Drip after drip of deflation data … Today's release on manufacturing activity by the Richmond Fed is pretty ghastly, as you would expect given that the effects of fiscal stimulus are now wearing off at an accelerating pace – before the happy handover to the private sector is safely consummated – and given that the structural East-West imbalances that lay behind the global crisis are getting worse again … This follows yesterday's horrendous fall in the Texas business activity index from the Dallas Fed, which fell from -4 in June to -21 in July. "Thirty-one percent of firms reported a worsening of activity, up from 22 percent in June," said the bank. Texas New Orders were -9.6 in July, -8.2 in June, and +15.8 in May. Capacity Utilization was -0.6 in July, +2.7 in June, and +18.7 in May. This of course is why Fed chair Ben Bernanke has been giving strong hints of QE2 (helicopters again) if necessary. – UK Telegraph
Dominant Social Theme: A deflationary depression coming at ya.
Free-Market Analysis: The Telegraph has been very good at diagnosing deflationary trends in the larger economy, and we have agreed with this analysis because it seems obvious. What is noteworthy, however, is that prices keep going down, as the Telegraph analyzes above, even though there are numerous proclamations that the "recession" is over.
In fact as much as we find the economic analysis of the Telegraph to be intriguing, the emphasis on deflation and the central banking response inevitably gives rise to a kind elitist dominant social theme: "If only central bankers would respond diligently and with the right monetary formula, all would be well or at least better."
Of course this theme plays right into the larger meme of central bankers as a kind of priesthood tending to a monetary Godhead. It is a secular religion, encouraged by the bankers themselves, that a technocratic elite can "manage" the economy to a monetary Nirvana. History and present day events of course show that bankers can do no such thing. But the meme will be continually trotted out, especially during times when central banking is seen as evidently and obviously failing.
What the Telegraph warns us about is a deflationary depression, which the Telegraph believes is the worst of all possible worlds. Various writers at the Telegraph then express their preferences for immediate and vigorous activity by central bankers to rev up the printing presses so as to prevent additional price deflation. Central bankers are in charge, according to this reading of economic history. But are they really? As we have pointed out in the past it is possible to see falling prices in another context as the inevitable outcome of a crack-up boom.
This is an Austrian free-market analysis. Such analysis perceives central banks as over-printing money, which fools people into believing that the economy is better than it really is. Thus, businesspeople over-expand and consumers splurge. Eventually the larger market realizes the reality of what is occurring and stocks pull back (often crash) and a "recession" sets in.
The crash and subsequent retrenchment have been worse than normal, as evidenced by the sharpness of the decline in 2008-2009, and its lingering effects. This, too, is entirely to be expected given that the current economic crisis is the end-result of decades of monetary stimulation starting at least as far back as the early 1980s. In fact, Western economies are bollixed up because constant monetary stimulation makes it very difficult for anyone to know what economies would actually look like – or how they would function – without it.
Even the words themselves are suspect. While there are formal definitions delineating the differences between a recession and depression, they do not get at the cause of the problem from our point of view. Recessions occur because central banks print additional money when the economy starts to slow. By printing a lot of additional money, central bankers can ease the economy into a "soft landing. "
But a "soft landing" is actually counterproductive because the larger economy is never allowed to wring out distortions. This is of major importance because if businesses are not allowed to fail and are always supported by monetary stimulation (and now bailouts) then price discovery ceases to work. Once price recovery doesn't work, lending stops because banks and other lenders don't know whom to lend to. The economy tends to freeze and the velocity of money diminishes.
That's where we are today, in our humble opinion. Because of constant monetary stimulation, the larger economy never had a chance to wring out excesses. Eventually there must be a much larger bust. According to this definition, smaller busts are times when bankers are successful in reflating, but larger busts (the Great Depression, the 1970s crises and now the Great Recession of the 2000s) are indicative of epochs when monetary stimulation doesn't do the trick.
Within this context, it is certainly understandable that prices head downward as they are doing now. The question one must grapple with – especially if one is an investor who wants to understand such things – is whether central bankers can do anything to reflate during a "larger bust." We've indicated in past articles that the unwinding and diminishing prices are probably inevitable and that when central bankers print money during such times they are simply raising the odds of price inflation down the road.
We have little doubt that at some point, price deflation (deleveraging) will come to an end. Central banks will do everything in their power to prevent the natural unwinding of economies, thus storing up additional trouble for the next business cycle. Additionally, by making banks and certain other entities "too big to fail," the powers-that-be have added another level of confusion that further obscures economic indicators and increases the difficulty of normal price discovery.
From our point of view, these are all natural processes stemming from the determination of central bankers to use fiat money, which is inevitably prone to exaggerated booms and busts. The use of fiat money also makes figuring out what is going on economically very difficult. It even obscures the issue of what money actually is.
By constantly injecting money into the system and by not allowing businesses to fail, central banks further distort the business cycle. In this case, the distortion in the economy is very great and the central banking response has been proportionately greater, thus ensuring that the Great Recession will stretch out in length. Eventually, once prices have normalized, there will be some sort of "recovery." But because bankers have already baked "inflation" into the cake by printing so much money, price inflation will inevitably be generated by any recovery, causing bankers to raise rates, etc.
The above is a purely monetary approach to depressions, recessions, deflation and inflation. Ordinarily, economists like to speak about supply and demand and business factors influencing the economy. But in fiat-money economies, we would argue that there is little that matters beyond what is being accomplished monetarily. The ability to print money at will is such a powerful activity that it virtually overwhelms most if not all other business-cycle influences.
There is little from our point of view that central bankers can do to "cure" an initial downward spiral in prices in the context of a major crack-up such as the one the West is currently undergoing. It is a most normal part of the business-cycle. The idea that central bankers can "manage" the economy or even salvage it through money printing and bailouts gives the modern banking community more power than it actually has. The only power that central banking really gives to bankers is the power to inflate – a clumsy one at that. Central bankers can also retard the unwinding process of an economy by trying to inflate yet again and by promulgating "too big to fail" policies.
Since central banks have taken an unfortunately proactive approach (as they always do) this Great Recession will be even longer and more painful than it would have been otherwise. Prices will continue to fall and banks and other entities will be reluctant to lend until the distortions wring themselves out of the economy. Then, as activity picks up, prices will rise rapidly as central banks have already printed and attempted to circulate an overabundance of money. The question that will be asked in the meantime (though never in the mainstream media) is whether people will continue to tolerate the system as it is or demand changes.
The bankers already have a fallback plan, of course. They will apparently suggest a kind of IMF money, and insist that such new money will ameliorate past problems. The dollar (and perhaps the euro) may be sacrificed to popular wrath and a basket of currencies implemented as a new world money. But what won't be pointed out, were this scenario somehow to take place, is that the Anglo-American axis controls the IMF as thoroughly as it currently controls the dollar. Thus a change to IMF SDRs won't really be much of a change at all, were it to happen. What is really necessary at this juncture is the emergence of a private gold and silver standard. Perhaps one will emerge spontaneously. These are strange times, so perhaps it is possible.