Are We Experiencing Deflation?

I’m sending off the “Buy Gold and Silver Safely” book to the editors today. It’s been a lot of hard work, but well worth the time.

Are We Experiencing Deflation?

This is the question that has been going around and debated for a couple years now. Mish Shedlock, Gary North and others have locked horns over the issue.

I devote an entire chapter to the debate in my book in trying to help people understand what’s really going on in the economy and with the inflation/deflation debate. This chapter alone has 100 footnotes.

Just listening to CNBC this morning, they were asking the same deflation question, not really sure how to respond since it is a new phenomenon. The journalists had no clue as to what’s going on and one of the gentlemen on the show said “it’s a debate between the Keynesian’s and that other group, Hayek or something” according to the editorials he has read in the Wall Street Journal.

Kind of comical if you ask me. Especially him saying, “that other group.”

That other group he speaks of are the Austrian economists. But even those who call themselves “Austrian” are in disagreement.

While I can’t yet get into the entire debate until my book is released, I can give you some statistics and tell you I am clearly in the deflationary camp.

First, deflation needs to be properly defined. Jesús Huerta de Soto does this perfectly in his book Money, Bank Credit, and Economic Cycles.

Deflation: 3 Types

1. The first type consists of policies adopted by public authorities to deliberately reduce the quantity of money in circulation. This whole process of deliberate deflation contributes nothing and merely subjects the economic system to unnecessary pressure.
2. The second type of deflation, which should be clearly distinguished from the first, occurs when economic agents decide to save; that is, to refrain from consuming a significant portion of their income and to devote all or part of the monetary total saved to increasing their cash balances (i.e., to hoarding). In this case, the rise in the demand for money tends to push up the purchasing power of the monetary unit.
3. The third type of deflation we will consider results from the tightening of credit which normally occurs in the crisis and recession stage that follows all credit expansion. Just as credit expansion increases the quantity of money in circulation, the massive repayment of loans and the loss of value on the assets side of banks’ balance sheets, both caused by the crisis, trigger an inevitable, cumulative process of credit tightening which reduces the quantity of money in circulation and thus generates deflation. This third type of deflation arises when, as the crisis is emerging, not only does credit expansion stop increasing, but there is actually a credit squeeze and thus, deflation, or a drop in the money supply, or quantity of money in circulation.

PP. 445-448, 452-453 Money, Bank Credit, and Economic Cycles Jesús Huerta de Soto 2006

The government is not purposefully reducing the money supply, so we can discount the first definition above. The other two definitions are clearly in play at this time.

People are saving, not spending or “consuming.” There is a tightening of credit occurring as consumers and businesses aren’t borrowing as they try to stay afloat. Add to this dynamic the fact that banks aren’t lending and we have the perfect credit contraction deflation storm.

Consumers and especially businesses are unwinding all of that credit that was given to them during the boom years. This amount of credit stands at approximately 360% of GDP.

As this debt is unwound or defaulted upon, it sets loose a chain reaction that will be explained in a forthcoming article.

For now, the data (prices) speaks for itself. It clearly points to deflation. Remember…prices are the result of deflation.

*Producer prices actually fell for the 3rd time in 4 months.

*Consumer prices fell for the second straight month.

*Lumber has declined 21% in the last 5 weeks.

*Copper prices have fallen.

*The Journal of Commerce (JOC) Commodity Index that tracks the growth rate of steel, cattle hides, tallow and burlap plunged 57% in May, the most since October 2008.

*Real Estate prices are continuing to decline now that the government faucet has been turned off. Sales of new homes dropped a record 32.7 percent in May to the lowest level in at least four decades.

When I am confident about issues I try and start a conversation on various sites I frequent to see if there are any flaws. I’ll enjoy a chat with some intellectuals and this helps further confirm my point of view.

I did this recently on 6/22/2010 in reply to an article that was posted on one of the forums I frequent. Naturally the article was biased in one direction as it’s in their business name. The site the article came from is: http://inflation.us

The article was entitled; “U.S. Food Inflation Spiraling Out of Control.”

My comment on the article simply stated “I don’t have a bone to pick with the source of this information (inflation.us), but the following may paint a different picture. And yes, I’m a believer in gold, but believe we are in a deflationary period at present.”

I proceeded to post the same data from above in my reply, but was surprised when no one replied (as of today).

Normally I’ll get someone to reply, but it seems that many people who are bullish on gold just want to hear the inflation side of the story as that is the one repeated all the time.

Deflation is actually good for the economy however…., as long as the government doesn’t intervene.

Ludwig von Mises warned; “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

Deflation is also good for gold, but there’s more to the story than just that. I’ll explain this further in the weeks ahead.