Worried about Inflation, Stagflation or Hyperinflation? You shouldn't be.

자료: http://randolfe.typepad.com/randolfe/2008/10/worried-about-i.html

Monday, October 06, 2008

Worried about Inflation, Stagflation or Hyperinflation? You shouldn't be.

For at least 3-4 years now there has been a lot of fretting and hand wringing over the fears of inflation and its uglier siblings.  Certainly, consumer inflation has been growing fairly steadily since the late 1980s.  But with this Great Deleveraging that's now occurring globally, are we really right to worry about inflation, stagflation or hyperinflation?

First, some defintions:

Inflation:  The percentage change in the price level, usually referring to increasing prices.  "Price level" itself can be applied to various measures, most commonly to a basket or bundle of goods and services.

Inflation is generally spoken about as part of the Quantity Theory of Money.  It is through this theory's equations that people usually tie monetary policy to inflation.

Deflation, Disinflation:  The opposite of inflation.  The Great Depression was a deflationary cycle.  Recessions are also deflationary.

Stagflation:  A situation in which economic stagnation or even contraction occur simultaneously with inflation.  Stagflation is particularly interesting because it is theoretically impossible under classical, Keynesian economics.  But, of course, it happened twice in the US, leading to new theories and significant advancement of macroeconomic thought.  Stagflationary cycles have been broken by the central bank intentionally causing a recession, and thus deflation.  This was the famous action of former Federal Reserve Chairman Paul Volker.

Hyperinflation:  An inflationary cycle which compounds out of control until currency is effectively debased to zero value.  Most definitions of hyperinflation describe it as an order of magnitude increase in inflation per year, or 1% per day.  Hyperinflations are relatively rare, and happen primarily as a function of a country's central bank printing money in order to service foreign debts.  Hyperinflation has not occurred (for more than a brief moment as it began) within a country in the modern era so long as that country maintained a credible military force or was credibly protected by a country with such a military force.  These countries choose to default instead of willingly destroying their own population and inciting an internal revolution.  Famous hyperinflations, such as within pre-war Germany, were broken when the Germans militarized and broke war reparation agreements requiring them to repay crushing foreign debts.  More modern hyperinflations have been broken by IMF action (ie, foreign intervention), or by various forms of practical default.

The Case for Inflation

Plenty of internet resources exist describing inflation.  Suffices to say that we have been in a long-run period of general price inflation.  However, it is important to note that perceptions of inflation by average people are often overstated.  They usually do not recognize product-cycle-deflation.  Items such as consumer electronics, computers, and automobiles are exceptionally deflationary, though most people perceive them as steady-state or inflationary.  However, the value of those items rises as a function of technological innovation while the costs to produce them falls as a function of improved production techniques, all while prices tend to remain constant, fall, or rise more slowly than general price inflation.

Inflation is synonymous with a high-return global economy.  It has become more pronounced and recognized as rolling asset bubbles have plagued the global economy.

The Case for Stagflation

Stagflation occurs as some prices, usually prices of inelastic goods such as food and energy, rise rapidly during a period of economic slowing.  Other prices may continue to fall, however, increasingly disposable income falls as people shift spending to essential items for which the price is rising.  Stagflations occur due to some economic shock, such as a war or supply disruption.  Many have made the case that describes our current global situation, particularly in the US.  This case has merit, and I see as the second most likely outcome of the current situation.  It may also be that stagflation occurs as a transition into a more deflationary environment.

The Case for Hyperinflation

Hyperinflation is the least likely conclusion for the US, and for most western economies, in my opinion.  Even were a hyperinflation to ignite within the US, it is more likely we would either intentionally or naturally quickly break into a Great Depression-style deflation, probably as a result of either overt or effective default on our foreign debts.  Most who are calling for a hyperinflation in the US point solely to the "printing of money" as causing inevitable currency debasement.  That is flawed reasoning of linear extrapolation.  As Japan noted during their deflationary cycle, even cutting the interest rate to zero, and making the real rate negative (meaning one pays to store their cash in the bank instead of earning interest on it) did not result in a hyperinflationary debasement of their currency.  Instead they became trapped in a liquidity-trap, as situation in which the central bank lost its ability to affect aggregate demand.  I believe, for reasons outlined later, that this is (somewhat surprisingly, perhaps) where the US is headed.

The Case for Deflation

Financia Capital produced a reasonable analysis and essay making a case for deflation in their document MarketWatch Postscript: A Case for Deflation (PDF), June 2007.  Other notable works can easily be found by way of a Google search on the subject.

I'll leave their analysis to carry the weight of the deflation scenario argument and just bring out some basics here:

• Many products are strongly deflationary, as mentioned earlier.  Computers are an easily describable example.
• Stiff price increases in commodities is a function of global demand more than monetary policy.  During a period of slowing global economic growth, commodity prices subside.
• Pursuit of high-returns coupled with easy-money monetary policy has resulted in rolling asset bubbles.
• When the rolling bubble(s) encounter an end-game scenario, the popping of those bubbles is strictly deflationary.  I argue that real assets (as in real estate) represent the end-game scenario.  The amount of leverage generated and global capital deployed to inflate the global real estate bubble is so massive that no other asset class exists to adequately absorb the accrued inflation.  Therefore, as it pops, strict deflation must occur.
• Attempting to "inflate our way out of" the current scenario will result in a liquidity trap, further complicating deflation.  The system of credit is delevering, which necessarily implies, deflating.  That is, less credit will be available after the correction than before because capital is being levered much less.
• Less credit impacts the consumer sector of the US by decreasing aggregate demand, causing deflation.
• Investors will no longer seek high-returns instead preferring optimal risk-adjusted returns.  This will cause investment, which fuels credit, to be attracted to less risky, lower growth endeavors.  Lower growth adds to deflation.