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Years ago a friend of mine in New York told me about his massively overweight neighbour who took to wearing a black t-shirt with “I beat anorexia” printed on it.
I think that is how our central bankers look at the wonderful job they are doing. Since the last link to gold was severed in August 1971, the dollar has lost 82 percent of its purchasing power and the global economy is more geared than ever and now in the death throes of a four-decade leveraging bonanza but our central bankers proudly tell us, hey, at least we beat deflation!
Every day we are told that the world is in the grip of a deathly deflationary spiral. Or that it would be in a deathly deflationary spiral if it weren’t for the valiant efforts of our central bankers. Here is the Wall Street Journal reporting on those efforts:
“The growth in balance sheets (since 2007) has been startling: The combined assets of the four central banks will top $9 trillion by the end of March, compared with $3.5 trillion five years ago, Deutsche Bank says. The European Central Bank’s EUR3 trillion ($3.93 trillion) balance sheet is the biggest relative to the economy, at 32% of nominal euro-zone GDP,…”
Remember the ECB just gave another freshly printed EUR1 trillion to European banks at practically no cost for three years.
So, how are we doing on the deflation front?
Here is the outlook from the ECB at yesterday’s press conference:
“Euro-zone inflation will stay above 2% this year ‘with upside risks prevailing’ Mr. Draghi (the President of the European Central Bank) said.”
Upside risk? No kidding.
Is anybody surprised that an orgy of money printing has lead to, what’s the term Draghi used, ‘stubbornly high inflation’?
In 2011, inflation in the eurozone rose throughout the Greek debt crisis. Now inflation is above target and ‘stubbornly high’, yet the ECB expanded its balance sheet by a cool 55% (in words: fifty five) over the past 12 months – most of it towards the end of the period, meaning the full inflationary effects are still to be felt in the future. Upside risk indeed.
Is inflation caused by inflation?
No doubt, the ECB will take credit for avoiding deflation but will take no blame for inflation. This is entirely somebody else’s fault.
“The ECB raised its inflation forecasts in response to a mix of higher oil prices and tax increases. ECB staff expects inflation to average 2.4% this year, well above the ECB’s 2% target, before declining to 1.6% in 2013.”
Get it? Deflation can be avoided through money-printing, but money-printing doesn’t cause inflation. Inflation is rising prices, which can be explained by, er, rising prices, such as oil prices. Genius.
But the advocates of easy money, and they are numerous, tell us that we are splitting hairs here. Thank God we didn’t get that nasty deflation. Because economies grow when they have inflation and contract when they have deflation. Every child knows that.
So with that stubbornly high inflation we get some growth in Europe, right?
Well- no, we do not.
“The ECB said its staff economists shaved their euro-zone gross domestic product forecast for 2012 from 0.3% growth to a slight contraction. Still, Mr. Draghi said he expects the economy to recover “gradually” over the course of the year,…”
So an explosion in euro-liquidity has raised prices but the economy is still contracting, if only mildly. No surprises here, I would say. Just what one should expect. The ECB’s policy – and that of any other central bank – is not designed to solve the crisis but to arrest the collapse, to cover up the problems, to sustain balance sheets and asset prices at artificial levels, and to postpone the day of reckoning – preferably to after the retirement date of the present policy elite.
Not on my watch.
But, of course, by extending the problem they are making it bigger.
No deleveraging please!
When I presented my book to various groups of investors and hedge fund managers at the end of last year, I was often told that we would be subject to considerable deflationary forces as a result of the deleveraging of the European banks. That deleveraging would, of course, be an important step towards unwinding the excesses from the credit boom but it would be deflationary.
Guess what. Deleveraging has been put on ice. With limitless money for free the European banks are not in the mood for scaling back. Here is the Wall Street Journal again:
“The long-awaited restructuring of Europe’s banking industry has creaked into motion, but the pace may remain sluggish thanks in part to the European Central Bank’s recent wave of cheap lending to the Continent’s banks. …
‘It isn’t as important now,’ said the chairman of a major European bank. His bank has temporarily shelved plans to sell certain portfolios of real-estate assets, figuring that the bank can afford to wait until prices bounce back from their current lows.
