In response to Misguided Worries About Inflation I received an email from “GR” telling me “The deflation metaphor is not playing out. Every month the things I consume go up in price.”

He pointed numerous price increases, including gasoline, up a nickel in a week.

Excuse me but isn’t the price of gasoline down $1.50 or more from a year ago?

More to the point, I clearly spelled out in the post that prices are symptoms, not the definition of deflation.

Confusion Over Inflation

Articles like these have people confused about what inflation is. Indeed every week I have someone email me that “We have inflation and deflation at the same time.”

No we don’t. It is not possible. The reason is falling prices are a symptom of deflation not a definition of it. Falling prices frequently accompany deflation, but they are not a necessary ingredient.

If you need a refresher course please read Inflation: What the heck is it?.

Better yet, read and understand Fiat World Mathematical Model.

Talking about the auto industry and Walmart, “GR” says “They will not sell below cost even if the demand graph drops to zero. They will somehow find a way to get government subsidy, or else they will find a consumer gimmick to increase the price.”

Well GM sold cars at a loss for 5 years and that is why they eventually went bankrupt. If GM sold no cars insisting they break even they would have gone bankrupt sooner.

Currently, commercial real estate bankruptcies are growing at a massive rate. So too are bank failures, foreclosures, and credit card defaults. And bankruptcies, foreclosures, and credit card defaults result in the destruction of credit, the very essence of deflation.

Somehow “GR”, like many others, has intense faith in the Fed to get prices up and consumers spending. This is in spite of the fact that prices are falling and demand is sinking in the face of the biggest stimulus package the world has ever seen!

Scorecard Shows How Little Power Bernanke Has

In a second email “GR” sent a long list of why what is happening can’t happen even though it clearly is. He concluded with “Celente, Schiff, and Weber cannot be wrong, only their timing may be off.”

Their timing is off indeed, perhaps by as much as Prechter’s was in his deflation call: decades. Prechter was at least right, finally. Deflation is here. Hyperinflationists were wrong betting it would come before deflation. And they are still waiting for Godot.

The reality is Bernanke’s Deflation Preventing Scorecard shows how little power the Fed actually has once consumer attitudes change.

Fed Controls Price Of Gold?

A second person told me “The gold market is totally controlled by the FED”

Bernanke is scrambling to prevent the second great depression, cannot get consumers to buy or banks to lend, did not see any of this coming, could not and did not prevent the housing crash, could not and did not prevent the crash in commercial real estate, and has a scorecard of zero in preventing deflation, yet somehow the Fed controls the piece of gold.

Really?

Deflation Denial In Spite Of Overwhelming Evidence

People have misguided faith in the Fed’s ability to forever blow bubbles although the power of the Fed is all an illusion.

It’s easy to blow bubbles and get consumers to spend when consumer attitudes are on your side. However, it’s much more difficult now that consumer attitudes towards spending and banks attitudes towards lending have dramatically reversed.

The Wizard behind the curtain has now been exposed as a fraud. Yet, in spite of massive evidence the Wizard is powerless to change attitudes, most stubbornly believe in the Wizard.

The Winds Of Frugality Blow In Bernanke’s Face

Please consider The Consumer Has Dug in His Heels by Bill Bonner.

Since 1945, the US economy – and much of the rest of the world economy – has been carried on the backs of American consumers. First, they spent money they earned during the war years. Then, they spent money they earned in the big boom of the ’50s and ’60s. And then they spent money they hadn’t earned at all. They borrowed from future earnings…increasing total US debt from just 120% of GDP in the ’70s…to 370% of GDP in 2007.

In the last 15 years of that period, especially, each time the consumer showed a reluctance to continue spending, the feds rushed to give him more credit. And during the final five years – the Bubble Epoque – debt doubled.

Now, the consumer has dug in his heels. He’s not going a step further until he unloads his excess baggage of debt.

Once again, the feds are trying to stimulate him. The Fed’s key interest rate is practically at zero. The feds are pumping money into the economy as fast as they can. And they’ll give a fellow up to $4,500 if he’ll agree to kill his old car.

