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Is the following Chart Inflationary or Deflationary?

Is the following Chart Inflationary or Deflationary?
Article of the Day, July 4
by Jay Taylor



Advocates of the view that we are in the early stages of a 15- to 20-year bull market in commodities like to suggest the chart on your left makes their case. This chart measures the inflationadjusted value of 17 commodities in the CRB Index. They like to point to the recent upturn in the index and suggest we are in a parallel situation with the beginning of the upturn at the bottom of the 1930’s depression. At first blush, this would seem to fit quite well with Ian Gordon’s Kondratieff cycle theory in that we are now in about the 5th year of the Kondratieff winter. (The winter officially began with the cycle high equity top in 2000). Commodities bottomed out a couple of years after the 1929 stock market crash during the last Kondratieff winter, and a quick glance shows that the bottom for commodities in the current cycle bottomed close to the 2000 stock market crash. But there are a couple of factors I would like to point out before you automatically agree to accept the premise that it will be onward and upward from here through the next several decades for commodities. I’m not ruling that possibility out, though my belief in the deflationary pressures of the K-cycle causes me to think we have a lot more downside in commodities before we see the “real McCoy” in the next commodity bull market. I say that for a couple of reasons.

First, a more careful glance at the chart shows that commodities actually bottomed before the stock market bottomed in the current cycle, whereas in the last cycle, they did not bottom until the start of the Great Depression. In other words, the process of debt repudiation, bankruptcies and job losses weighted heavily on the demand for commodities. That has certainly not happened yet in the current Kondratieff winter. I believe the Fed has been more effective so far in staving off (but not avoiding) the Great Depression II, such that unlike 1931-32, cleansing adjustments in our economy have been staved off. In other words, the markets have not been permitted to wash out the excesses nearly as well as they had by this stage of the last depression.

Thirdly, I would point out that even if we were to see a replay of the great commodity bull market that began in about 1932, it wasn’t until about 1940, or eight years later, that the major move got underway, and it wasn’t until about 1949—the year that Ian Gordon believes was when the current cycle began—that we saw new highs in commodities. In other words, we could rise from about 85 to 145, or about 70%, from current levels before we even got to the levels of the 1920s! I do not rule out a move in commodities of that magnitude which is one reason despite my deflationary views, we have retained inflationary hedges in our Model Portfolio.

But if you were to look at the 1930s debt levels relative to GDP at that time, debt was not nearly as high then as it is now. The following chart, which I used for a Cambridge House show in Calgary in 2002, only partly illustrates that fact. In 2002, total U.S. debt was 32.3 trillion and GDP was 10.7 trillion. That figures out to a debt/income ratio of 302%, and that compares with a peak debt/GDP ratio of 265% before the start of the Great Depression. Since 2002, debt has grown by 23.8% to $40 Trillion while GDP is grown by a only 3.6% to 11.088 trillion!

At this stage of the current Kondratieff winter, we have not even begun to repudiate our debt, even though trillions of dollars have been lost in equity values during the first leg down in the equity bear market that began in 2000. The Fed and the Bush Administration have been “successful” in delaying the next Great Depression by inducing Americans to continue borrowing to buy houses and cars and whatever junk they can convince us we need. They want us to keep spending even though it is leading America into national poverty. As such, our ability to service debt is far inferior to that of Americans during the early days of the 1930s’ depression. In fact, the chart above is quite out of date, because total debt is now $40 trillion (up 23.8%), while income (GDP) has grown by $388 billion, or only 3.6%! As such, the current ratio of debt to GDP is now more than 360%, compared to 265% in the early 1930's.

Why the Next Depression May Be Worse Than the 1930's



I shudder to think of what will happen to commodity prices and prices overall when Ben Bernanke’s helicopter printing press inevitably fails to keep the impending deflationary debtrepudiation process from starting.



Once again, I must show my “favorite” chart, which is just another way of looking at the chart above, because I think this illustrates why deflation is inevitable and why Ben Bernanke’s helicopter money will ultimately—perhaps very soon—fail to avoid a deflationary collapse. Sadly, the only thing our policy makers know to do to stave off the next depression is to print more money. But whenever they do that, they necessarily create more debt, because debt is the raw material from which fiat money (as opposed to free market money) is manufactured. Because of these terribly wrong policies, we are, as Stephen Roach said above, living on borrowed time and that is a dangerous way of running an economy. How long can debt continue its exponential growth while income continues to rise by 3% or so per year before the entire house of cards comes tumbling down? I don’t know the answer to that question, but it seems to me we Americans are playing a dangerous game of Russian roulette, and that is a game that has kept my wife and me from nearly succumbing to the temptation of buying a beautiful three-bedroom home in Queens.

