Thursday, 14 June 2012

The Dreaded “D” Word

Prices are falling. The Fed will interpret this as “deflation” whereas it is more related to lack of demand. They will interpret falling prices as “deflation” and view this as dangerous to the economy. Here is a summary of the PPI and Ex-Im prices indices. Tomorrow (Thursday) the CPI will come out and my guess is that it will also be down.
This raises the likelihood of more QE, thus more destruction of real savings and capital, and will result in continued stagnation.

Prices are falling. Here are today’s numbers of the Producer Price Index for May 2012, and the Export-Import Price Index for May. These are YoY charts:
Why, we ask, are prices falling when money supply is expanding world wide? 
1) Demand is weak because the world is falling into stagnation or recession.
2) Monetary expansion has failed to re-start failing economies.
One more chart, on GDP for the G20 to prove my point:
Successive rounds of monetary inflation have resulted in several rounds of boom-bust cycles, each of which have destroyed real savings/capital which is the reason we and the rest of the world are stagnating. More monetary stimulation will only further destroy the real capital needed to drive economies.
The thing to understand here is that the Fed doesn’t understand this. They fail to see that the mechanics of monetary inflation actually do the opposite of what they intend. They will see falling prices not as a result of lack of demand, but rather a dangerous “deflationary” trend. “Deflation” as they define it are falling prices and wages. Rather, it is actually a decline on money supply. This confusion has ruled Fed policy for generations. The result has been our roller coaster economy.
The Fed views falling prices as a very dangerous signal that they must do something. That something is the same thing they have been doing which is to attempt to create price inflation by expanding the money supply. That hasn’t worked before and it won’t work now. The result will be a benefit to the financial markets, but more and more stagnation. Think “Japan.”
The CPI comes out tomorrow and my guess it will also be down. I think we’ll start hearing the “D” word soon.

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