Inflation Versus Deflation

The last post covered the main case for another deflationary event in the financial markets and broader economy. I lean towards this argument because I think it remains the more likely scenario. Going back to 2008, the only thing the deflationists were reliably wrong on was stock market forecasts. On the flip side, the only thing inflationists really got right was the nominal price of stocks. Commodities imploded, interest rates kept reaching new lows, nominal economic growth, let alone real growth, remained stubbornly low.

Having said that, inflation can start at any moment. Investors must be prepared for either outcome because deflation happens fast within this framework. Declines are increasing in both size and speed. I fear a probable scenario is a crash like in 1987 because absent a crash, dip buyers keep coming into the market. Perhpas a multi-day crash that sucks in dip buyers and kills speculation for years. Wipe out the leveraged players (including those holding derivatives and options) and thereby prevent dip buying.

ZH:The Inflation Or Disinflation Debate Continues

One takeaway from the discussion is the debate between inflation and deflation/disinflation is inherently uncertain. Not only are the assumptions behind each case credibly at risk of being invalidated, but the narratives behind each case are also inherently unpredictable.

As a result, it doesn’t make much sense to “win” the argument by figuring out whether inflation or deflation will prevail. For example, if you believe inflation will stay, are you willing to bet everything that financial asset values are well supported and can’t get revalued much lower? Because if asset values collapse, there will be a massive deflation.

By the same token, if you believe in deflation, are you willing to bet everything that when the crap hits the fan, that rules limiting the Fed’s actions won’t suddenly become much more optional? Because if that happens, inflation will jump quickly.

Some on the inflation side still don't see the failure of QE and its disinflationary nature, but for the most part, the debate between inflation and deflation is one of timing. How many crashes will it take before the central banks or governments of the world throw all caution to the wind? Nobody has the answer. All I can say is that as of April 2021, there are familiar signs of an inflationary burst running out of steam. If it plays out as it did in 2011, 2014-2016, 2018 and 2020, the result will be an intense asset price implosion followed by a burst of inflation. The deflationary endgame is that markets ignore all central bank efforts. Asset prices plunge no matter what happeens. This will turn into the inflationary endgame because governments will "do someting" too late. At the bottom of a deflationary panic, the market is cleared and ready for explosive rebound growth. Adding more fuel ignites inflation. The non-deflation endgame is that central banks and governments go overboard earlier.