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Why I’m not worried about inflation … at least for a good while yet

Well, I wish I could take the credit for having constructed a brilliant analysis, but really, the best answer I can give is “What she said.” That is, Ilargi and Stoneleigh have been running analysis of the credit crisis since before most people knew there was a crisis. I frankly thought Ilargi was out of his mind when he told me that the economic crisis would reshape peak oil and climate change discourse, and ought to be our focus. I was wrong, he was right. Their analysis has been solidly spot-on, and I think it will continue to be. We are in a self-reinforcing deflationary spiral. Inflation may eventually be a response to that, but for right now and the immediate future, well, it isn’t. Here’s an excerpt from Stoneleigh’s remarkable analysis.

“Thanks to a credit boom that dates back to at least the early 1980s, and which accelerated rapidly after the millennium, the vast majority of the effective money supply is credit. A credit boom can mimic currency inflation in important ways, as credit acts as a money equivalent during the expansion phase. There are, however, important differences. Whereas currency inflation divides the real wealth pie into smaller and smaller pieces, devaluing each one in a form of forced loss sharing, credit expansion creates multiple and mutually exclusive claims to the same pieces of pie. This generates the appearance of a substantial increase in real wealth through leverage, but is an illusion. The apparent wealth is virtual, and once expansion morphs into contraction, the excess claims are rapidly extinguished in a chaotic real wealth grab. It is this prospect that we are currently facing today, as credit destruction is already well underway, and the destruction of credit is hugely deflationary. As money is the lubricant in the economic engine, a shortage will cause that engine to seize up, as happened in the 1930s. An important point to remember is that demand is not what people want, it is what they are ready, willing and able to pay for. The fall in aggregate demand that characterizes a depression reflects a lack of purchasing power, not a lack of want. With very little money and no access to credit, people can starve amid plenty.

Attempts by governments and central bankers to reinflate the money supply are doomed to fail as debt monetization cannot keep pace with credit destruction, and liquidity injected into the system is being hoarded by nervous banks rather than being used to initiate new lending, as was the stated intent of the various bailout schemes. Bailouts only ever benefit a few insiders. Available credit is already being squeezed across the board, although we are still far closer to the beginning of the contraction than the end of it. Further attempts at reinflation may eventually cause a crisis of confidence among international lenders, which could lead to a serious dislocation in the treasury bond market at some point.”

I think it is important that we be prepared for the real crisis - a long term, deep, deflationary Depression. As I’ve mentioned before, most rhetoric about the Depression tends to look at the deepest part of the Depression, observe that we aren’t there yet (something along the lines of “During the Depression, unemployment was 25%, but at present we are nearly at 7%, a long way away from that). All of this ignores the fact that during the Depression, unemployment rose gradually too. In the fall of 1929, unemployment rose only very slowly. But between March 1930 and March 1931, unemployment doubled, and didn’t reach its peak until 1933, more than 3 1/2 years after the crash.

My claim is not that we will travel precisely the same road as described in the Depression. But one of the things about crises worth noting is this. They have their moments of screaming and running around, of explosions and flames. And then they have most of the rest of the time, which is rather like life, only with incrementally painful shifts.

One of the incrementally painful shifts we are facing is that addressing peak oil and climate change are likely to be pushed to the back burner. Obama has already noted that some of his energy goals will probably have to be put off. The problem is that the odds are good that if they are put off, they won’t happen. Meanwhile, over at The Oil Drum, Gail the Actuary has another clear-eyed post about how this will affect our long term energy infrastructure.

BTW, if you’ve relied as much as I have on their analysis, and can afford it, you might consider donating to the Automatic Earth’s Holiday Fundraiser, on the sidebar. Ilargi has been doing the work of researching and writing full time, and essentially, they are trying to make sure he can keep doing it. His goal - to make as much as a McDonalds burger flipper by exploring the financial crisis and helping people address it - seems pretty reasonable to me - I’d sure as heck rather have the two of them doing this work.

Sharon

Editorial Notes: While the current economy isn't good for developing new energy sources, as Gail Tverberg writes today, it pushes us to conserve and become efficient - good preparation for the next bout of commodity inflation. Automatic Earth was recommended by Jim Barton when he was on a recent visit to EB headquarters in California. Their current post, How to Build a Lifeboat looks good. Their recommendations: 1) Hold no debt (for most people this means renting) 2) Hold cash and cash equivalents (short term treasuries) under your own control 3) Don't trust the banking system, deposit insurance or no deposit insurance 4) Sell equities, real estate, most bonds, commodities, collectibles (or short if you can afford to gamble) 5) Gain some control over the necessities of your own existence if you can afford it 6) Be prepared to work with others as that will give you far greater scope for resilience and security 7) If you have done all that and still have spare resources, consider precious metals as an insurance policy 8) Be worth more to your employer than he is paying you 9) Look after your health! -BA

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