Tuesday, May 15, 2007

Inflation or Deflation?

It is accepted wisdom that in a fiat currency system all roads lead to inflation. I, myself, have trumpeted that view many times on other forums. If we operate on the premise that the trump card where the U.S. economic system is concerned resides in the dollar's reserve currency status, particularly with respect to the petro-dollar trade, then hyper-inflation presents a most dangerous course to take by the monetary authorities. Why?

The U.S. is able to engage in its financial profligacy, to owe the world as much as it does, because the world trades the essentials, particularly petroleum, in dollars. Remove that prop, and a hyper-inflation most assuredly would, and the U.S. economy resembles an economic banana republic almost overnight. The fact is the world is trying to get out from under the petro-dollar regime and there really is nothing that can be done other than to forestall the day of reckoning.

Clearly the dollar's demise is being managed, as in the manner of a terminal cancer patient, in a slow motion sort of way. Let me amend that, it appears as if the dollar's slow death is being managed. However, the look of an orderly decline may be just a mirage, or a temporary condition that will give way to a runaway debacle at some unspecified point in the not too distant future. I am keeping my eye on multi-decade support in the dollar that is being tested for either the fifth or sixth time, right now. In my view, all bets are off as to how ugly things will get when, there is no IF as far as I can tell, the multi-decade support fails.

The deflation argument has more going for it than one might be tempted to think from the standpoint that Peak Oil, Peak Resources, in general, are ultimately massively deflationary since they in essence create enormous and irrevocable demand destruction. As some of you may know, demand destruction and Peak Oil/Resources go hand in hand. If folks like Matt Simmons of "Twilight in The Desert" are right, we should expect unhealthy doses of inflation first, (sound familiar?) followed by deflationary collapse.

Of course sans peak everything, the advent of the prosaic phenomenon known as pushing on a string, where available credit/debt is not tapped because those who would tap it are tapped out, may wind up providing the context for the onset of a runaway deflation. The ongoing housing debacle comes to mind as a state of affairs that will have a great deal of influence on the U.S. consumer's wherewithal going forward; And that in turn will have much to say about which outcome we are faced with, inflation or deflation. Make no mistake, a defeated consumer means a defeated economy.

10 comments:

DED said...

a defeated consumer means a defeated economy.

Agreed. But I've heard the pundits declare the consumer tired a few times over the last couple of years but yet the consumer keeps rebounding.

I don't disagree with your post at all. A crash of some sort is coming. I can't see how we can continue at this pace, but China keeps underwriting our debt (both in Treasuries and Trade) and hasn't shown any signs of easing up.

At some point, the market will decide to switch from dollars per barrel to euro per barrel and then we'll be up the creek. I don't know if I want this to hold off as long as possible or happen within the next two years. In the case of the latter, the populace will put the blame on W and the right wing pundits won't be able to spin their way out of it. If it happens anytime after Jan 2008, then W's successor will have yet another heaping pile of crap to clean up (as if there wasn't enough already).

Edwardo said...

Ded, I think there is plenty of evidence the consumer is on the ropes, but not in a Muhammed Ali versus George Foreman sort of way, but rather more like a Joe Frazier versus George Foreman, i.e. on the ropes prepatory to a vicious KO.

I also beg to differ about China's intentions as they have signaled an unwillingness to purchase bonds with the same gusto as in prior years. In fact, the Chinese are in the process of taking their 1.2 trillion dollar surplus and making energy and resource investments all over the planet. They even tried to buy Unocal, but Congress blocked it. That was likely something of a watershed moment for the Chinese who must have realized at that point, (if they didn't already suspect so) that their role as bolsterer of U.S. debt markets was, however neccessary for them to engage in, a badly lopsided deal in favor of the U.S.

That, coupled with the Bush administrations power grabs in the M.E., has sealed the deal with respect to the inevitable end of dollar hegemony. The other big players have long since had enough, but now they have far more leverage to do something about it.

The petrol market, in various realms, is in the process of switching to euros, and some have even speculated that that was a big reason why we invaded Iraq, to reverse the new euro petrol regime that the late, but not lamented, Saddam Hussein, committed his country to, namely oil for euros. Iran is on the same course, and Bush and Cheney would love to squash them, but they risk a FINWAR if they do. Nukes are the least of Bush and Cheney's fears as we near and pass the threshold of Peak Oil.

As far as when the bottom drops out, it's difficult to say. Equally it's difficult to say who will get the lion's share of blame for the end of the dollar's reserve currency status. My view is that Bush, through a haze of false pretexts, aka lies, WMDs,
Democracy in Iraq, Al-Queda in Iraq, etc. etc. has tried to forestall the end, but has, instead, fatally botched things.

DED said...

Re: consumer. Plenty of signs, yes, but I'm still waiting for more. I'm not disagreeing with you. It's just the whole little boy who cried wolf thing is wearing on this villager. I know there's a wolf out there and it's going to attack the sheep, but is it now?

More evidence to bolster your argument is the fact that I saw commercial recently (I forget for whom) where they brag about how now is a wonderful opportunity to buy houses as forclosure rates are skyrocketing. They flashed a graphic of the US divided into 3 regions with foreclosure rate increases labeled out. It went from up 25% in the heartland to up 70-75% on the coasts. Actual figures may vary but you get the idea. Kinda scary that someone sees a silver lining in that cloud.

Re: China. Yes, I know about the stymied Unocal bid and the decline in gusto over buying treasuries and the grand investment in energy (especially in nuclear power), but they're still buying up T-bills in sufficient quantities to keep this miasma going. If they weren't, wouldn't the Fed have raised rates to make the dollar seem worthwhile again to others?

I'm still waiting for a major sign that China's abandoning the dollar. If they took their dollar reserves and started buying euros that would certainly be the death knell for the petrodollar hegemony. Or maybe, it'll be just a slow process. A death by a 1,000 cuts. China's been known to be patient. They actually waited those 99 years to get Hong Kong back. Once China's internal economy reaches a critical mass, they'll be able to keep a big chunk of those exports to satisfy the needs of its middle class.

I think we agree more than we disagree. The question of "when", being the bulk of disagreement.

And yes, W has certainly botched things. The gov't could've used its resources to ease the pain of transition but instead we got... well, you know what we got.

Edwardo said...

Thanks, Ded, for your astute comments.

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