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The End to the Inflation - Deflation Debate

By Kenneth J.Gerbino      Printer Friendly Version
Feb 6 2009 2:23PM

Before I address the inflation - deflation question, it’s important to define some economic terms so everyone is on the same page.

Inflation: 1) Prices of goods and services increasing due to currency depreciation (printing or creating money). 2) The cost of living increasing without a corresponding increase in wages and salaries. 3) The result of currency depreciation that affects everyday prices of consumer goods. 4) The lowering of the standard of living of wage and salary earners.

Note: You can “inflate” a balloon. You can “inflate” the money supply by increasing the supply. You can have “inflated” home prices and commodity prices due to supply and demand and speculation BUT this is not the economic term we are dealing with. Therefore do not confuse something increasing in value or getting bigger or rising in price with the 1-4 monetary definitions above. If consumer items like toothpaste go up, that’s usually inflation, unless there is a shortage of certain materials.  If your home value goes up that’s another thing entirely, because a home is a capital asset. If IBM goes up this is not inflation.

The best way to distinguish this is as follows: If the common man is getting hurt then it is inflation.

Remember that the usage of the word inflation in common practice has many meanings so make sure you understand what meaning is relevant to what is being discussed, otherwise confusion will reign and understanding will evaporate.

Deflation: 1) Prices of goods and services decreasing due to monetary stability or a decrease of money in circulation. 2) The cost of living decreasing without  an equal or corresponding decrease in wages and salaries. In other words, the wage and salary earner is actually buying more goods and services for his paycheck every month or year. His/her standard of living is actually getting better. He or she is getting more bang for the buck.

Note: Because a mild deflation actually benefits 95% of the population, the 5% of the population who do not benefit (the banking establishment) will attempt to convince the 95% that deflation is bad. House prices going down is not deflation. This is a price going down of a capital or investment asset. If IBM goes down, this is not deflation. Wheat going up for three years and then correcting down on the commodity markets for three or four months is not necessarily deflation. It is simply wheat going down.

Of course, if many commodities continued to go down for years – then this could be because of deflation, but your clue here would be the prices of consumer goods. During the ‘80’s and 90s most commodity prices went down but inflation was always with us. The prices of just about everything else were going up. So the important thing to look at is the Consumer Price Index, as this takes a lot of things into consideration from raw materials to energy, labor costs and services etc. This is also confusing because the time factor involved in these price changes presents a gray area to this definition. There is some subjective reasoning here that makes this even more confusing.

An ideal economy would have no increases in the money supply (monetary stability) and continuing increases in productivity of goods and services. This would eventually allow almost everyone everywhere to become affluent. More on this below.

Price swings most of the time, are just that - price swings. Longer term trends in commodities and consumer goods can be defined as “inflationary” or “deflationary” especially if they are both going in the same direction.

Inflation and Deflation should only be used in the context of the entire economy.

Price Increases: Keep it simple. It means the price of something is going up. It is not necessarily from inflation because it can be the result of supply and demand problems or speculation. Long and continued price increase in consumer goods is usually called inflation.

Price Decreases: Prices going down. It also can be from supply and demand imbalances or speculation. Again, if prices of consumer goods and services continue over long periods to go down then this could also be called deflation.

The above definitions can be, and are many times, used interchangeably and this has caused confusion and misunderstandings in the field of economics, the media, and Wall Street. Unfortunately, some usages are technically wrong, but so close to the truth, they are acceptable and can make sense. For instance: “My house has inflated in value”. This makes sense to anyone who hears it. The point I am trying to make is that when thinking “inflation” try and think in terms of currency depreciation and people not benefitting from the prices of consumer goods and services going up and in the context of the entire economy.

Recession: A period of time when economic activity is negative. In the U.S., it is defined as two consecutive quarters of decreasing economic activity. It could also be used to describe a prolonged period of very low economic growth, for instance three years of 1/2% growth could be considered by many to be a recession, even though the economy at the time did not actually “recede”.

Depression: The most commonly thought about concept is from the 1930’s in the United States. This was a decade of economic stagnation brought about and prolonged by government intervention. Unemployment was as high as 25%. A severe recession in modern times can also be considered by some to be a Depression. The use of this word is usually meant to reflect the 1930’s in America and Europe. Using this word today because the economy is in lousy shape and people have lost a lot of value in the stock market and real estate markets and unemployment is rising is a question of viewpoint.

