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The Very Real Danger of Another Nasty DEFLATION Episode

Chris Temple 0

COMMENTARY: September 16, 2022

In mid-September, a prediction was made by Cathie Wood, the chief cook and bottle washer for Ark Invest: that a nasty deflation in the economy is at the door. This is by no means the first time she’s made this utterance: we heard it for many months as inflation rose and (though not to the extent of some of the more flamboyant, promotional and habitually wrong perma-bears out there—and Fed Chairman Jay Powell) she was warning that inflation would be a flash in the pan. Deflation, she insisted all along, would come and bite us all.

With her newest such warning being joined by such high-profile folks as Jeffrey Gundlach and Elon Musk, though, onlookers are forgiving Wood now for the beating she and her investors have taken in this bear market. In unison, these three (and others) are worried that the Fed is going to raise interest rates too much and add to the unfolding declines in some commodities not to mention cause a recession.

 And as the middle week of September ended, stocks’ funk of the preceding few days was added to by Fed Ex's C.E.O. Raj Subramaniam, who bluntly stated we are entering a "worldwide recession."            

Said Gundlach—who said the Fed should slow down and raise rates by only 25 basis points at its Sept. 20-21 meeting, while Musk is urging a cut of that size already, “In spite of the fact that the narrative today is exactly the opposite, the deflation risk is much higher today than it’s been for the past two years. I’m not talking about next month. I’m talking about sometime later next year, certainly in 2023.”

But in focusing chiefly on economic activity and prices of commodities, producer/consumer goods, etc. even these well-meaning (and correct, as far as they go) folks are too narrowly focused on the real danger in front of us. Yes, Powell’s “oversteering” on monetary policy as Gundlach puts it will cause a reduction in consumption and many consumer/producer prices. Powell and other Fed heads have been uncharacteristically frank of late in essentially telling us that, YES, they may well cause a recession: but that’s a less bad price to pay to vanquish inflation than to let it run hot endlessly.

 The damage, though, from a new, nasty bout of asset price deflation is less understood, however; though it should not be.

I cannot stress enough that you MUST understand, amid all of the superficial comparisons these days between Powell and former Fed Chairman Paul Volcker, THE ONE KEY DIFFERENCE BETWEEN NOW AND THEN. I have explained this often: at a dinner gathering last Spring in the Chicagoland area (https://www.youtube.com/watch?v=UqmLVme0UkI) one of many historical pieces on this archived on my web site (at https://www.nationalinvestor.com/2168/the-fed-and-your-money-in-2020-volcker-revisited/) and for The Epoch Times earlier this year at https://www.theepochtimes.com/the-forgotten-legacy-of-paul-volcker_4204594.html.

 In short, Powell’s “second act” following his renomination by President Reagan was far more pivotal to today’s world than his first of ostensibly killing off the double-digit inflation he inherited. For Powell, as I described, inaugurated the present-day upending of the very rules of economics and markets known before.

 Together with fiscal and other policy from Washington, he turned markets and asset prices into the determiners of economic growth as a first matter. Make no mistake: monetary growth exploded under Volcker; and has continued to as well under his successors. But by channeling it as a first matter into asset prices and creating “the wealth effect” as a means of augmenting real-world economic growth, Volcker instituted the boom-bust cycles we have had in the years since.

 When Volcker in his first act tightened monetary policy in 1980-1982, the only risk pretty much was the health of the organic economy. Yes, by raising rates to then-draconian levels, he stifled demand sufficiently and shored up the U.S. dollar enough that commodity and other prices came down, etc. 

 But due to the system he then instituted in latter 1982 and onward, he and his successors added financial market risk, “contagion” and all that to the mix. Stocks soared thanks to Volcker’s switch throughout the 80’s only to crash spectacularly in October, 1987. Since then there have been numerous other instances where major busts in asset prices which cause or exacerbate economic recessions have come about. 2000-2002. 2007-2008. A few other relatively smaller ones, followed by the really wild swing down and then up in early 2020.

 Given the fact that asset price inflation since early 2020 was wholly unprecedented (by reports, 30% of ALL the U.S. dollars ever created were birthed by Powell and Co. just since then) one has to acknowledge the possibility that yet another debacle is possible, if not looming. And as before in this modern era of fractional reserve banking gone wild, this bust will follow a reckless and fleeting boom caused by the Fed now telling us they’ll clean up their mess. It’s simple mathematics, folks.

“Fire Marshall Jay” may well extinguish a lot of the inflation he created; at least for a while. But the price may be in doing some major “extinguishing of asset prices and all as well.

 So the real looming danger of deflation right now is not the economy going into a mild/medium recession as the Fed throttles growth…raises joblessness somewhat…pushes the dollar’s value higher to bring commodities down…causes mortgage rates to move upward (6%+ for a 30-year mortgage again, and counting) to cool off housing anew…etc. It is that never before have there been (certainly not in Volcker’s time when NONE of this yet existed) the skyscrapers of debt the world now has to deal with ($300 trillion or so), asset markets “valued” at often fictional levels thanks to all this monetary alchemy and the rest.

 As I have been describing in detail in recent days, both Europe and China single-handedly could undermine global markets—and economic growth with it all—at least for a while. Each is sitting on a precipice caused by financial excesses, bad policy and leverage on top of leverage.

 Many trillions of dollars worth of dollar-denominated debt owed by developing/emerging market nations has gone from being unpayable to now even unserviceable. Many other potential shoes thus waiting to drop here, too.

So as Powell ostensibly does his “tough” Volcker channeling, be mindful that the risks are WAY beyond what you’re being told. If he and his comrades at The Eccles Building do pull one too many sticks out in their current game of Monetary Jenga, the consequences, at least for a spell, could make 2008 pale in comparison.         

 The aftermath will be a more intractable stagflation; a destination we have already arrived at, but one which could get far worse if an asset price deflation gets out of hand first. The worst of both “flation” worlds will be the average yokel seeing his/her wealth effect shrivel further as real estate and stocks come back down towards earth…that’s the bad deflation that will hurt individual fortunes.

Yet at the same time, geopolitical and other changes I have been discussing/warning of for a while now as well (see https://www.youtube.com/watch?v=VGn-i1vbCes for one example; this is one of my presentations of late on “The New FAANGs”) will help keep costs for many basic commodities chronically high.

            Successfully navigating the kind of world unfolding—one which is in the process of being greatly exacerbated, as the Fed goes from one policy extreme to another—is our challenge.

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