population. Look at the countries with the highest and the lowest inflation today, what do you note? Those with the highest inflation are the least stable and the ones with most problems in almost every respect (economic, social, political) while the countries with the lowest inflation are the strongest. On the one end (highest inflation) we have Zimbabwe which is collapsing totally (lowest GDP per capital of all countries), on the other end (lowest inflation under the big states) is Japan, a country that is in a very good position compared to other nations: low unemployment, low criminality, high exports, politically stable. In the best case I expect a 50/50 scenarioNormally the main forecasts are distinguishing between a preferred (more likely) and an alternate (less likely) scenario that usually only diverge on the price axis but not on the time axis. Timing is always more important, reliable & accurate in the Amanita forecasts than prices. for the US (50% unemployment, 50% GDP collapse) and a 30/30 scenarioNormally the main forecasts are distinguishing between a preferred (more likely) and an alternate (less likely) scenario that usually only diverge on the price axis but not on the time axis. Timing is always more important, reliable & accurate in the Amanita forecasts than prices. for Europe.

Meanwhile the depression is slowly recognized by the mainstream, as expected the Jupiter-Pluto depression cycleA cycle is a recurring event in the markets has kicked in. I did already warn in 2005 that the conjunction of Jupiter and Pluto in December 2007 would start a depression (more).

fallacy #3: "The ongoing and imminent defaults are deflationary"

In principle that is correct, however, every deflationary pulse has to be overcompensated many times (!) and that is very inflationary. A true (sustainable) deflation is not possible in the final stage of the fiat money experiment because it would almost inevitably destroy the system and lead to a total collapse! It's so simple that no one understands it... Inflation is the invisible hand that washes real debt away, i.e. the US trashery bonds have a negative yield of not much less than -10% (real-world inflation is almost 10% higher than the interest rate paid by the US government), i.e. the existing debt is shrinking by about 10% each year if adjusted by inflation (at the expense of bond holders). Inflation is the only way to reconcile book (= fantasy) values of toxic papers like CDS and others with market values. E.g. a paper is worth 100 in the books but the market only pays 50, then you need +100% inflation to reconcile the two. If the market price is only 20, then you need +400% inflation for a ‘solution'. This is a quite schematic model not discussing many factors but I think you understand the logic: it's inflation and only inflation that postpone the inevitable collapse of the Ponzi scheme (for a few years),.

That's why even a mild reduction of the speed of money printing already feels like a catastrophe. The money creation by the commercial banks bogged down in 2008, therefore central banks had to step in to prevent the Ponzi scheme from collapsing. M0 is central bank money resp. the monetary base (http://en.wikipedia.org/wiki/Monetary_base), it is now growing faster than at any time in history, with almost +40% (the upper chart has the data through October, the lower chart is more up-to-date). Money supply leads consumer price inflation, the US CPI exploded to +99% in the peak month (July 1946).

It would be a miracle if we are getting away with ‘only' +100% inflation this time. The growth of FTTM (Fed & Treasury Total Money) has already accelerated to about +120% over the past year (http://www.nowandfutures.com/images/fed_all.png), a monster inflation wave is approaching the planet the next years.

Bank credits are expanding as hell, a quote from the late John Mauldin letter:
"Meanwhile, in the US, bank lending is already responding to Fed's tactics. Total commercial and consumer bank lending has grown by an annualized rate of almost 50% in the last month and a half."

Government expenses are another huge warning sign since government expenses and inflation are correlated closely. The chart below based on official date shows the clear connection of government expenses and inflation, the correlation has been almost perfect since 1971 when the gold window was closed (the red line added by myself tries to correct the counterfeited inflation numbers). According to David Greenlaw, Morgan Stanley's chief economist, we should expect a US deficit of some $2 trillion (!) in 2009, which amounts to 10-15% of the official GDP and even 15-20% of the true GDP numbers. Government expenses rising by 50-100% will send inflation rates to this level (inflation nirvana). Don't forget that the state is the main beneficiary of inflation, an interesting quote of Alan Greenspan on that topic, "Deficit spending is simply a scheme for the confiscation of wealth [through inflation]."

fallacy #4: "A sharp pullback in commodity prices (or bursting bubbles in general) indicate deflation"

This assmumption is not true in a fiat money system (since 1971), bursting bubbles are disinflationary (data from shadowstats.com):

• In 1980 the commodity bubble burst and US$ inflation fell from 14.8% to 3.3% in 38 months (by 11.5%)

• In 1990 the Japan bubble burst (stocks & real estate) and the oil market started a sharp bear market, the CPI fell from 8.6% to 5.1% in 16 months (by 3.5%)

• In 2000 the stock market bubble burst, the CPI dropped from 10.0% to 7.5% in 18 months (by 2.5%)

• In 2007 the real estate bubble imploded, so far the CPI only dropped from over 13% to below 12% (by about 1.5%)

The key is to understand that commodities - and to some degree the financial markets in general - correlate with the rate of change (growth rate over the past year), with M3 being crucial in this context. Euro M3 topped in October 2007 (= stock market top) and US M3 topped in July 2008 (= commodity top as measured by the CCI index). M3 growth is now in the largest correction in several years, this correction was leveraged by commodities & stocks to the downside just as the expansion before was leveraged the upside. Meanwhile M3 has recovered and the incredible M0 spike will almost inevitably lead to massive M3 expansion to at least 20-30% or more, but with a delay. And needless to say, inflation is not linear: even the +2500% rally in gold and the +3500% rally in silver into the 1980 high was interrupted in the mid-1970ies by a correction of 6 months of silver and even of 18 months in gold, halving prices.

fallacy #5: "Inflation is bad for the stock markets"

Analysts apparently don't realize that someone is profiting from the fact that consumers pay higher prices: the companies that are generating higher sales. Analysts frequently seem to confuse inflation with interest rates or use one as the proxy for the other: it's true that high interest rates are poisonous for the equities while inflation is very bullish. Historically, inflation and yields move more or less in tandem but over the past decade both have decoupled entirely. At the inflation top at the early 1980ies the 10-year T-note yield (TNX) & inflation were balanced at around 15%, and we still had an equilibrium at 8-9% in 1990. In the meantime everything has gotten out of control, the TNX has collapsed to 4% while real-word inflation has soared to 13%.