Even with the stimulus spending…and the stimulating low interest rates…he’s still not willing to add debt. Of course, this is just what happened in Japan. The public sector spent; the private sector saved. Net result: an on-again, off-again recession that has lasted almost 20 years.

This morning’s news tells us that the federal deficit through July comes to $1.27 trillion. We didn’t think that was possible. And despite this inferno of new debt…the 10-year Treasury bond yields barely 3.6%. We never thought that was possible either.

So, anything could happen. But generally, government stimulus only works when it is not needed. That is, it only works when it goes in the same direction as the underlying trend…not against it.

But now, the underlying trend has reversed. It’s no longer a credit expansion; it’s a credit contraction. The consumer has had his fill of debt. He’s cutting back on his spending and paying off debt. That’s what the July figures show. That’s been the history of entire downturn. That’s why it’s a depression, not a recession. It’s a major change of direction that will take years to accomplish. Now, stimulus is not only useless – since it is against the major trend – its counterproductive. It delays and contradicts the adjustments that need to be made.

Encouraging people to buy too much was what caused the problem in the first place. Encouraging them to buy more now is not a solution; it’s just a continuation of the same flawed policy of stimulating consumer demand…a policy that has been in place for decades.

But now the wind is blowing in the other direction. The government may not like it, but they can’t stop it.

That article is a great read in entirety. I encourage you to read it. Without even mentioning the word “attitude” that’s what Bonner is talking about.

Greenspan was able to reflate time and time again because consumers were trained “cash is trash” and to “buy the dip”. Yet Greenspan’s power was an illusion, his manipulations were all in the direction of the trend.

Japan failed to stimulate credit because of changed consumer attitudes towards debt.

Bernanke will fail as well. Indeed he already has. His deflation prevention scorecard is proof enough.

Crash Course For Bernanke

Flashback January 28, 2008: Inquiring minds are reviewing a Crash Course For Bernanke

Four Reasons Bernanke Will Fail

Final analysis will show that Bernanke can change interest rates but not attitudes, and attitudes are far more important. Indeed, changes in attitudes will render all of Bernanke’s academic theories about the Great Depression meaningless.

Greenspan had the wind of consumers’ willingness and ability to go deeper in debt at his back. Bernanke has the wind of boomers fearing retirement in the midst of falling home prices and impaired bank balance sheets blowing stiffly in his face. There is no cure for what ails us other than time and price. And with the aforementioned attitude changes, the biggest, most reckless, global credit expansion experiment the world has ever seen is coming to an end. Central banks are powerless to do anything about it.

Fed Subject to Real and Practical Constraints

The “central banks are powerless argument” always leads to the inevitable response: Why can’t the Fed print money and give it away to everyone. The answer is the Fed has no power to give away money to consumers, and even IF they had that power they would not do it. The reason is people would pay off their loans and banks do not want to be paid back with cheaper dollars.

The Fed will not act against its own best interests, and giving money to consumers would be doing just that. That is a practical constraint that nearly everyone misses! Indeed, look who was bailed out, it sure was not consumers, it was banks at consumer expense.

Zero-Bound interest rates is a real constraint. Recently fed Governor Janet Yellen stated the Fed wold lower interest rates if it could. Well it can’t!

Thus there are practical as well as real constraints on what the Fed can and will do. Nearly everyone ignores those constraints in their analysis.

Congress in theory and practice can give away money. Indeed, Congress even does that to a certain extent. Extensions to unemployment insurance, increases in food stamps, and cash for clunkers are prime examples.

However, those are a drop in the bucket compared to the total amount of credit that is blowing up. Take a look at the charts in Fiat World Mathematical Model if you need proof.

The key point is it is the difference between Fed printing and the destruction of credit that matters! As long as credit marked to market blows up faster than handouts and monetary printing increase we will be in deflation. Deflation will not last forever, but it can last a lot longer than most think.

Mike “Mish” Shedlock
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