Thereโ€™s always something to howl about.

Deflationary Or Inflationary? Laying Economists End To End

The last half of the title came to me as I recalled one of Johnny Carson’s most memorable lines. He was talking about how economists are supposed to be the smartest kids in the room, but at the same time can’t agree with each other what day it is. He said, “If we laid all the economists end to end around the world…it would be a good idea.” (Insert rimshot here.)

There are two basic schools of economic theory — Those who believe economies can be centrally controlled, engineered if you will — And those who believe economies should be as free as prudently possible, with regulation in place to abort fraud etc., i.e. they avoid central control as much as possible.

The engineers think they know better what ‘needs’ to be done, while consciously eschewing human responsive behavior as part of their equation. They believe if you raise/lower taxes the result will be arithmetic in nature, and that you and I won’t modify our behavior in either circumstance. That’s surely an oversimplification, but accurate.

The free market crowd says if you raise taxes you slow economies down, and if taxes are lowered more jobs are created due to more capital venturing into the market because of the lowered cost (taxes).

Then there are the folks who think they’re smarter than both schools. They try to blend what they think are the best ideas from both theories. Good luck. ๐Ÿ™‚

We’ve all seen the argument between the two camps rage since we learned to spell economics.

I bring this up only to illustrate the current example of how the smart kids in at least one of the schools just doesn’t get it. I’ll leave it to you to decide which school that might be.

The argument today is, Are we in a deflationary cycle or are we about to enter what could be a hyper-inflationary cycle?

I lean toward deflation. Every single time an economy, any economy in the last eight centuries, has gone through a massive deleveraging, it’s been deflationary in nature. There have been no exceptions found in the research, as in zip, zero, zilch, nada. The last time we, as Americans, experienced deleveraging at this intensity level it resulted in massive deflation. According to the research, the time leading up to, and the subsequent deflationary cycle were almost textbook examples of the consequences of massive deleveraging.

I realize there are folks, (I used to be one of ’em.) who point to the massive money printing going on by the Fed, coupled with their buying of treasuries. They say that’s the working definition of inflation. Not true. For it to be inflationary, the liquidity it creates must overwhelm the economy’s ability to absorb it. The analogy might be water into a huge sponge. If the sponge is bone dry, and has a capacity of 10 gallons of water before it ‘leaks’ water (inflation), yet we only pour eight gallons into it (money printing), there’s no leakage. It was all absorbed. No inflation.

My crystal ball is as cracked as the next guy’s. But I think I’m right about being on the road to deflation. Whether on Wall Street, Main Street, or real estate in general, there’s simply far too much deleveraging to accomplish for inflation to win this battle. The sponge isn’t impressed so far.

We can’t say, “The Fed’s printin’ too much money, we’re gonna have double digit inflation” — While outa the other side of our mouths decry all the negative leverage on Wall Street and the monster default tsunami about to hit lenders. We gotta pick one. We can’t be morbidly obese and a marathon runner at the same time.

Of course, this is where the stagflation crowd enters, stage left. ๐Ÿ™‚ Go ahead, make your case. I’d love to hear how we get inflation amidst all this deleveraging — not to mention the incredibly growing federal/state deficits. The fact remains, for over 800 years there’s not been one exception to the result of massive deleveraging in a macro economy — it’s deflationary.

I’m not only willing, I’m praying to be found wrong as we look back several years from now. I just hope I’m wrong by degree, and not because we endured hyper-inflation.

What say you?