Deflation

The Looming Threat of Credit Collapse and Deflation

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THREAT OF CREDIT COLLAPSE 

The threat of a credit collapse and subsequent deflation currently outweigh the risks associated with higher inflation. This article explores the threat of a credit collapse and its implications for economies and societies worldwide.

After more than one hundred years of practicing inflation with intent and purpose, the Federal Reserve has backed themselves into a corner. The “dual mandate” objectives claimed by Chair Powell and his predecessors are little more than a smokescreen to hide the Fed’s scrambling efforts to contain the effects of the inflation which it has created over the past century.

In his latest attempt to divert attention away from the Fed, Powell has mentioned the potential negative effects of tariffs on the Fed’s efforts: “We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension.”

There should be no doubt that tariffs will be disruptive and harmful to the economy. Tariffs are self-inflicted wounds that have serious negative economic consequences. They do not work as intended or as described by their proponents.

That being said, it is important to consider the vulnerable state of the economy and the markets that existed before tariffs became front-page headlines. The fact of the matter is, that both financially and economically, the United States and the world stood at the edge of a precipice.

If someone pushes me from behind under ordinary circumstances, I might end up on the ground, but, I likely won’t suffer much damage. Then I could gather my thoughts, appraise the situation and stand up again.

What is currently happening is more closely akin to being pushed from behind while standing on one leg at the cliff’s edge. Even if the action were not malicious, the effects of the action cannot be rescinded or modified.

SIGNS OF THE TIMES

Universal credit default happens when individuals, corporations, and countries can no longer sustain the debt they have assumed on a scale that overwhelms ordinary financial and market activity.

This happened in 2008 with education loans, mortgages, and auto loans.  The price of non-performing debt sank into a deep hole, until the government and Federal Reserve embarked on a new experiment of making more and cheaper credit available and buying up the non-performing debt.

Now, almost two decades later, commercial real estate could be the trigger that sends the credit markets into a similar tailspin.

Sometimes, when stock prices decline badly, investors flee to the perceived safety of bonds. Unfortunately, that logic doesn’t work in reverse. If the bond market collapses, stocks will not provide a safe haven from the storm for bondholders. Currently, long-term bond prices (including Treasuries) are down fifty percent from their vaunted perch only three years ago.

As far as stock prices are concerned, we are currently experiencing the fourth decline of serious significance in this century. Previously, the stock market exhibited extreme volatility in 2000-02, 2007-09, and in 2020. While those extremes have not yet manifested this time, they could happen quickly.

We are possibly in the early stages of an asset price collapse. meaning all assets denominated in dollars – stocks, bonds, commodities, and real estate – are in danger of huge price declines.

That bad news is made worse because of bank failures. The worst financial and economic events in history were accompanied by bank failures. Bank failures were a common occurrence during the early 1930s and are evidence of the ongoing risks associated with fractional-reserve banking. Today, we have a system of no-reserve banking. There are no minimum reserve requirements for banks. How safe is your money? (see Fractional-Reserve Banking – Elephant In The Room)

DEFLATION 

Deflation is the opposite of inflation; it is a contraction in the supply of money and credit.

The effects of deflation result in fewer currency units (dollars) in circulation and an increase in purchasing power of the remaining units. In other words, your dollars will buy more – not less.

As the deflation takes hold, the prices of goods and services will decline, rather than increase. In and of itself, deflation can be a good thing. However, when deflation is severe enough, the result would be a catastrophic economic depression.

The depression will last longer than can be anticipated as it will take longer for the economy to cleanse itself of the ill effects of Federal Reserve inflation and mismanagement.

This is true even though the Federal Reserve and the government will do everything possible to counter the effects of deflation and depression. Unfortunately, their efforts will be overwhelmed by the tidal wave of financial and economic destruction headed our way.

CONCLUSION

President Trump and his tariffs are deserving of the blowback received. Chair Powell and the Fed deserve to share in the limelight for the decades of horrible financial and economic policies that have brought us to such a vulnerable state of affairs. (also see No Winners When The Inflation Balloon Pops and Liquidity Problems Could Overwhelm Inflation’s Effects)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

No Winners When The Inflation Balloon Pops

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As the economy slowly grinds to a standstill, the expectations of worsening inflation continue to rise. “Stagflation”, you say? Possibly; but, there is another risk that is greater than stagflation. And, the prospects are much gloomier than those envisioned by a scenario which features an ordinary recession accompanied by marginally higher prices.

