Generational Dynamics World View

[John J. Xenakis]

*** 15-Jun-21 World View -- The hysteria over inflation in a deflationary era

This morning's key headlines from GenerationalDynamics.com

• The hysteria over the Consumer Price Index
  
• Historical consumer price index changes
  
• Understanding inflation, deflation and the CPI
  
• Financial crisis of 2007-2008
  

****
**** The hysteria over the Consumer Price Index
****


Velocity of Money, 1959-2021 (St. Louis Fed)

In mid-May, the Bureau of Labor Statistics (BLS) published its monthly
computation of the change in the Consumer Price Index (CPI) of 4.2%,
the highest rate since September 2008. This means that consumer
prices had risen 4.2% in the preceding 12 months.

The media went hysterical and started predicting hyperinflation. A
typical media statement by so-called "experts" was some variation of
the following:

<QUOTE>"Inflation exploded in April at an annual rate of
4.2%, the highest rate since Sept 2008, so inflation is already
occurring, and we can expect much higher inflation or
hyperinflation in the next few months!"<END QUOTE>

Long-time readers are aware that I have a low opinion of economists,
and the above statement is one more example. If the inflation
rate was even higher in September 2008, then why wasn't there
hyperinflation in 2009? These "experts" are too dumb to even ask
that question. As it turned out, there was mild deflation in
2009, so the Law of Reversion of the Mean took hold.

Then in mid-June, the BLS reported a CPI increase of 4.99%. Here's
how CNBC reported it:

<QUOTE>"The consumer price index, which represents a basket
including food, energy, groceries, housing costs and sales across
a spectrum of goods, rose 5% from a year ago. Economists surveyed
by Dow Jones had been expecting a gain of 4.7%.

The reading represented the biggest CPI gain since the 5.3%
increase in August 2008, just before the worst of the financial
crisis sent the U.S. spiraling into the worst recession it had
seen since the Great Depression."<END QUOTE>

This was actually a pretty good report, since it balanced the
inflation hysteria with a sober report about what happened in 2009.

However, it didn't stop the hysteria from the so-called "experts" on
TV, who have been predicting hyperinflationary doom, because they just
can't seem to grasp that this CPI change is a temporary spike.

****
**** Historical consumer price index changes
****

The following page contains a table of historical changes in the CPI
month by month for the preceding 12 months, from 1913 to the present:

Historical Consumer Price Index Change

If you'd like, you can copy and paste the table on that page into a
text file or into a spreadsheet, or you can just read the table on the
web page.

You should spend a few minutes studying that table. It shows how the
current spike in inflation is not unusual in the last three decades,
and that there were previous larger spikes that didn't lead to
sustained inflation.

As I've written many times, the "experts" have been consistently wrong
about inflation since 2003, when I started keeping track, and
predicted a deflationary era. For the last 70 quarters, the "experts"
predicted that there would be inflation or super-inflation in the
following quarter, and for 70 quarters they've been wrong every
quarter and I've been right every quarter. And now it's the same
thing all over again.

It would be VERY nice if even one of these "experts" at least
acknowledged that they've been wrong for the last 70 quarters, and
explained why "this time it's different" this quarter. But they never
do.

****
**** Understanding inflation, deflation and the CPI
****

When I first wrote about deflation in 2003, I really didn't understand
what was going on, and in fact I said that inflation is "very
mysterious." But I knew we were in a stock market bubble, and I knew
that public debt was very high, and I knew that we were in a
generational Crisis era, so I assumed that we would be following the
deflationary path of the 1930s, and that we were in a "deflationary
era."

That turned out to be correct. But now, having seen what happened in
the last almost 20 years, I now have a much better idea about what a
"deflationary era" means. It means two things:

• that there will be NO sustained hyperinflation as in the
  1970s, and
  
• the deflationary era will end with a financial crisis that will
  trigger a deflationary crash.

There are two economic measures that define a deflationary era:

• the falling velocity of money, which measures the reluctance
  of people to spend money or increase wages
  
• the rising level of debt, which will lead to a deflationary
  crash.

