Wikinvest Wire

The inflation-deflation debate continues

Thursday, June 18, 2009

The musings of Van R. Hoisington and Lacy Hunt at Hoisington Investment Management have been crossing my computer screen for years now, thanks largely to John Mauldin's weekly emails. They've always made for interesting reading and, today, CNN/Money files this report on their views regarding the raging inflation-deflation debate.

During a recent speech, money manager Van Hoisington, president of Hoisington Investment Management, asked his audience of sophisticated investors to raise a hand if they thought inflation was going to be a problem sooner or later.

Everyone raised a hand -- except Hoisington.

This "inflationist view of the world," which he outlines in his firm's recent quarterly review and outlook, stems from Milton Friedman's observation that "inflation is always and everywhere a monetary phenomenon." Hoisington goes on to say that "the Fed has expanded the money supply dramatically, and since inflation is too much money chasing too few goods," people think inflation is inevitable. But he thinks they're wrong.
It's important to remember that they are a largely a fixed-income investment management company so, to some extent, they are talking their book, a book that happens to have done quite well in recent years.

Nonetheless, it is somewhat tiring to hear the same comparisons to the 1930s era when, as noted here on many occasions in the past, just about everything is different than it was 75 years ago, most importantly, the money itself.

Second in change only to the nature of the money are two other important factors - emerging economies around the world and the finite nature of natural resources, all of which set the stage for a commodity driven surge in inflation, sometime down the road.

But, there's where the disagreement between inflationists and Mr. Hoisington lie.
For starters, Hoisington believes the economy will continue to be weak for years. And with unemployment at such high levels, companies won't be raising wages, and consumers won't be increasing their spending. That means demand for commodities and other goods will be muted, so there will be no upward pressure on prices. Overall, he sees the economy being no bigger in 2012 than it is today.

Even if inflation and interest rates were to rise in this recession or the beginning of a recovery, the economy would quickly stall. "With unemployment widespread, wages would seriously lag inflation," he writes. "Thus, real household income would decline and truncate any potential gain in consumer spending."

What about all the money the government is pumping into the system? That's not by itself inflationary, he says, pointing to the work of economist Irving Fisher (who died in 1947).

Fisher believed that gross domestic product is equal to money times its turnover, or velocity, which is basically, the speed with which people spend it. In the last two quarters, money supply has grown at 14% but velocity has declined by about 17%, so nominal (non inflation-adjusted) GDP fell 4.5%.

One reason velocity is down, according to Hoisington, is that people would rather repay debt than go out and buy a lot of new stuff. He points again to Fisher, who wrote in a 1933 article "The Debt-Deflation Theory of Great Depressions" that excessive debt controls all, or nearly all, other economic variables.

Hoisington sees this today. "People are more interested in trying to get out of debt than increasing it, which means the economy cannot grow," he says. "If there's no increase in demand, there can be no increase in prices."
This is a very U.S.-centric view of the world that will soon be put to the test. Personal debt is virtually unheard of in much of the rest of the world, a point that shouldn't be ignored.


marku said...

My expectation is that we will have both...deflation in wages, consumer goods and stock market assets, and inflation in things you can't do without: oil, health care, and food. And since the government stats don't accurately track these (health care inflation is 4%? Give me a break!) and "core" inflation ignores the "volatile" food and energy commodities, the official numbers won't look too bad.

But for the poor shmoe trying to make ends meet in some dead-end service job, it is going to be a big time squeeze.

And probably rising energy prices will squeeze off any nascent recovery, so we will get stuck in a series of slight recovery/deep recession cycles ad nauseum

The most astonishing graph I have ever seen about oil production is this one from the oil drum comparing oil price VS production. Production just hits a hard wall as prices rocket up.

It is past time to retool the economy for a future with less oil...

staghounds said...

"people would rather repay debt than go out and buy a lot of new stuff."

Which people are these? In what fantasy world do they reside?

Seriously. You hit the nail on the head almost- although the money is different, the basic unarticulated feeling of the people using it is different, too.

In 1940s America, every adult had grown up in a time of sound U. S. dollars. With sound money, avoiding debt and saving make sense. What one saves today can be used tomorrow.

Now, only the very oldest Americans grew up with relatively sound money, and the past forty years have been times of uninterrupted universal decline in the purchasing value of all currencies everywhere.

In a fiat money world, saving is profoundly stupid. The money you hold loses value by the month right in front of your eyes. Why would one trade anything for a declining value asset, except for a brief convenience like cashing a paycheck and apportioning it to creditors?

Of course, the next step- the one we're in now- is that the goods the declining money buys become shorter and shorter term too, as they become shoddier and as consumers expect less and less permanence. Can you imagine the condition our economy would be in today if consumer goods had just double their expected life span?

The ideal fiat money consumer is someone on public assistance who owns barely the clothes on her back. Her paycheck is already spent when it arrives, on rent to own, credit cards, and so forth.

Sound money will never return in our lifetimes.

News said...


People all over the world took on good amounts of debt during the last few years of the credit boom. I have relatives in other countries that took out loans that are crazier than anything I've seen here.

Anonymous said...

Sorry for the name-calling, but deflationists are royally stupid.

Their theory is that the US dollar will INCREASE in value no matter what.

OK, then let's all go on the government dole at $100k annually provided by the FED. The dollar would collapse in value. Yet this is what is happening NOW, albeit slowly.

Anonymous said...

Hoisington ignores population growth and continuing third world development. In order for global demand to remain stable, the US/EC economy needs to shrink by an offsetting value.

Even if that happens, we will ultimately start growing again. Given that no one has learned (or been forced to learn) any lessons from this crisis, that money supply worldwide has been massively increased, and that no one has addressed the tens of trillions in toxic "assets" which are still floating around (USD denominated), deflationistas may act smug and hip today, but surely they will be dragged from their cars and beaten to death in four years.

And, in conclusion, I'm with Taleb on this whole issue anyway. Hoisington has no clue and neither do I.

Adam said...

Deflation is happening right now.

Those toxic assets are deflationary, not inflationary.

You guys really need to read more about Minsky and Fisher.

Credit expansion is what makes inflation. We saw it in the housing bubbles. Credit expansion has just popped. Where then is the inflation coming from? Government stimulus? The private sector is much more a part of the economy than the public. And it is the private sector debt that caused this crisis, not public sector spending.

Anonymous said...

Adam...later, not now, later.

staghounds said...

Toxic assets are deflationary only if they are written down to their true valye. If money is created to cover the gap between the real value and the book value, AND the toxic assets stay on the books at their false high values, that's inflationary.

Anonymous said...

It's deflation, deflation, deflation. The only reason there's a debate is because rich folk want their assets to constantly inflate like they did in the olden days, not deflate, like they're doing now. But look around. Everything's 30-50% off, and still retailers/service providers are desperate. Want your cable bill cut in half? Easy: Just call Comcast/Time Warner and tell 'em you're going to cancel. Piece of cake!

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