THE EFFECTS OF INFLATION 

Inflation is the debasement of money by government. As governments (via their central banks) create money by expanding the supply of money and credit, it cheapens the value of all the money in circulation and causes a loss of purchasing power in the currency (dollar, euro, etc.). The loss of purchasing power results in higher prices for goods and services.

All governments purposely inflate and destroy their own currencies. Over time, the inflation takes its toll and its effects are cumulative, volatile, and unpredictable. The Fed and other central banks think they can control (“manage”) the effects of the inflation which they create, but they end up spending most of their time reacting to and trying to contain those effects.

Today, the U.S. dollar is worth less than 1 penny compared to the dollar of a century ago. Theoretically, the dollar’s decline in purchasing power can continue indefinitely. Hence, some predict the inevitability of hyperinflation and complete repudiation of the dollar. (see Two Reasons Hyperinflation Is Unlikely)

RISK OF DEFLATION AND DEPRESSION 

There are dangers to the world economy which transcend those of hyperinflation and dollar destruction. Those dangers include wholesale deflation and a full-scale depression. The onset of deflation and depression could be triggered by a credit collapse. Or, we might continue to sink slowly and less obviously into a pit of financial quagmire. At some point, recognition of the awful reality would be obvious, but, too late for a reasoned response.

A certain amount of inflation is necessary to keep things from cascading downward. Over time, the effects of inflation are less obvious, so, additional money creation is required periodically in order to maintain the status quo. Beyond that, there is less of the stimulation that was intended. It is very similar to the vicious cycle of a drug addict.

The dependency on the drug (money) is heightened over time. The drug’s effects wear off more quickly and the dosage needs to be greater just to maintain stability, let alone get the desired effect as originally intended. The symptoms of withdrawal are often so bad as to prompt further addiction, rather than endure what is necessary stop the habit.

THE END OF INFLATION 

Historically speaking, periods of entrenched inflation always end in economic collapse. There are examples of ridiculously high inflation rates which ended up at dramatically lower levels after a collapse. And, the economic collapse can happen either with, or without, experiencing runaway inflation.

Weakening economic conditions and a stubbornly strong U.S. dollar are not indicative of worsening inflation. Credit market problems and liquidity issues shift the emphasis from the supply side (too much money) to the demand side (not enough money).

As the demand for cash increases, people begin to sell things – anything and everything. It will require a deflationary collapse to heal completely and to recover from the ill effects of Fed inflation over the past century.

Deflation means that the dollar would buy more, not less; however, there would be fewer dollars available. The demand for money would supplant the fears and concerns associated with the effects of inflation. (see The End Of Inflation?)

RISKS FOR INVESTORS 

It doesn’t matter much what you own at this point. If there is $ sign which indicates its value, that value will be significantly less (by 50% or more) in the event of a credit collapse and the onset of deflation. The biggest losses will come early; and they will be difficult to reverse.

In the past, quick response by the Fed has allowed for varying degrees of restoration and recovery. The long-term addiction described earlier has made it less likely that any Fed response to the next financial and economic catastrophe will offset the tidal wave of credit collapse and bankruptcies that ensue.

The popping of investors’ inflation-supported balloons (stocks, bonds, commodities, real estate, cryptocurrencies, etc) will be devastating.

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

Liquidity Problems Could Overwhelm Inflation’s Effects

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LIQUIDITY PROBLEMS – 1929 

In 1928 and 1929, the Fed raised interest rates for the purpose of curbing rampant speculation in stocks. At that time, investors could borrow as much as 90% of the stock price for their proposed investment. The banks were just as aggressive as investors and were happy to oblige.

Raising rates did not slow stock speculation by investors or banks, however.

What it did do was cause a slowdown in economic activity. Thus, as economic activity declined, the stock market continued its rise, unabated.

