Inflate, deflate, reflate, debate

The inflation vs. deflation debate just keeps going on, with no resolution in sight. I was hearing lots about it on Bloomberg TV in the past two days and it’s the debate that just keeps on giving.

The recent market crash and economic slump hasn’t made the deflation camp the clear winner, even though there are early signs of deflation in (to farmers chagrin) commodities, asset values (everybody’s house), the value of money (it’s buying more of those last two things). That’s because governments around the world have leapt into action and began pouring money into the financial system in a kind of Keynesian craze. That’s got lots of people talking about the possibility of serious inflation – or even hyperinflation – as the economy “reflates” from its present deflated state.

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Of course, that assumes that the present slump is a temporary shrinkage from the economy/market’s rightful size, rather than the result of the bursting of a bubble of artificial prosperity. There’s always a crew that thinks that the inevitable and eternal path of the economy and market is up, up, up, and any setback is temporary and to be short-lived and that we’re soon about to return to the former peak of the stock market, which was Normal and Right. That seems to be true, if you look at market history in the extremely long term, but as J.M. Keynes said, all this talk of the long run is misplaced, because in the long run we’re all dead.

And if you take a long term view – rather than the super-long-term view – you’ll see that there are often extended periods when world equity markets go nowhere, and world economies don’t do much better. Look at 1967 to 1982. Look at 1929 to the early 1940s. Those were long roads to nowhere. So I think some of the calls for inflation coming out of an inevitable recovery of the economy ASAP are based on a wilful blindness to history. Those two periods were inflationary periods, but not because the economy was growing after recovering from a short term slump.

There also seems to be a belief that all the government money being poured into banks and assets-gone-bad is increasing the money supply, flushing money through the economic system and thereby setting the stage for money to cheapen in relative value. But if the banks don’t take all that money and aggressively lend it, and the bad assets are just wound down and retired, and everyone who gets any cash stuffs it into his mattress, the money supply hasn’t increased, has it? Seems as likely that money’s going to disappear into the black holes in the economy. Governments can throw a lot of money at taxpayers, but if those taxpayers take that money, or the pay from make-work projects (“infrastructure spending”) and use it to pay off credit card bills, that money isn’t making it back out into the economy.

Still, for ag prices fears of inflation are a generally good thing, because if lots of people feel their money is going to cheapen in value, they’re likely to pour it into assets such as ag commodities, thereby creating one of those self-fulfilling prophecies. Commodity prices go up because of fears of inflation, making it cost more money to buy the same amount of a commodity, and there you have it – inflation!

There’s been a powerful and impressive rally in the stock markets of the world for the past month and that’s got many people feeling that the worst of the financial and economic situation is passed. It’s made the inflation side of the debate more convincing for many. If this turns out to be the beginning of the next bull market, then the inflationmongers right now will appear in the future to have been the Wise Men of the Crash. But if this is just a bear market rally, and we turn back down and slump down past the early March lows, the deflationists are going to return to their former privileged position, methinks.

What do they say about stock market investing? Sell in May and Go Away. Let’s see if that happens this year.