Both of these economic measures are generational, in the sense that
they occur during generational Crisis eras, and are the opposite of
what occurred in the generational Awakening era of the 1970s. During
the 1970s, people were still recovering from the Great Depression and
public debt was extremely low, so people were willing to incur debt
and spend money, resulting in a high velocity of money in the 1970s,
and inflation.

****
**** Financial crisis of 2007-2008
****

The global financial crisis of 2007-2008 caused many people to go
bankrupt or to lose their homes, and that made people extremely averse
to spending. This reluctance to spend was measured by the velocity of
money, which has been falling sharply since then. You can see that
clearly by the graph at the beginning of this article.

This doesn't cause deflation, but it does put a lid on inflation
during this deflationary era. It also means that when there's a burst
of inflation caused by scarcity, like today, it will not encourage
people to spend more, but instead will cause people to become more
cautious and pull back even further, often resulting in a brief period
of deflation as the scarcity unwinds. This happened in 2009,
following an inflationary spike in 2008.

The second factor, besides velocity of money, is increasing public
debt.

But today, public debt is extremely high and growing. This feeds into
the velocity of money, since people in debt are very reluctant to
spend and pay high prices, which would only increase their debt.

Furthermore, the high public debt leads to the second outcome of a
deflationary era, namely that it ends with a sharp deflationary crash.
This is because of the chain reaction that starts at the beginning of
a financial crisis. As debts come due, people are no longer able to
borrow money to roll debts over, so they have to sell assets and
collect money owed through other people's interlocking debts, and that
forces other people to sell their assets, resulting in a chain
reaction and a full-fledged deflationary spiral.

I was actually expecting this to happen in 2008, with the collapse of
Lehman and other banks. But something happened that I didn't expect
-- that the Fed would flood the markets with "quantitative easing"
(printed money), which provided banks with plenty of liquidity so that
they could lend money to roll debts over. The problem is that this
exacerbated the problem of interlocking debt and extended it around
the world, so that the next crisis won't be resolved by quantitative
easing, especially if it happens in the context of war.

Here's a final ironic point. When the US government "prints money,"
knee-jerk economists say that this will result in "too many dollars
chasing too few goods" and inflation. This was true in the 1970s, but
the opposite is true in a generational Crisis era, which the knee-jerk
economists don't grasp at all. Printing money today does not generate
inflation today. Printing money today increases public debt, which
makes people more cautious and lowers the velocity of money. So
printing money today does not cause inflation. It creates
disinflationary pressure, and eventually will make the deflationary
crash much larger. So printing money today actually causes more
deflation.

You know, I used to think that the amount of money in the economy (M2)
at least had some effect on the inflation rate, but as time has gone
on, I increasingly believe that the amount of money has absolutely
nothing to do with the inflation rate, at least in the American
economy.

The inflation rate is not a monetary phenomenon. It's a generational
phenomenon. It's not the Fed that affects the inflation rate. It's
the people and the mood of the people that affect the inflation rate.

Sources:

• Velocity of M2 Money Stock (M2V) (St Louis Fed, 14-Jun-2021)
  
• Consumer prices jump 5% in May, fastest pace since the summer of 2008 (CNBC, 10-Jun-2021)

Related Articles:

• Understanding deflation: Why there's less money in the world today than a month ago. (10-Sep-2007)
  
  
• Fed Chairman Ben Bernanke delivers incredibly bizarre speech on inflation (11-Jul-2007)
  
  
• The velocity of money keeps plummeting, indicating no economic growth (04-Mar-2017)
  
  
• German 10 year bund yield goes negative, as deflationary spiral continues (15-Jun-2016)
  
  
• Explanation of Price/Earnings ratio and Stock Valuations (28-Aug-2015)
  

KEYS: Generational Dynamics, consumer price index, cpi,
Bureau of Labor Statistics, BLS,
inflation, deflation, hyperinflation,
velocity of money, M2

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John J. Xenakis
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