As the decline in economic activity continued, both businesses and consumers were affected negatively. The money was available for investors to buy more stocks, albeit at a higher cost; but, businesses and consumers struggled with liquidity problems.

STOCK BUBBLE BURSTS 

The crash in the stock market brought illiquidity issues to light. Layoffs in the financial industry were numerous and swift. The ranks of the unemployed ballooned.

If you were an investor who had purchased stock with 10% down, it would take only a 20% decline for you to have lost twice as much as your original investment.

Now, imagine the plight of the banks who had lent money to investors using stocks as collateral. The collateral was worth as much as 30% less after one day of trading. Bank failures became almost commonplace during the Great Depression that followed.

FED RESPONSE

As might be expected, the Fed did purchase government securities in the open market and lowered the discount rate. It also assured commercial banks that it would supply needed reserves.

Unfortunately, “too little; too late” became the common descriptive phrase used when referring to Federal Reserve response to the crisis which it had caused. That is because the economic devastation was overwhelming.

Unemployment soared to as much as 25% and prices declined (deflation) by more than one-third. The aggressive, free-spending social programs of the 1930s government could not stop the slide and contributed to the length and breadth of the depression. At the depths of the Great Depression in 1932, the stock market had declined by 90%.

The stock market crash was not the cause of the Great Depression, though. The Great Depression was caused by a Fed policy of higher interest rates. Whatever the intention or merits of the action (the higher rates were imposed for the purpose of curbing rampant stock speculation), it led to a reduction in economic activity which was well underway before stocks crashed.

INFLATION, DEFLATION, AND THE FED 

The Federal Reserve officially implemented an interest rate policy of “higher for longer” almost three years ago. Rates moved up rapidly and bond prices have lost one-third to one-half of their value since then, depending on length of maturity. (see “And So Rates Will Be Higher” – Jerome Powell)

It matters not what the intention was or whether it was correct. What matters at this point are the circumstances in which the Fed finds itself now.

Most, or all, of our serious financial and economic problems are the result of a century of intentional inflation. The effects of that inflation lead to a loss of purchasing power in the currency (U.S. dollar). When the Fed intervenes in the markets either directly (by purchasing or selling securities) or indirectly (manipulating interest rates), it creates distortions which have ripple effects and are amplified.

In addition, those effects are unknown with regards to extent, duration, and timing. Remember being surprised at the higher increases in consumer prices post-Covid and economic shutdown. Those increases are attributable to government (and central banks) actions in response to the ‘pandemic’.

The economic shutdown was forced upon society by government – rightly or wrongly. As a result, the decline in economic activity led to huge financial and economic problems for society, including supply chain issues. These problems were met with phenomenally huge financial largesse (inflation) by governments and central banks, which, in turn, led to higher consumer prices (effects of inflation).

After more than one hundred years of trial and error, it is apparent that…

  1. The Federal Reserve causes the problems and crises with which it continues to grapple.
  2. The Fed is doomed to a role of reacting to crises of varying intensity (worse) and frequency (more often).
  3. Serious deflation and economic depression would overwhelm efforts by government to reverse the effects or contain the damage.

CONCLUSION 

There is no path to financial stability from the current point that does not involve a cleansing of huge magnitude. The cleansing will be accompanied by serious financial and economic pain. The Fed is continually dancing with its own devils amid music which is horribly out of tune. The only option left is to wait until the music stops. (also see If The Markets Turn Quickly, How Bad Can Things Get? )

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

Global Credit Collapse Is Deflationary

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NOTE TO READERS:  “Global Credit Collapse Is Deflationary” was originally published as an exclusive for TalkMarkets on October 29, 2024. I have not changed anything in the article, nor is there any reason to modify or alter what is written below because of U.S. election results.

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Destruction Of Money Keeps Inflation In Check

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DESTRUCTION OF MONEY 

The “biggest collapse in the money supply since the Great Depression” continues unabated at this point. (See Ryan McMaken’s article here.)

The decline in the money supply is nearly three years old and dates back to April 2021.

This decline is a destruction of money and is the opposite of what might be expected if one is looking for evidence that could support some of the more extreme expectations and projections for inflation and its effects.

