The Deflation Case in April 2021

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved. -Ludwig Von Mises

My view on inflation/deflation right now: there aren't enough signs of inflation breaking out yet. Many prices are higher, but there are supply-chain and coronavirus issues working their way through the economy. The best factor for inflation I see right now is home construction and lumber prices because hoome buying is a conduit for sustained inflation of credit. The other is the potential for unending deficit spending in Washington, with the caveat that political opposition is growing and it only takes on Democrat Senator to end it. Additionally, Japan did infrastructure stimulus in the 1990s and 2000s and it didn't work. They built bridges and roads to nowhere, all to little effect. Finally, much of the infrastructure bill (I have heard as much as 90 peprcent of it) is welfare spending that will have zero long-term impact. a reversal in globalization would be positive for inflation, but the Biden administration is, on net, undoing inflationary Trump policies.

Intermediate-term: what do you call autumn 2018, September 2019 (when the Fed restarted QE via the repo market) and March 2020? I see deflationary outbreaks whenever policy makers stop increasing stimulus or quantitative easing because the fundamental problem is lack of borrowing. The credit bubble never popped and it gets bigger every time they prevent it from popping. We are stuck at the edge of the credit black hole, forever being pulled by the gravity of unrepayable credit, kept out by timely burst of inflationary activity that then increases the gravitational pull of the black hole. We can quibble over March 2020, but things started going poorly for markets in September 2019.

Long-term: see Mises. The end is always a deflationary collapse. Weimar ended in deflationary collapse. Zimbabwe collapsed. Venezuela has collapsed. Inflation requires sustained and rising credit and money growth. Without it, financial assets deflate. Once hyperinflation begins, the currency itself ceases to function and the economy decomposes. At the apex, everyone is a speculator. In Weimar Germany, you did well holding gold from the start, but the specualtors who made fortunes were the ones who timed the market and sold everything before the new currency was introduced. At the peak of hyperinflation, cash was the best investment again. Nominal prices will go higher in hyperinflation, but at the end, the real price of many assets will be less than when the inflation started because the economy will be destroyed, while many goods and services will cost more because their supply will be reduced by the hyperinflation (or currency devaluation). Credit inflation is also very old, going back to the early 1970s. This isn't an inflation that has suddenly appeared, it is the final endgame at the end. I fully expect the currency will be destroyed in the end, but the question is how do we get there? The evidence tells me another deflationary panic is likely.

The main case for deflation and eventual currency destruction is that the economy is still trapped in the post-2008 environment. Massive debt and aging demographics are powerful headwinds. Central banks and governments are still unwilling to take the steps required because the steps required are explicit currency destruction. That is the price to get inflation: you have to be so cavalier and open about your intentions, that you take the blame for it. I don't think the Federal Reserve will ever do it intentionally. USG might be willing to do it in a panic worse than March 2020. They did pump in March 2020 and in September 2008. Perhaps MMT-theories have convinced some that inflation is impossible, but right now even they need a panic to get enough votes in the Senate.

In April 2021, the market is still in the eye of the stimulus hurricane. Twelve-month CPI should peak in May 2021. Going back to February 2020, inflation isn't very high now. Inflationists rightly point out that inflation starts small. It could keep rising, and then the Fed will be in trouble much sooner than expected. The deflationists also have a strong case in the eye of the storm: what if all that simulus is nowhere near enough? What if the economy is far worse than people realize? Here's the eurodollar curve. Back in 2013, people expected more inflation and higher interest rates 5 years out than they do today. If you expect inflation, you can make a fortune betting against the market.

Total loans and leases (TOTLL) includes mortgages, credit cards, business loans. If there is inflation coming, you take out as much debt as possible as fast as possible and convert it into real assets. As with the eurodollar curve, there's no sign of a change from the prior 12-year trend.

Of course the year-on-year comparison is going to be negative here given the spike last March and April, but even going back to pre-pandemic TOTLL, growth is only on par with the prior years. That is to say, pandemic-related lending only returned the economy to trend. It's at a lower level though, with a "credit gap" of about $200 billion. If tehre wasn't a pandemic, but instead normal economic activity, there would be at least $200 billion more in credit. Lending is weak because the eocnomy hasn't reopened yet or because the economy is in really bad shape and all the stimulus thus far hasn't ignited a real boom yet. Here's TOTLL with trendlines. The blue line is the trend in place back in 2014 and it confirms what the eurodollar futures curve shows: people were more optimistic/more willing to borrow in 2014. Then there was the "Trump boom" that is the 2018 trend. TOTLL has a $200 billion credit gap from that 2018 trend and $400 billion below the 2014 trend. To put that into perspective, credit growth is runnning around $300 to $400 billion annually at the moment. The highest single-year increase was $644 billion in 2006, which at the time was around 10 percent growth. The U.S. economy is a long-way from resembling an economy experiencing a high level of credit inflation outside of government borrowing.

I continue to believe gold will win because when the next crash inevitably comes, there