No doubt, the debate of defining what to call bad economic times will continue. My usage of the word Depression refers to the1930’s type economy, with breadlines and 25% unemployment and basically nothing going on and a time of drastically decreased economic activity.

Germany is the worlds 3rd largest economy. From 2003 to 2007 it’s GDP increased by almost 8%, roughly 2% a year. Their unemployment rate for those four years averaged 17%! (seventeen). For those of you that think the U.S. is going to collapse into the greatest depression in history should calm down when our unemployment rate increases. We may not even get to 10%. It’s bad, but not the end of the world.

Back to Inflation - Deflation

This is a confusing debate for three reasons:

  1. Commentators are referring to three totally different classes of economic goods (capital goods, consumer goods, and investment goods) when discussing price increases or decreases. Labeling then becomes misunderstood. Prices of certain assets have little to do with either inflation or deflation. But the prices of many assets can be eventually influenced by inflation or deflation. Therefore this debate becomes very confusing.

  2. Short term price swings up or down of any economic good or service is irrelevant and calling this phenomena inflationary or deflationary is improper. Short term swings should always be referred to as price increases or price decreases.

  3. The term deflation and inflation are ill defined and used out of context even though the usage can make sense.
    Let’s start with the last item. Properly defined, deflation refers to the general price level of the overall goods and services of an economy going down. The value of a Picasso painting selling for $5 million at Sotheby’s and then selling for $4 million a few months later is not deflation…it is the price of an art asset going down. It could have been overpriced to begin with or sold by the current owner due to distress. If IBM goes from $125 to $75 this is not deflation it is a stock going down.

If the CPI goes down month after month and year after year then that is deflation. If it goes down for six months and had been going up for 40 years, I wouldn’t say that is deflation, at least not until a solid trend developed.

Deflation is also described as relating to “deflating” the money supply as occurred in the 1930’s. This should be referred to as “decreasing” the money supply not deflating it, although in the English language “deflating the money supply” is accepted. In economic theory it can be confusing. You need to know the different meanings by knowing the theory behind these terms.

Inflation suffers the same problem. Gold or real estate going up is not necessarily inflationary. It merely means people are buying more of it and bidding up the prices. Now the bidding up of gold and real estate can certainly be caused by inflation in the economy. So this again can be very confusing. Bottom line, if there are inflationary tendencies in the economy such as increases of the money supply, government meddling in productivity by over regulation etc., then one can assume overall prices are going up because of that. Don’t forget that currency depreciation and speculation and supply and demand problems can all make the prices of commodities and gold go up all at the same time. This I believe will happen in the future.

What is definitely inflationary is currency depreciation. That is the correct word. This occurs as governments and central banks create paper money out of thin air.

There are only four main rules that should govern all concepts and considerations about the inflation – deflation debate:

  1. Creating money creates inflation or currency depreciation
  2. Decreasing the money supply creates deflation
  3. Creating more goods and services than the money supply creates deflation
  4. Lessening the amount of goods and services than the money supply creates inflation.

That is all you need to know.

If we actually had an honest money system, where the money supply was not increased, prices of almost everything would actually go down every year (this would be due to technology, know how, efficiencies of scale, etc.) and anyone with a job or savings would become wealthier every year.

Wealth is measured in purchasing power and the accumulation of economic goods or assets. When butchers, bakers and candlestick makers can afford a nice house in a nice middle class neighborhood and send the kids to college and take a two week vacation to Europe with the family and also save 10-15% of their paychecks every week, then you can bet we would have an honest monetary system. This is only possible with a stable monetary system. Currently world governments have their populations on a Mickey Mouse monetary system.

The positive scenario above is where production of goods and services flourishes and the money buys you more and more each year. The natural order of mankind, in his basic state, would have almost all workers, executives, professionals getting more for their money each year…getting more stuff…not necessarily more money.  Poverty would only be for the sick, lazy, insane as well as socialist and suppressed societies. Businesses would flourish because they would lower their costs each year and sell more products to an expanding population.