That is because most, if not all, of the analysis about inflation and its effects focuses on the supply of money and its seemingly unlimited growth.

Discussion about money creation by governments and central banks almost universally excludes mention of the demand for money.

DEMAND FOR MONEY 

Money has a demand side, too. We are not talking about the demand for goods and services. We are talking about the demand for money, itself. People need money to pay taxes and transact business; to save and invest.

As long as the supply of money is relatively stable and sufficient to finance existing normal economic activity, then the result is price stability. Without price stability, the economy cannot function reasonably.

Since the inception of the Federal Reserve, excessive growth in the money supply has led to a ninety-nine percent loss of purchasing power in the U.S. dollar.

Currently, though, the money supply is not growing. It is shrinking.

A SHRINKING MONEY SUPPLY 

A shrinking money supply is directly opposite to that which has happened which has made the U.S. dollar nearly worthless compared to a century ago.

It is also not supportive to arguments that the U.S. dollar is about to collapse and that hyperinflation is on the way.

Without the continual infusions of “new” money,  the previous inflationary “highs” cannot be maintained, let alone increased.

If a shrinking money supply continues, the end result is deflation. (see An End To Inflation – Three Possibilities)

WHAT IS DEFLATION? 

Deflation is the exact opposite of inflation. The result is a stronger currency. Instead of losing purchasing power, your dollars would buy more – not less.

Deflation is not bad. However, some of the accompanying economic effects would be very difficult to endure. The U.S. dollar would go further, but there would be fewer dollars to go around.

There would be huge price reductions in real and financial asset prices, depressed economic activity and high unemployment. Conditions would rival and probably exceed those of the Great Depression of the 1930s.

Fortunately, at least for now, we are not there yet.

CONCLUSION 

An infusion of new money might temporarily reverse the shrinking money supply and its negative economic effects, but that is not necessarily a good thing.

Think of it this way. Would you recommend a new fix to a drug addict who is undergoing withdrawal symptoms resulting from curtailing their drug use and attempting a return to sobriety?

Intentional inflation by government and central banks in the form of cheap and easy credit has created artificial financial highs, bubbles in asset prices, and a false sense of economic security.

You cannot ignore fundamental financial and economic law forever. Sooner or later (more likely sooner), we will all pay the price. (also see Gold And The Shrinking Money Supply)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!

 

Gold And The Shrinking Money Supply

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GOLD AND THE MONEY SUPPLY

A recent article (Credit Crunch: The Money Supply Has Shrunk For Eight Months In A Row) by Ryan McMaken of the Mises Institute explained clearly the historical significance of the contraction in the money supply that has occurred over the past eight months.

In this article, I will be talking about the possible effects of this ongoing contraction as they relate to the price of gold.

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Demand For Money Could Cause Deflation

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 BANKING CRISIS = LIQUIDITY CRISIS = DEMAND FOR MONEY

Events this past week are indicative of what could be a more formidable problem for the Fed, investors, and the economy. Before we talk about that, lets first emphasize the key point made in my article SVB, MMT, TNT.

What happened at Silicon Valley Bank, Signature Bank, and now, Credit Suisse and First Republic banks, are not individual issues. All of them are the obvious signs of banking system fragility due to the practice of fractional-reserve banking. Therefore…

What has been termed a banking crisis is actually a liquidity crisis; and the loss of liquidity translates to a DEMAND for money.

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Default – Deflation – Depression

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DEFAULT – DEFLATION – DEPRESSION

Inflation is the primary game plan of governments and central banks. Its effects have left their mark on societies throughout history. As the effects of inflation continue to dominate headlines, financial and economic activity is scrutinized and analyzed with the intent of planning, projecting, and predicting it.

Most people think they understand inflation – they don’t – but for now, let’s look the other way. There is a triple-decker bus coming straight at us.

Default can happen three different ways:

1) Credit default

2) Bank failures

3) Asset price collapse

Universal credit default happens when individuals, corporations, and countries can no longer sustain the debt they have assumed on a scale that overwhelms ordinary financial and market activity.

