Outside the Box

A Little Chronic Deflation

October 13, 2012

One of the questions I (and other analysts) get asked most frequently is whether I think there is deflation or inflation in store for the US. My quick answer is "Yes." A brief answer is that we are in a deflationary period and have been for over 30 years, but like all cycles it will come to an end. A great deal of the "when" depends on how the US deals with its deficit following the election. If we put the US on a realistic glide path to a balanced budget (over time) then that deflationary impulse will last longer than most observers think, even given QE3+++. If we do not deal with the issue, and try once again to kick the can to the next election, inflation could be a very real problem.

But one of the definitive experts on the question, and someone who has taught me a great deal over the years, is Dr. Gary Shilling, who has literally written the book (several, actually) on deflation. This week he summarizes a recent client letter for our Outside the Box, and I think you'll will find stimulating. His is not the consensus view, but it's one we need to understand.

You can subscribe to Gary Shilling's Insight for the special introductory rate of $275 for Outside the Box readers (email delivery) and get a copy of the full Insight report excerpted here plus a copy of Gary's latest book, Letting Off Steam, a collection of his commentaries on matters great and small, complex and mundane, serious and frivolous.

Gary will be writing about the details of who will be winners and losers in the Fed's QE3 program, how overseas economies are faring, and what it all means for US stocks and the American economy. To subscribe to Insight call them at 1-888-346-7444 or 973-467-0070 and be sure to mention you read about the offer here.

This has been an interesting week. I was supposed to speak at a client meeting for Common Sense Investments at noon on Wednesday in Portland. Kyle Bass of Hayman Advisors was also speaking, so he graciously offered to let me fly with him in his plane rather than catching a redeye the night before. I got up early and made it to the hangar, but the plane had a mechanical problem. A quick call to American Airlines and a mad dash to the airport got me on a scheduled flight that would have gotten me in on time. Except that flight too had issues and the other flights were booked solid. An extremely helpful staff member at American somehow sorted it out and got me onto a full flight (with wifi!) and into Portland in time to let me give a speech as the "closer" for the day. Meanwhile, Kyle was in Chicago and found another way to get to Portland. The other speaker had a personal tragedy to deal with and couldn't make it; so I called my old friend Ed Easterling, who lives not far from Portland, and he kicked the meeting off with his usual dynamic presentation while the rest of us figured out how to get there.

The next day, the founder of Common Sense Investments, Jim Bisenius, took us to his 36,000 acre ranch (and wildlife preserve) in Eastern Oregon to do a little hunting and fishing. It is a rather amazing place. He is such a gracious host and has a gift for getting people to tell their stories. Kyle brought along a young man who had been Special Operations in Iraq and who now carries around about four pounds of metal from a IED that can't be gotten out of him. He's in quite a lot of chronic pain but is rather cheerful and can tell some pretty amazing stories. It makes me humble to realize what sacrifices people make for our freedoms. The courage he and his brethren display on a regular basis is inspiring. I simply stand in awe and gratitude.

I was able to hitch a ride back to Dallas, got in late, got up the next morning, taped videos and read some emails, and then hopped another plane to Houston, where I am getting ready to go to my 40th Rice University class reunion. I am sure it will be another night of old friends and great stories, so I think I will hit the send button and go on to the party. Have a great week!

Your rather amazed at how much fun I get to have analyst,

(Even more amazing is that I get paid for this!)

John Mauldin, Editor
Outside the Box

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Discuss This


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Dallas Kennedy

Nov. 5, 2012, 1:10 p.m.

When Shilling talks about deflation, what exactly does he mean? If he means a *general* fall in prices, “deflation” is certainly not correct. We had a brief fling with general deflation at the of 2008, but that’s it.

The analogies with Japan are misplaced. Japan is a surplus country, with a constantly appreciating currency and a bias toward general deflation. The US is a deficit country, with a depreciating currency and a bias toward general inflation. (BTW, Japan will soon be running out of domestic savings and foreign currency reserves and will face a dramatic bond market crisis.)

If “deflation” means *asset* deflation, then we’re in the right ballpark. But even here, Shilling’s message is misguided in the long run, because he claims that this is associated with low interest rates. A better way to think of it is in terms of bond prices, which are in an inflated bubble. When that bubbles bursts, bond prices will fall—deflation. And interest rates will rise, sharply. We might also see a dollar crisis.

John Roberts 29106

Oct. 14, 2012, 10:03 p.m.

John, I would be very interested in your future writing to hear what Kyle Bass has to think about our economic future. He is a “mind among the Mauldin’s” that I want to hear about…
John Roberts

Ed Porter

Oct. 14, 2012, 5:39 p.m.

