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Friday, September 17, 2010 12:23 PM

Myths About "What's Economically Important"

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Day in and day out I hear it from readers who insist that we are not in deflation and will not be in deflation because prices are rising and continue to rise.

Still others tell me it is illogical for a deflationist to like gold.

When I counter with a discussion about credit conditions I tend to get a blank stare or a comment like "I do not care about credit conditions. I own my home. What I care about are rising prices of food and energy."

When I counter with falling asset prices and zero percent interest rates on savings accounts I am likely to get as statement like "Who cares, I rent?", or perhaps "The poor have no assets or savings, all they care about is food prices."


Such comments come from those who are not thinking clearly about what's important. Here's why:

  • In a fiat credit-based financial system, when credit is plunging businesses are not hiring. There are currently 14.9 million unemployed who want a job but do not have a job because businesses are not hiring. There are 2.4 million "marginally attached" persons who do not have a job yet want a job, but are not considered unemployed because they stopped looking. There are 8.9 million part-time workers who want a full time job but cannot get one because businesses are not hiring. There are countless millions of college graduates who are underemployed, working at WalMart, delivering pizzas, or attempting to sell trinkets on eBay, because businesses are not hiring. There a still millions more in college hoping for a job upon graduation who will not get one because businesses are not hiring. This is all related to the ongoing credit contraction.

  • When credit is plunging so do yields on treasuries and in turn yields on savings accounts. Those on fixed incomes attempting to live off interest income are screwed. Indeed, many are rapidly draining their principal because they collect no interest.

  • Those who have a job, pay for those who don't. Food stamp usage is soaring and now costs over $60 billion dollars a year.

  • When credit is plunging, consumers are not shopping, business earnings are under pressure, and wages stagnate or in many cases outright decline. Even those with jobs and no debt have been affected by deteriorating credit conditions. Public employees had escaped this debacle so far, but that is about to change in a big way, with huge implications.

  • When business earnings are under pressure or when business owners face uncertainty over consumer spending trends, businesses cut back on benefits, especially health care. Those with health cares benefits are asked to chip in more of the costs. This too is a function of deflation.

  • When profits are weak and business uncertainty high, stock prices do not act well (at least in the long run). Those with 401Ks or personal investments are affected.

  • With credit falling and wages stagnant or falling, anyone in debt is likely to have a harder time paying back that debt. Foreclosures rise so do bankruptcies and divorces. Entire families have gone homeless.

So, What's Really More Important?

Expanding credit (inflation) created an enormous housing bubble, a commercial real estate boom, a rising stock market, and an enormous number of jobs.

Contracting credit (deflation), burst the housing bubble, burst the commercial real estate bubble, burst the stock market bubble, resulting in millions of foreclosures and bankruptcies, millions of broken homes, millions on food stamps, 26.2 million unemployed or partially employed, and countless additional millions who are underemployed.

People notice food and energy prices because they tend to be somewhat sticky. Everyone has to eat, heat their homes, and take some form of transportation at times, but is that what's important?


In the grand scheme of things, nominal increases in food and energy prices are but a few grains of salt in the world's largest salt-shaker compared to the massive effects of rising or falling credit conditions.

Yet, every day, someone writes to me complaining about the price of milk (or something else) going up 30 cents or whatever telling me that is "inflation" or that is what is most important.

Inflation/Deflation Definitions Once Again

  • Inflation is a net expansion of money and credit, with credit marked to market.
  • Deflation is a net contraction of money and credit, with credit marked to market.
Those are my definitions. I cannot force anyone to accept those definitions but they do explain what is happening quite nicely.


Those who think prices are what matters, even those who have no debt and no assets, are simply missing the boat about the importance of credit expansion and credit contraction in fiat credit-based financial system. As shown above, a credit contraction affects everyone, in many ways, and in far more important ways than simple price changes.

The stimulus and bailouts helped the financial economy (for a while), but not the real economy. Because credit dwarfs money supply, trillions of dollars of so-called stimulus vanished into thin air, with no lasting impact on the jobs market.

The inflationists and hperinflationists who ignored credit and focused on money supply alone (or consumer prices) never saw the plunge in interest rates coming or the massive pounding in global equity markets.

Those who knew a credit implosion was coming, got treasury yields correct, the equity crash correct, the rise in the dollar correct, and the strength in gold correct.

Gold does well in times of economic stress, especially in the senior currency - in this case the US dollar. It is the only commodity whose long term trendline is intact from 2000. Gold is money and as money it should do well in deflation in the country of the senior currency. It did.

In credit-based system, especially where credit dwarf money supply, credit itself (and the value of credit marked-to-market on the balance sheets of banks) is of paramount importance.

Those who insist inflation is about prices, as well as those who view inflation as an increase in money supply alone (ignoring credit), are going to continue to get the economic picture wrong.

If you are focused on prices or money supply alone, you are focused on the wrong thing.

In a fiat credit-based economy, where credit dwarfs money supply, changes in credit is what's important, not changes in money supply, not nominal changes in prices.

It's as simple as that.

Mike "Mish" Shedlock
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