Z1 (Overall Credit) Turns Up – Has Deflation Threat Passed?

Z1 (Overall Credit) Turns Up – Has Deflation Threat Passed?

Overall credit, as measured by the quarterly Z1 report, turned up significantly in the 3rd quarter for the first time in a few quarters – does this mean the deflation threat passed?

Fellow deflationist Vox Day is not impressed – he writes:

So, while Z1 reports a quarterly increase of 0.43% in overall credit, the first increase after five straight negative quarters, this meager increase almost entirely consists of swapping financial sector debt for federal government sector debt.  This is consistent with what I described was likely to happen in The Return of the Great Depression and is also consistent with the Misean definition of inflation that includes credit as opposed to the Friedmanite one that does not.  The $52 trillion question is how long this debt transference process can be maintained.  If it can go on indefinitely, then there will eventually be hyperinflation.  If it cannot, there will be deflation.  High metal prices notwithstanding, I still maintain that it cannot go on indefinitely, and the fact that the Fed and the Treasury are limiting their credit expansion to approximately the level of the private sector credit contraction tends to suggest that this is the case.  Three years is impressive, but it is neither infinite nor conclusive.

Read Vox’s full piece here (with chart and breakdown of debt outstanding by sector).

I concur – I also do not think the expansion of government debt can go on indefinitely.

But, I am now opening my mind to the possibility that we see inflation in certain things, and deflation in others.  Inflation in the things you need, deflation in the things you want.  Inflation in the services provided for by the government (ie. medical care), and deflation in the services provided for by the free market (ie. software).

As we’ve discussed before, the Federal government needs reported inflation (as per CPI) to stay low – so that the Fed can continue to run QE programs, to keep interest rates low, and the stock market propped up.

And I have to give it to Bernanke – so far so good.  Gold and silver have shot through the roof, but your average slob doesn’t really care.  Stock prices continue to levitate, and for the time being, Treasury auctions are well bid (thanks to the newly printed dollars).

Of course the “so far so good” is probably more akin to the guy who jumps off the 100-story building, and hasn’t yet experienced any ill effects at floor 30.  We all know this will probably end poorly – the question is how.

Your guess is as good as mine.  While previously I was of the mindset that we’d see massive deflation, then probably inflation, I now think the deflationary portion could be some sort of soft deflation, with spot helpings of inflation mixed in (the metals, for example).

We’ll explore a potential portfolio for all seasons in a future column.

Hat tip Carson for the links.