Deflation and Disinflation. What they really mean and where we are int he Secular Market.
Deflation. based on the contraction of the global money supply. started with the asian currency crisis and then the dot com bust. lot of money invested on development stage companies with no revenue. that was borrowed money on future revenue that did not appear. When it all busted the global money supply contracted.
Deflation is what you call disinflation when the disinflation goes from slowing positive growth down to below the zero line. its still the slowing of growth but its gone inverse and starts eating at the existing economy. the IT industry contracted severely in 2000 and resulted in a massive industry wide contraction, or targetted deflation. That reverberated through the global economy slowing inflation. That is one of the reasons that Greenspan lowered rates. To dislodge a lot of foreign bank money in US treasuries and get it circulating through the world economy to jump start inflation again.
Let me explain. The difference between disinflation, deflation, depression, recession, contraction, is a matter of point of view. In an period of positive inflation, defined as growth in an economy's GDP and money supply any event or action that reduced the growth rate of that supply or the size of the economy as defined by those two metrics is disinflationary. It is also defined as a contraction of growth. It can also be defined as any targetted deflationary pressure in a section of an economy that is in overall inflation.
So say that there were not any deflationary effects on the economy until now is a mistake in the understanding of the secular market we are in. If you only want to look at the 2002-2007 bull market and look at it as an inflationary period I'll agree with you. It was an inflationary cycle but a cyclical one inside of a secular contraction that has been on going since 2000. There will always be periods of inflation inside the secular one that run counter to the overall trend.
It is usually through monetary policy devoted to countering or preventing the severity of the contraction. In the short term it's effect is successful and over inflate but over the course of the secular trend it only results in lowering potential\future expansion for the sake of a short term recovery or "soft landing". This reinforces that the next contraction will be more severe. You think you are looking at THE big picture but there is an even bigger picture that spans generational trends. Let me repeat that.... Generational.
Picture a balloon that an economy of 10 people are blowing up. Each of 10 men are an inflationary pressure. If 1 of the 10 men decides to stop blowing, he is disinflationary. He is not contributing but not hampering the other 9 who are inflationary. If another of those men decides to instead to poke a hole in the balloon then he is deflationary. He has the impact of not only stopping his contribution, but to also hinder the inflationary of 1 of the others. The economy is still in net inflation because you have 8 men inflating but 1 who is not working and 1 who is counter productive. So your net inflation is 7 men.
You see over the period of the secular market the 15-20 contraction will need to have a massive generational shift in sentiment on the participants of that economy. The tulip bulb mania that we had in 1990-2000 was the culmination of a secular trend. That mania of daytrading and speculation does not easily get weeded out as survivors have not learned their lesson. They only see the next contraction as a new opportunity to profit on the next big run up. Instead of reducing risk exposure then instead leverage up, take more risk to counter the losses in the previous contraction. They become more speculative and the effects of following contractions become more severe. More participates are punished. Over the course of the secular cycle the survivors and most successful are those who took the least risk and focused on capital preservation.
We are now at the lows of the cyclical contraction inside of a secular contraction. This is the second one in the secular trend since 2000. We may be in for 1 or 2 more depending on how how it is managed and how severe the damage was from the recent credit contraction. The inflationary pressure of dumping trillions of dollars into the banking system to shore it up is helping again in the short term but the money supply growth was so tremendous that I think this next cyclical recovery (?2009-2013?) will be the weakest of all. It potential is lost. We borrowed the money supply that would be produced in that expansion to pay for the recovery today. So when we get to 2012, 2013, 2014 a portion of growth in GDP, money supply will be used to pay that money borrowed. And it is a lot of money. So when that next cyclical contraction (?2014-2016?) comes after the cyclical expansion (?2009-2013?) we are going into ends its going to hit hard... very hard. Its gong to so a lot of damage to the bond markets that will run interest rates like it ran volatility this past year. I only hope Volker is around and in charge of the Treasury when that happens again.
But don't worry, as we muddle through the contraction in 2014-2016 the following recovery will probably lead to a new secular expansion. We will not realize it because by that time everyone will have excepted we are in some kind of deflation or depression and will be griped with financial fear. Those who are ahead of the curve will ignore the media and the sentiment of participants and engage in long term investment despite the multitude of recessions and high unemployment that will exist through out the 2020s.