The reason that deflation gets a bad rap and does not happen is because the ruling “Paper Aristocracy” (a great name coined by good friend and newsletter writer Howie Katz) gets to rip off the productive people by creating money from nothing and accumulating assets as well as goods and services that are being paid for by the printing press as opposed to the blood sweat and tears of others.

Once again: The best monetary system is where the money supply stays stagnant and technology, progress, experience and efficiencies create more and more products and the cost of living goes down slightly every year. Everyone gets more bang for the buck every year.

Inflation or Deflation?

Currently, because of the recent speculation in commodities, real estate and other tangible goods, prices went well above a normal trend and now these prices are retreating. This normally would not be considered deflationary unless the general price levels of everyday goods and services also continued to go down. Because some of the components of the CPI have retreated we do have a slow down and decreasing of prices. Gas in California was over $4.00 a short while ago and is now $2.35.

Using short term statistics is a bad way to make financial decisions. Because stocks, real estate and commodities have come down from historic highs in 2007 and early 2008 does not mean the inflationary trend since WW II is over. In fact, this trend is taking a rest because it got way ahead of itself. The reason these assets became so overvalued is the same reason which will create the future inflationary economy - paper money, easy credit, and the manipulation of interest rates by Central Banks. Money is the lifeblood of any economy, to create it out of thin air poisons the whole system and creates havoc.

Because the money supply of the United States did not go down when the banks and insurance companies and investment bankers were going bankrupt, it was telling us that there will be no deflation but inflation. Simply because, to bail out Wall Street, the Feds have created a massive amount of liquidity, money, credit or whatever you want to call it – and there is much more coming.

It means one thing and one thing only…inflation is coming.

How can the deflation proponents deny this outrageous truth that the money supply is expanding while economic activity is slowing down? This is text book inflation reasoning. Their weak argument is that asset prices are coming down – yes this is true - but it is only because they were ridiculously valued and bid up by speculators.

Just because house prices are tumbling doesn’t mean toothpaste and doctor visits and other items are going to go down. Real estate was up 50% in three years (2005-2007) in the United States. Did you ever see any headlines saying inflation will now be 50% or that horrible inflationary times are coming because of this? How about stocks going from 1,000 on the Dow to 14,000 …did you see any headlines saying inflation is going to be 1400%? No. Then, why are the deflationistas now claiming because house prices are down and the Dow is down we are going to have a terrible deflation?

The commentators on TV and the people in Congress are all claiming, because these prices (homes and stocks) are coming down, that it’s the end of the world. It isn’t. It’s just prices of real estate and financial assets (that had gone up because of past speculation), now going down. Do you remember 1986 -1996? The Dow Jones Average and the price of homes were well below where they are today and I don’t recall a great Depression then. So why now?

The final outcome is that the inflation –deflation debate is unwinnable because both sides have some truths buried in their arguments. The inflationists can say too much money being created is going to lead to inflation. The deflationistas can say prices are going down everywhere. Both sides have some credibility and many pundits are saying deflation now and inflation later. The main thing to understand is what is going to happen in the future. Inflation is coming because they are creating more money. It doesn’t get any simpler than that.

Gold Mining Stocks

The gold stocks are currently the best value and growth story on Wall Street. The major producers are selling at hefty discounts to the price of gold and current interest rates. Historically it has been a good time to own them at these valuations.

The exploration stocks, of which about 3,000 new ones were created out of thin air, were mostly destroyed in 2007 and 2008. Ninety-nine percent of these companies will never make it. The best buys are the developmental companies with the goods (gold and silver) in the ground.

Bottom Line

  • The authorities are throwing a lot of money at the economy. They are out of control and confused. Trillions more will be created.
  • The bailout so far has been mostly for the benefit of the established banking and investment banking community. Now it will shift to political patronage to whoever has lobbying clout.
  • The inflationary backlash from all the new credit and monetary bailouts will be severe. It will take some time but the prices of just about everything will be going back up.
  • 50% of the stimulus packages you are reading about are “slush fundings” and pork barrel projects that Congressmen and Senators have been trying to sneak into other bills for years. It is a disgrace.
  • The dollar will slowly move lower and gold will go to new highs.

For more information on the economy, gold and markets visit our website:

Ken J. Gerbino
4 February 2009



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