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Mish Shedlock on Deflation: We’re Almost There, or Already There

by Brett on July 13, 2010

Real nice post by Mish Shedlock over on his always excellent blog entitled Are we “Trending Towards Deflation” or in It?

I know many readers share my view on the inflation/deflation debate – namely that because we have a credit based economy, the Fed is relatively powerless to stop inflation.  If that’s your take, then you’ll enjoy Mish’s piece.

And if not, hey, it’s always good to check your assumptions with a well thought out counterargument!

Mish writes:

I define inflation as a net expansion of money supply and credit, with credit marked-to-market. Deflation is a net contraction of money supply and credit, with credit marked-to-market.

Given that consumer credit is plunging at unprecedented rates, given that credit dwarfs money supply creation, and given that marked-to-market valuations of credit on the balance sheets of banks is again falling, I propose we are back again in deflation.

My model suggests part of 2007 and all of 2008 were deflationary years. Inflation returned in 2009, and the economy is back in deflation now.

Proof is in conditions one would expect to see in deflation.

You can read the rest here.

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  • Luke

    I’m glad that Mish defined inflation and deflation as not only money supply but also credit. Many people don’t even take credit into account (ie, the Fed).

    Brett – do you think that the contraction in money supply (M3) and credit will lead t0 “deflation” in the sense of a deflationary price spiral like occured from 1929 to 1933 – around a 40% fall in CPI? I think this is an impossibility since, as you say, we have a fiat, credit based monetary system that is far different from the days of 1929 and the gold standard. I have no idea what will happen, but at least it will be exciting to be a participant!

  • Brett

    Hey Luke – I think it’s possible, but that’s not what I expect either from a CPI standpoint. I expect more of a Japan style deflation, one that crushes asset prices (stocks, real estate, etc), but is rather gentle from a CPI standpoint.

    A few months back I heard Mish debate with someone else whether or not Japan actually experienced deflation during the last two decades…the other joker said no, because CPI prices were up more than they were down. Mish told him he was crazy – the Nikkei fell by 80% and real estate also got whacked – over a period lasting two decades – that’s deflation enough for me as well!

  • Luke

    Thanks for the response Brett.

    As Japan and many others have found out over the years, credit bubbles can really wreck shop. If the US= Japan in the next decade, I say that is a best case scenario. Really enjoying the blog!

    Cheers.

  • http://globaleconomicanalysis.blogspot.com/ Mike “Mish” Shedlock

    Good memory Brett!

    Here is the post
    http://globaleconomicanalysis.blogspot.com/2009/09/daniel-amerman-vs-mish-reflections-on.html

    And I agree with you on the CPI.
    Those watching it sure missed the big picture – collapsing credit and the effect it has on asset prices

    Mish

  • Brett

    Thanks Mish, for the link and weighing in! Your post summary is fantastic – my head was spinning listening to the interview podcast…Amerman’s inflation/deflation definitions didn’t make any sense to me. They reminded me of an academic who develops a theory in the classroom, and gets whooped as soon as they start to trade with real money.

    I’m real glad you addressed housing prices, and their lack of inclusion in the CPI as well. From ‘03-’05 that seemed like the biggest joke of it all – that the biggest ticket item for most Americans was not reflected in the inflation numbers. Meanwhile, all of my friends who jumped into the housing market as first time buyers were immediately “tapped out” and found themselves with little/no discretionary income after overpaying for a house! And now of course the debt deflation is going the other way, as they walk away from their overpriced homes via short sales, etc.

  • Pingback: M1 Money Multiplier Still in the Tank (Deflation Still in Control) — The Contrary Investing Report

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