The ECB loan program ‘has bought time,’ said Richard Barnes, a credit analyst at Standard & Poor’s.”
Pricewaterhouse Coopers estimates that European banks plan to shed EUR2.5 trillion of non-core assets over the next, wait for this, ten years. That is right. Slowly, slowly catchy monkey.
Make a guess how much will be shed this year! – EUR50 billion.
Well, the ECB just pumped a nifty EUR1,000 billion into the banking sector in three months and the banks ‘delever’ by EUR50 billion in 12 months? – Dear hedge fund managers, please forgive me if I do not take the deleveraging argument seriously.
Where we are going.
I am not saying that two-and-a-half percent inflation is a disaster in itself. But it won’t stay at 2 percent, and it certainly won’t go down to 1.6 percent as the eggheads at the ECB with their stupid output-gap models are telling us. All central banks tell us that inflation will go down next year. Always next year. That is what their models tell them.
I am not arguing for deflation per se. Deflation in itself has no benefit but deleveraging has. After a credit boom that is what is needed to get the economy back in shape. Economies are not growing because of deflation. That is nonsense. Economies are not growing because of the massive imbalances that have accumulated as a result of years and decades of cheap credit. A cleansing correction – in balance sheets, state budgets and debt levels – is urgently needed. Present policy doesn’t allow it. So the economy won’t grow.
We should accept that deleveraging is ultimately unavoidable. If it comes with a period of deflation – so be it. But we will get neither. The system will be sustained at this stage of arrested collapse for as long as policymakers can get away with it. My outlook is that we will get even bigger central bank balance sheets (forget exit strategies! There is no exit!), we will get no sustained growth but inflation will creep higher.
The noisy advocates of easy money and of government stimulus always pretend to care for Europe’s unemployed youth. It is today’s youth that would have most to gain from a cleansing correction now, and it is those who already made their money and who sit on inflated assets and overstretched balance sheets that have most to gain from the central bank’s policy of extend and pretend. That is, until the whole thing goes pop anyway. Which won’t take too long.
In the meantime, the debasement of paper money continues.
22 Responses to The deflation delusion
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“It is today’s youth that would have most to gain from a cleansing correction now, and it is those who already made their money and who sit on inflated assets and overstretched balance sheets that have most to gain from the central bank’s policy of extend and pretend.” Amen. I am one of these youths. I can’t really believe in building a future until we start clearing away the falsity and debris cluttering balance sheets of the past.
Very interesting moves in the CDS market, with the main arbiter saying it’s “extend and pretend” hoping to avoid the mess.
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Thank you again Detlev, for another cogent discussion of this slow motion train wreck. As you say, the debasement of paper money continues.
And I would add hopefully, that in the meantime, the debasement of confidence in the state, and it’s interventions, continues.
I was wondering what you thought of this video by Professor Steve Keen…http://www.youtube.com/watch?v=3qo3t8EBNSg He argues that Debt-Deflation is the major problem.
He says too much debt is a problem, and I agree with him on that one. There is too much debt out there, so you need to allow the market to get rid of it (through default and deleveraging). In the first part of the interview he says we should led banks default. I agree with him on that one, too. You have to go through the crisis. This will involve defaults, deleveraging and most certainly deflation. But all of this is part of the solution, albeit painful. I always say that if the central banks stopped printing money now we would have a deflationary correction. (Point being, they do not stop printing money!) But I see no other solution than the deflationary correction. And I don’t think Professor Keen has a solution. What is it? More money printing? More government spending? That would mean more debt, not less debt. Why do we not get the deflation just yet? Because the central banks print massive amounts of money, and they won’t stop. I disagree with Keen that that is not inflationary. Of course it will be. You telling me that central banks can print unlimited amounts of money and they still cannot destroy money’s purchasing power?
I disagree with Keen that elastic forms of money are desirable or that they can be made stable. That is precisely what my book is about. All his talk about global warming and running out of resources distracts from the monetary argument. That doesn’t add anything meaningful to understanding this crisis.
“You telling me that central banks can print unlimited amounts of money and they still cannot destroy money’s purchasing power?”