With regard to the 6 reasons the US dollar will stay pre-eminent :

1 Check
2 Check
3 Check
4 Is this some kind of joke? - Um,  LOL, if it (presumably) is.
5 Check
6 Check

Gerald Lampton

Oct. 14, 2012, 12:58 p.m.

I think that whether you think we live in a world of inflation or deflation depends on your definition of “money.” 

If, by “money,” you mean the real money of gold and silver, then we have been in a world of deflation for some time. 

If, by “money,” you mean federal reserve notes and other fiat curencies, then we are in a world of inflation and likely to remain there for the foreseeable future.

John Caldicott

Oct. 13, 2012, 9:03 p.m.

Very interesting and authoritative analysis, with Shilling’s “call” of a further 20% decline in US single-family median house prices a counterpoint to Jamie Dimon’s apparent recent assertion that US housing may have “turned the corner” (for the better) and even Bud Conrad of The Casey Report recently suggesting that there may be upside in US housing and a case for putting a “selective toe” in that water.

S.D. Maley

Oct. 13, 2012, 6:08 p.m.

“Zeal for yield” was one factor in the years leading up to the Great Depression, according to Garet Garrett (see, for example:  http://en.wikipedia.org/wiki/Garet_Garrett). That resource has a link to an online (PDF) of his 1932 “The Bubble that Broke the World”. A reprinted, 2012 edition is available from: http://lfb.org/shop/american/a-bubble-that-broke-the-world

Ski Milburn

Oct. 13, 2012, 4:32 p.m.

You have to live in a pretty rarefied environment of academic definitions to boldly state that the US has been in a deflationary environment for the last 30 years, but I agree that deflation is our current reality and likely future.

And the various descriptions are interesting, but where I come from (just down the road a bit from John) this is pretty simple. 

Inflation is when prices go up faster than your paycheck, and deflation is when your paycheck falls faster than prices.  Either way, the bank gets what’s mine, and I get the shaft.

But you have to read all the way to the very end of this otherwise excellent article to get to the totally unfounded whopper in the last sentence.

With a current administration completely sold out to Wall Street, and a challenger that IS Wall Street, the only outcome that we can expect is what is good for the big banks.  And deflation is very, very bad for them.

So, whoever wins in November, expect more deflation, and frantic stimulus by the government to tip it the other way.  By February, you can bet your bottom dollar that “deficits don’t matter” but they will be worse under a Republican administration.  Why, because history teaches that they always are.

Ashley King

Oct. 13, 2012, 3:53 p.m.

“I distinguished between two types of deflation—the Good Deflation of excess supply and the Bad Deflation of deficient demand.” Well, deficient demand could only come from deficient supply (Say’s Law).  So you can’t have deflation from the latter.  Look at the bank failures since 2008. That is credit contraction, in the short run.  And the increased burdens on business from new entitlements like Obamacare have cooled investment and hiring.  There is your deficient demand problem.

David Perry

Oct. 13, 2012, 3:24 p.m.

When it comes to housing, Gary seems to be using an entirely different dataset than Bud Conrad references in the just released Casey Report. They appear to come to diametrically opposed conclusions.

Secondly, I have several responses to Gary’s reasons why the US dollar can be expected to remain strong—which follow his arguments below:

Gary writes: The dollar should continue to meet at least five of my six criteria for being the dominant global currency:

1. After deleveraging is complete, the U.S. will return to rapid growth in the economy and in GDP per capita, driven by robust productivity.—How can robust productivity appear without a robust economy? Will a recovery happen in 5-7 years with an impoverished baby boomer generation?

2. The American economy is large and likely to remain the world’s biggest for decades.—OK, maybe.

3. The U.S. has deep and broad financial markets.—Will this still be true following a “complete” deleveraging?

4. America has free and open financial markets and economy.—What planet is he living on?

5. No likely substitute for the dollar on the global stage is in sight.—China has moved agressively to sign numerous bilateral trade agreements using non-US currencies. They have every reason to continue expanding this practice.

6. Credibility in the buck has been in decline since 1985, but may revive if long-run government deficits are addressed and consumer retrenchment and other factors shrink the foreign trade and current account deficits.—How can the deficits possibly be addressed without massive intentional devaluation of the dollar? The numbers are impossible. What does Gary think that will do to price inflation/deflation?


Robert Braun

Oct. 13, 2012, 2:02 p.m.

Appologies for not being intimateely familiar with Mr. Shilling’s economic thinking but there is not one measly word utteres in this text about money supply. Is that by design or by ommission?