It would seem to be a paradox, but I am convinced it is true. The more the banking system creates, we get less liquidity, not more. And that is why I believe we are inevitably heading toward deflation, not inflation. The following remark made by Dr. Kurt Richebacher in “The Daily Reckoning” makes this point very well. As of last year, Americans were holding onto $37 trillion in debt - more than $123,000 for every man, woman and child in the United States. This amount of debt is more than three times the total number of dollars in existence anywhere - in home and business equity, checking and savings accounts, stock markets and even those held by foreign investors (66% of all dollars are held by foreign investors, by the way). If all of this debt comes due, there literally isn't enough money on Earth to pay it. Dr. Kurt Richebacher, in The Daily Reckoning Let me say it again: Debt is the raw material from which fiat money (as opposed to free market money) is manufactured. And so, it is a fact of life given the currently deceitful form of money that has been imposed on us, the more money that is printed, the more debt we have. More importantly, as the K-cycle matures, excessive amounts of money turn into mal investment—investment that produces no cash returns from which to service the debt. The behavior of the Fed and the banking system in printing money to avoid the next painful recession (which is a necessary market cleansing mechanism) is every bit as pathological as the behavior of a heroin addict that shoots up higher does of heroin on an more and more frequent basis, in order to avoid his/her next encounter with painful reality.

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Some Questions for My Inflationist Friends

Most gold bugs believe gold will surge on inflation. They are very skeptical about the potential for gold to rise in light of deflation, even though history suggests gold performs far better during deflationary episodes rather than inflationary events. I frequently receive questions from my readers and those who read some of what I write on some of the Internet sites. I try to answer their challenges to my deflationary views as much as time permits me to do so.

Sometimes questions are best answered with questions, and so on the topic of inflation/deflation, I found the following excerpted material written by a fellow deflationist, namely Mike Shedlock (“Mish”) to be very worthwhile. It turns the widely based assumption—that nations can always inflate their debt problems away by printing money—on its head.

Questions for Inflationists in the Infaltion/Deflation Debate

“I keep getting e-mail responses to my articles telling me why I am wrong about deflation. I also keep seeing posts, like the following one, explaining why inflation is inevitable. This recent post from “Wendy” on The Motley Fool is typical:

“It's clear from this that the same factors that threaten to pop the U.S. real estate bubble would also pop a worldwide real estate bubble. Like the popping of Japan's real estate bubble in 1990, this could lead to longterm recession.

“I believe that the world's central banks would flood the world with liquidity to prevent this from happening. Both Japan and China have already done this, with the central banks ‘creating’ hundreds of billions of dollars worth of their own currencies, which they used to buy U.S. Treasuries.

“This is a major reason that I believe that the economic problem of the future will be inflation, not recession.” “OK, Wendy -- or any other inflationists out there -- it's time to step up to the plate. Here are the questions I would like you to address:

“1. Can you please define the ending point in your cycle? Does the cycle end when everyone has three houses and no renters? Twenty houses and no renters? “2. Can the government print money from now until the end of time to forestall a recession? If it's so easy to prevent a recession by printing money, why do we ever have them? “3. Is there no end to the demand for credit regardless of wage growth, outsourcing, and loss of union and other jobs? “4. Can Japan keep printing money and buying U.S. Treasuries until U.S. Treasury rates hit zero? What then? “5. Can home prices keep climbing exponentially if wages do not support prices? “6. How are people going to pay property taxes and medical expenses unless wages pick up? “7. Is GM about to offer unions more money? “8. Is outsourcing to India and China about to stop? “9. Are telecom mergers -- slated to destroy 20,000 jobs this year -- going to reverse? “10. Are bank mergers and other mergers that will destroy jobs going to stop? “11. Is productivity going to fall off a cliff so that more workers will be needed tomorrow than are needed today? 12. Are wages and employment going to rise while outsourcing, mergers, and productivity are increasing? “13. Is the demand for housing infinite regardless of price?

“14. Is the willingness to supply credit for housing infinite regardless of price and regardless of the credit worthiness of borrowers?

“Can ANY inflationist out there please address all of those questions in a single, coherent post and tell me how -- with falling wages and stagnant jobs -- the demand for money AND the willingness to lend it can be infinite? “Right now, people are willing to borrow and banks are willing to lend on the foolish belief that housing prices can rise forever. We had the exact same belief about the stock market in 2000. The only logical way to believe in inflation is to believe that credit expansion and the willingness to lend can go on forever in spite of falling wages and job losses to mergers and outsourcing.

“Wait a second. That's not logical at all. Then again, perhaps you think outsourcing will stop, GM will raise wages, airlines will become profitable, medical expenses will drop, and property taxes will not increase with rising home prices. Hmm, that does not exactly seem very logical, either. Is this a new paradigm such that logic and fundamentals will be meaningless from now until forever more?

“I have one final issue I would like inflationists to address: It would seem to me that hyperinflation would bail out debtors at the expense of banks and lenders. Are banks going to want to do that? If so, why? Wouldn't that make all of the malinvestment in property a smart thing to do? Does that seem likely or logical?

“OK, would some inflationist out there please tie all of those questions together for me in a nice, logical reply? I am getting tired of the short answer always offered to every deflationist argument: “The Fed will not allow deflation and will print its way out of it.”

“It is time for someone to step up to the plate and put some consistently logical reasons together addressing the questions I laid out above -- and then tackle the final nut to crack, why banks would bring hyperinflation on themselves to bail out debtors at their expense.

“I have been asking these questions for months and still have not found a taker. “Any takers? ************************************


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