Detlev I know you are right in this point, but as I have said before, the reason inflation/deflation doesn’t kick in yet is because people, even politicians and uncomprehending high paid bureaucrats, do not not know what is going on. If they do know something- they don’t understand the situation. Which is probably why the panic hasn’t set in. Politicians, bureaucrats and Joe public are convinced what is in their bank a/c is real money as they are totally ignorant of history and economics.
Here in Australia the last 5 Federal treasurers and maybe even more of them going back 30 years and more, have/had no economic qualifications or financial market experience.
Why worry about price inflation/deflation? In either case, the central banks and their buddies are stealing wealth from the private sector by issuing counterfeit money… irrespective of price inflation/deflation! Better to try and become a central banker!!!
Detlev, what you are writing here is similiar to the tail of the “Emperor without clothes”. Majority part of the “intellectual phd level economist” are touting the virtue of money printing and how the debt is not a problem, even saying that the actual problem today is that “banks do not lend enough money” and/or “consumers do not take enough new loans”, and therefore further saying that goverment must leverage, and spend money and “stimulate the economy”, and further this leads to a virtuous cycle, and suddenly all of our dept related problems have vanished.
This sounds to me simply maddness, and I have always strucled with the majority ruling that the inflation is good and deflation is really really bad. Well, maybe inflation is good for higly leveraged individuals and companies, but for the prudent ones, like me, this sounds crazy!
So when referring to tail of Emperor, I mean that I see that the economy today do not have clothes, but there are very few people who are shouting this to the public. And therefore I’m very glad that you have taken this role as trying to tell to the public high crazy this situation is.
Well he has stated that he wants a debt jubilee, and a nationalization of the financial system. He seems to feel that there will be no inflationary consequences. Keen is a Keynesian (although he is critical of his fellow Keynesians) who has stated that his main influence has been Hyman Minsky. Here is a video of him discussing the debt jubilee and other things… http://www.youtube.com/watch?v=SkesgECRXtM
Here is an Austrian look at Minsky’s theory by Frank Shostack http://mises.org/daily/2787
Omar, Steve Keen advocates an economic theory called Modern Monetary Theory. MMT is basically a neo-chartalist movement. If you imagine the current Corporatist/Keynesian system on crack cocaine you’d be in the ballpark.
MMT has been dismissed by most established economists. Krugman has described it more or less as gibberish (Ok, he has little positive to say about the Austrian school). Robert Murphy has done a fairly indepth critique.
Keen has been feted by the banking/state establishment because his theories endorse their favourite brand of toxicity (More paper money).
The MMTer’s would be well served if they had a long sit down with Detlev’s book.
A critique of MMT from Businessinsider attached.
http://articles.businessinsider.com/2010-12-19/markets/30041069_1_deficit-concerns-mandatory-readings-due-diligence
Hi Detlev, another great straight-to-the point piece challenging common wisdom .
I would humbly suggest you create a share facility to linkedin as I’d love to propagate to my professional network some of your pieces.
Thank you, Ahmed. I will look into it.
We now added icons at the bottom of every blog to share the blog on LinkedIN and email.
It seems we never learn from history.
I came across an old yet interesting and thought-provoking video about inflation.
The star is not a “terrible” Detlev-like Austrian but a good-old-days mainstream economist: Milton Friedman.
The video is quite long and can be watched here (without having to glue bits an pieces from YouTube):
http://www.gotgoldreport.com/2012/03/friedman-how-to-cure-inflation.html
It is worth every minute!
I wonder what “our” mainstream economists would reply had Friedman to repeat those statements today!
Suffice it to say that in the late part of his life Friedman got to the conclusion that it would be better to completely abolish central banks (Friedman an Austrian???)!
Is there any doubt Detlev is right?
[...] Schlichter is on typically forceful (and, yes, depressing) form over at Paper Money Collapse. We should accept that deleveraging is ultimately unavoidable. If it comes with a period of [...]
I keep hearing about how there is too much debt in Europe and this is probably true but when I hear the explanations of what caused it, the finger-pointing and confusion begins about deflation, or hyperinflation, and it’s difficult to know who to believe without have information I am not privy to. All I experience is what happens at the street-level… when money is taken out of the pockets of consumers through austerity measures. Austerity is equated with Fear. If we don’t have austerity something really bad will happen to us. Well, it turns out, taking the Greek example, bad things are going to happen anyway.