This happened in 2008 with education loans, mortgages, and auto loans.  The price of all this non-performing debt sank into a deep hole, until the government and Federal Reserve embarked on a new experiment of making more and cheaper credit available and buying up the non-performing debt.

Bank failures happen when banks violate the reserve requirements set by the Federal Reserve and are unable to meet the ongoing demand for money from their customers.

Bank failures were a common occurrence during the early 1930s and are evidence of the ongoing risks associated with fractional-reserve banking. (see Fractional-Reserve Banking – Elephant In The Room)

An asset price collapse is more often than not associated with stock prices. The stock market collapse in 1929 is the most prominent example; and it was a factor on three occasions in this century (2000-02, 2007-09, 2020).

An asset price collapse, however, includes all assets denominated in dollars and includes stocks, bonds, commodities, and real estate. We are currently in the early stages of another asset price collapse.

DEFLATION

Deflation is the opposite of inflation; it is a contraction in the supply of money and credit.

The effects of deflation result in fewer currency units (dollars) in circulation and an increase in purchasing power of the remaining units. In other words, your dollars will buy more – not less.

As the deflation takes hold, the prices of goods and services will decline, rather than increase. In and of itself, deflation is a good thing; however, when deflation is severe enough, the result would be a catastrophic economic depression.

Any single one, or combination, of the three types of default (credit default, bank failures, asset price collapse) can result in deflation. This happens because of the huge sums of money involved which are subsequently wiped out.

DEPRESSION

According to Investopedia, “A depression is a severe and prolonged downturn in economic activity.”

The stock market crash in 1929 did not cause the Great Depression. The Great Depression was the result of a flip-flop in Federal Reserve policy.

During the Roaring Twenties, the Fed pursued a generous approach to loans and interest rates. Because of concern about the rampant stock speculation fueled by their own generosity, the Fed became more restrictive and economic activity slowed. This slowdown in economic activity was underway before the stock market crash in October 1929.

It is quite possible that the Fed’s current efforts to raise interest rates could trigger a credit collapse, ushering in deflation and a New Great Depression. (see A Depression for the 21st Century)

MORE ABOUT DEFLATION, DEPRESSION

Deflation occurs when the system can no longer sustain itself on cheap and easy credit. The more aggressive the creation of the credit, the more horribly destructive are the effects of deflation when it occurs.

The effects of deflation are not nearly so subtle as those from the long years of inflation preceding it.

An implosion of the debt pyramid and destruction of credit would cause a settling of prices for everything (stocks, real estate, commodities, etc.) worldwide at anywhere from 50-90 percent less than current levels. It would translate to a very strong U.S. dollar and a much lower gold price.

The most severe effects would be felt in the credit markets and in any asset whose value is primarily determined and supported by the supply of credit available.

Conditions would be much worse than what we experienced in 2008-12.  The biggest difference would be that the changes would result in another Greater Depression on a scale most of us can’t imagine.  And the depression would likely last for years, maybe  decades.

CAN’T THE FED STOP DEFLATION?

They will try, of course, just as they tried and failed in the 1930s. The Great Depression lasted much longer than necessary because the U.S. government and the Fed persisted in efforts to counter the natural effects of deflation.

The effects of a credit collapse and deflation now would overwhelm any efforts by the Fed to re-inflate and stimulate.

The Federal Reserve, in its current attempt to avoid a complete and total rejection of the U.S. dollar, is trying to raise interest rates. Recent strength in the U.S. dollar indicates a measure of success thus far.

Unfortunately, the Fed’s efforts might backfire and trigger another credit collapse. In fact, a collapse might already be underway.

CONCLUSION

We are all hooked on the drug of cheap credit. But cheap credit was not buoying economic activity to the extent hoped for. Now, higher interest rates are choking off more of the activity that would normally have been there.

The Federal Reserve does not act preemptively. They are restricted by necessity to a policy of containment and reaction regarding the negative, implosive effects of their own making.

The problem is that the bond market is telling us that a credit collapse, deflation, and economic depression are on the horizon. The Fed knows this and can’t do anything about it.

The three Ds – default, deflation, depression – are upon us. If you are focusing on inflation, you need to look the other way.

(also see Effect Of Deflation On The Gold Price)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!