From a truly long-termLong-term means a time horizon of years. point of view (since 1929) the stock markets nave gained little or nothing at all in real terms, i.e. nominal gains are mainly sham profits created by money losing its purchasing power. To give that a positive spin: over the long haul stocks are an excellent hedge against inflation, that's it. The Pearson correlation coefficient of the Dow Jones with the time axis since 1982 is r=95.7% which means that over the past 26 years the Dow Jones could be entirely explained as a function of time. And in a time money system time is almost equivalent with inflation. Almost no one realizes that with a perspective of several decades, equities and not (!) commodities are the best inflation hedge because commodities on average lag inflation by 1-2% each year. These explanations are just the long-termLong-term means a time horizon of years. view, short-term stocks and commodities mainly mirror the M3 rate-of-change of as discussed above.

The chart below tells us that real gains in the Dow Jones Industrials were mainly restricted to the 19th century, since 1929 we are heading sideways. Because of the manipulation of the CPI data in the 1980ies the Dow Jones in reality did not form a significant new all-time high but mainly a double-top to 1929 and 1966 (the red lines added try to correct the chart). Silver has behaved just the other way round: it was strong in the 19th century but a bad investment in the 20th century with the only exception of the years around the 1980 top.

As a sidenote: it is grotesque but 99% of the so-called experts don't understand that the stock markets as measured by the benchmark USA have already experienced the biggest bear market in history! The inflation-adjusted SPX all-time high 1553 points from March 2000 translates to about 3500 points today adjusted for real-world inflation, so with a drop to 840 the SPX has already dropped a whopping 76% (!) below the all-time high. The Dow Jones saw larger real losses (about -80%) only in the 1929-32 bear market, because of the deflation (gold standard) nominal losses were larger than real losses. However, one should take into consideration that 70-80 years ago the Dow Jones was still a somewhat speculative index that can be compared to a blend of S&P 500 and Nasdaq 100 index today. The blue chips at this time were mainly in the Transports index, today the Dow Jones Industrials only consists of the bluest of blue chips. The Nasdaq 100 index has already plunged by -88% below the 2000 high, the mean of -76% and -88% is -82%, i.e. we have already experienced the biggest bear market in the history of capitalism... which is not understood by 99% of the market participants, what an irony!

The next biggest declines in the history of capitalism were the bear markets 1906-1921 and 1968-1982 with each about -70%. The biggest declines in the 19th century were smaller because the gold standard stabilized the system and bubbles were weaker, that's why the crashes were not as severe. After the biggest bear market in the history of capitalism the question is legitimate how much the indices can still lose...? Sentiment is beating the same drum, it's so pessimistic that it's positive surprise if we are not all dead by tomorrow! :-)

fallacy #6: "Now a 1930ies deflation is looming"

That is not the case at all because until 1933/34 we had (in the US) a gold standard, then a blend and since 1971 a pure fiat money system which is always favoring inflation over deflation, in the best case (Japan) it's producing stability.

fallacy #7: "Starting in the US, the world is now facing a Japanese deflation"

Japan is in crucial factors almost 180° different then the US, so you should expect a 180° different result:
(a)   In contrast to the US, Japan is not spending vast (unproductive) amounts of money on war, by and large we have the equation war = inflation (both are results of excessive yang energy).
(b)   Japan has always remain a very competitive nation, Japan & Germany are the leaders in exports - unlike the US which are losing competitiveness all the time.
(c)   Japan is still a very solid and strong nation with a low share of foreigners and with very little criminality, compared to the US which are one of the most dangerous nations on the planet (highest criminality among industrialized countries).
(d)   The yen never was the world's reserve currency like the dollar.
(e) After the bubble burst Japan still had a high savings rate - the exact opposite to the US today.
(f) After the bursting of the bubble in 1990 money supply growth rate fell back from +12% to 0% and even below, so inflation was more or less erased, a very healthy and natural reaction and a sign of economic health. In the Western world just the opposite happened after the dotcom bubble burst in 2000, the printing press is running as fast as never before in history. This also explains why the Nikkei 225 index fell back to the lowest level since the early 1980ies, the main reason is that the yen was hardly devaluated by inflation (link). The basic rule explained above does apply, too: the better the situation (and Japan is still in a good position), the lower inflation.
(g) The new money supply created by Japan was mainly exported abroad (through the carry trade), so it did pump up bubbles in other countries but did not have a main impact on Japan.
(h) The Japanese stimulus packages were about 10 times (!) smaller than today's stimulus packages.

In a nutshell one could say that the danger of deflation is as realistic as dying from heat on the north pole. The ongoing deflation debate is hoax spread by the mainstream media and initiated by the high finance in order to delude people and clear the path for the coming inflation wave that will be much larger than 99% of the people can imagine.