The eurocrats and the troika must be purposely sabotaging the European economies: you can’t get growth when you’re taking money out of the pockets of consumers through austerity measures. As economic output shrinks, tax revenue falls and welfare outlays rise.
To put that money in the pockets of consumers it first must be taken from someone else, who is also a consumer, and a firm, and or, a banker. The mainstream obsession with economic identitys and aggregate accounting confuses economics tremendously. Government spending must be funded somehow, so when it is cut the purchasing power taken from one person must be returned to another person who is a consumer at some point. Since production is done for consumption, the two things are one and the same.
Austerity causes a short run fall in output as purchasing power moved from one person to another causes a readjustment. However since wealth is not generated through consumption, it is generated through saving and improving capital stock, this return of purchasing power to those who will in the “evil pursuit for profit” invest it long-run projects generating future wealth and better consumption, will in the long run increase output
Thomas & Joe,
you are both right!
The problem is the definition of “austerity”.
Governments and zombie banksters tell us that we need Austerity = (less public spending)+(more taxes) to put our finance in order and to “live within our means”.
Make no mistake: it is the usual big “aggregate” lie that wants us to believe is only the final sum that matters.IT IS NOT!
What governments are doing is cutting spending a bit, while promising more will be done in the future (when???) and increasing taxation a lot!
The two actions are not the same and have simply opposite economic effects.
So, to me, you are both right.
Well yes I very much doubt that once bond markets calm down and money printing forces another bubble somewhere governments will quickly stop budget cutting and start chucking money around to win votes. Spain has already announced it will not meet its target this year, or probably next and markets have hardly reacted.
And as you say most countries are still running deficits and are hardly cutting total spending.
In Greece the problem is that as money is repaid by the government or defaulted on it does disappear as it existed previously as an entry on a fractional reserve bank balance sheet and now simply doesnt. This should kill off inflation or cause a correction and asset prices to fall. But it won’t because there priced in euros. This currency is currently undergoing a massive expansion by the ECB. So we kind of have a deflationary debt repaying/defaulting correction but no falling prices to end the cycle.
So actually now that ive taken further time to think, Thomas has a fair point, it’s just not austerity alone that’s ruining Greece as many would like to have us believe.
Detlev,
What do you think about “sterilized QE”? Is that a possible solution to delaying money printing to pay off the federal debt?
My view is it can only be enacted for as long as the Fed/Congress can stand economic weakening. The result of sterilized QE would take capital out of the private sector and would likely cause rates outside of Treasuries to rise (and short-term Treasuries may rise as well.) Also if it pushes up the Fed Funds rate and the Fed has to push it back down that could be inflationary as well.
Andrew, apologies for the late response. No, I don’t think that’s a good idea at all. First of all, ‘sterilized QE’ seems to be a bit of an oxymoron. QE entails the direct expansion of certain monetary aggregates (usually the monetary base) by the central bank. As the name says, the purpose is a quantitative impact. Sterilizing means reducing the quantitative impact of a monetary intervention again. I think what you may be referring to is the recent discussion about using the repo-market to manipulate Treasury prices without expanding the monetary base. How that should work in detail I am not sure. But it won’t solve the problem. Why should private holders of Treasuries sit tight and let the Fed manipulate the yields on Treasuries consistently to below-inflation levels? We are talking overt confiscation here. The private market will dump the Treasuries if it considers yields unattractive. The Fed will then have to buy those Treasuries in order to keep their yields low. There is no other way then for the Fed to buy ANY amount of Treasuries in order to fix their yields. That, of course, involves money-printing on a gigantic scale. If the Fed wanted to offset (sterilize) the quantitative impact on monetary aggregates of its Treasury-buying, then it would have to sell its other assets (mainly its portfolio of MBS). The problem is it would soon run out of things to sell, and also, what would that mean to the MBS market?
Inflating the debt away is already a crazy idea that won’t work. But manipulating the debt away without even generating inflation? – that is even conceptually impossible in my view.