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Letter Re: The Real Threat is Deflation

Mr. Rawles,
I greatly respect your advice and columns on most matters yet I continue to see people like yourself claiming we are facing an inflationary holocaust. People in the inflationary camp point to the size of the Mother of All Bailouts (MOAB) or the rate or printing as if that number alone meant something. You cannot take that number alone, sir, but must measure it against the value of assets that have been destroyed by the deflation going on around you. The total inflationary pulse from Europe, Japan, and the US thus far is approximately $7.5 trillion as best I can estimate. On the other hand, the total value of assets destroyed in 2008 alone was over $60 trillion dollars. In other words, deflation outweighs inflation here by a factor of about 8 to 1. Even if we get another $50 trillion in inflationary action, which I seriously doubt will occur, it would only be an attempt to stand still against the massive wave of deflation going on around us. And that doesn't count the losses that will come in 2009, 2010, and beyond. It is my firm belief that we are in the midst of a deflationary crash that is going to last 3-5 years and at the end of that crash is the dissolution of the United States due to its incredible financial obligations. What will come after that is similar to the breakup of the Soviet Union and the emergence of new nations, each similar to but different from what preceded it.

Given the above, I find it hard to take these warnings of impending inflationary disaster seriously. The US cannot inflate without antagonizing its trading partners who hold its bonds. Antagonizing them not only cuts off cash via lending but likely cuts off trade, resulting in a lack of goods here in the US which the US is no longer capable of filling by itself. Thus inflating is suicide. Instead all the action I see appears to be an attempt by the very rich to "ride the wave down" until it bottoms out. This bottoming out is the perfect time to consolidate wealth in the hands of those that hold cash by picking clean the pockets of the middle class who were heavily invested in the sucker's stock market. Paulson is guiding the consolidation of financial institutions into those few controlled by "friends of Hank" while people like Ben Bernanke harp on bailing out the financial institutions (the very wealthy) with hundreds of billions of dollars while disdaining to throw even breadcrumbs (by comparison) to companies that employ the middle class of America.

In fact, the classic advice during an inflation is to be in debt up to your eyeballs so you can pay the debt back with cheaper currency. Yet you give sound deflationary advice - be out of debt - with which I agree. I truly enjoy your column but wonder if it is time for you to prayerfully step back and really examine the direction of the financial world rather than simply continue to run based on old assumptions. If you stand back and simply examine the data, rather than beginning with an assumption, the data appears to very strongly point to deflation. Remember, Americans were told that the US would not allow the deflationary mess of the 1930s to happen either, but it did. And if you examine the Federal Reserve's role in that you see that they even inflated the money supply to extremes. For starters, I recommend that you please consider [Mish Shedlock's essay] Humpty Dumpty On Inflation. It's a well written article and certain graphs in there are truly eye-openers. If you are not a regular reader of Mr. Shedlock's column, you may wish to become one. He has been spot on the mark about everything in terms of deflation or else he has been too conservative. For instance, he said 2008 unemployment would exceed 6% clear back in 2007 when unemployment was 4.9%. People said he was insane yet look at what happened. He also documents the many ways wealth is being destroyed, such as the $10 trillion in household wealth destroyed during the 15 months from the beginning of the 4th quarter 2007 to the end of the 4th quarter 2008. And that doesn't count pension losses, or corporate and government losses plus it's only the US. Further, it's through Mish's columns (Mish is his nickname) that I discovered that many large corporations like HP and FedEx are freezing wages and suspending 401(k) contributions entirely. Those are not inflationary actions!

I really do urge you to give the deflationary scenario a good second look. The end of that road is just as horrible as the hyperinflationary one but the way we get there may be different and it may cause you to prepare in a somewhat different manner. Sincerely, - David R.

JWR Replies: You should be aware that I revised my predictions for inflation considerably since the onset of the global credit collapse in the third quarter of 2007. For more than a year, I have been predicting that we'll experience at least 18 months (more likely 24+ months) of sharp deflation, then followed by mass currency inflation. I stand by that prediction. Once the "worm turns", and the Almighty Dollar is rightly seen abroad as the bird cage liner that it really is, there will be some spectacular failures of US Treasury auctions. Then, in the great banana republic tradition, the Treasury Department will have no choice but to offer higher and higher rates of return in order to successfully peddle their paper. Meanwhile, the multi-trillions in spending that cannot be covered by tax revenues and borrowing will have to be covered by monetization, which as I've mentioned before is highly inflationary. Once the Treasury and Federal Reserve take the turn down that path--and I'm fairly confident that they will--then the fate of the dollar will be certain. From then on, it will be time to "warm up the helicopters", as the Dollar heads into at least double digit inflation--and possibly much higher rates.

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