Inflation/Deflation

Practical definitions for inflation and deflation are given below. In both cases credit must be marked-to-market to make any sense out of what is happening.

• Inflation is a net increase in money supply and (counterfeit) credit.
• Deflation is a net decrease in money supply and (counterfeit) credit.

When the FED prints money (i.e. adds liquidity to the system) but the banks refuse to lend it, then there is an increase in money but no increase in credit, so the net result is muted or no inflation. On the other hand, if there is debt destruction (e.g. people pay off their credit cards while the banks refuse to lend) then there is a decrease in the money supply but no increase in credit, so the net result is deflationary. Some sectors of the economy may undergo inflation while others deflation all at the same time. For example,

• Rising commodity prices (gasoline, food, etc.) is inflationary. Oil undergoes supply dynamics of its own--i.e. Middle East unrest and Peak Oil issues.
• Rising consumer prices is inflationary. This is a consequence of rising commodity prices for the most part--i.e. manufacturers are ultimately forced to pass through their costs.
• Rising unemployment is deflationary. Unemployment remains high in the U.S.
• Rising dollar (relative to other world currencies) is deflationary. The U.S. dollar is likely to become stronger as Europe's troubles with the PIGS continues and Japan's woes continue.
• Rising stock market is inflationary. Excess liquidity has been going into the stock market. QE2 has been the main driver for this.
• Rising bank failures is deflationary. This continues to be the case in 2011.
• Banks refusing to lend is deflationary. So far, this remains the case, chiefly because banks are afraid of loses--i.e. not getting paid back.
• Falling home prices is deflationary. The common belief is that home prices have further to fall, as much as another 20% lower into 2012 and beyond.
• Falling treasury yields (i.e. interest earned on U.S. Treasuries) is deflationary. At some point the U.S. government will be forced to increase yields in order to attract buyers. Thus, the common view is that treasury yields will be going up in the near future.

The U.S. economy can experience both (generally) deflationary and inflationary periods even while in a recession. This has certainly been true these last 4 years, where 2008-2009 was deflationary and 2010-2011 inflationary. We are likely to enter a (generally) deflationary period through the summer of 2011, due primary to the end of QE2 and strength of the dollar. This translates to a drop in commodity prices including gold and silver. More specifically, central banks in the U.S. and around the world have sponsored a liquidity surge that has fueled this speculative bubble in commodities, and that surge is about to be taken back to some extent through the summer of 2011.

Further reading, Inflation: What the heck is it?

Official and Real Inflation Rates

The following is derived from: Inflation Index Manipulation: Theft By Statistics

Our government has powerful incentives to manipulate inflation indexes. While the government officially reports 2%-3% per year on average, the true rate of inflation is closer to 10% per ShadowStats.com. With a true inflation rate of 10%, the dollar drops to half its value every 7 years. And in 20 years the dollar is worth 15 cents. This destruction of the value of the dollar is an entirely legal means of reneging on the government's debts, and effectively allows it to walk away from ever paying for past deficit spending, both domestically and internationally. It should be no wonder that it is a determined strategy of the government.

The problem is that there is no general "inflation rate" for a nation. Inflation is an enormously complex theoretical construct that is highly subjective even among well-intentioned economists. It is subject to the "basket" of goods and services chosen to track, as well as the particular methodologies and assumptions that go into the index itself. Therefore, what we call the "inflation rate" is both subjective and subject to political manipulation. And herein is the loophole for the government: The inflation index can be whatever the government says it is.

There is a cost to the government's need to turn the impossible into the possible: a steady impoverishment of the people who are owed the inflation-indexed payments.

How to combat inflation

Whether you are a general investor or inflation-indexed beneficiary, the first and most obvious step is to choose to invest in the reality of tangible assets rather than symbols. These tangible assets could be gold, silver, real estate, energy or farmland, to name some of the most prominent examples.

In combination with the tangible asset step, there is a second step to take as well, whether you are a Boomer, or older or younger - and that is to gain the knowledge you need to protect yourself, and even turn adversity into opportunity. You must learn how to turn inflation into wealth.

Do you know how to Turn Inflation Into Wealth? To position yourself so that inflation will redistribute real wealth to you, and the higher the rate of inflation - the more your after-inflation net worth grows? Do you know how to achieve these gains on a long-term and tax-advantaged basis? Do you know how to potentially triple your after-tax and after-inflation returns through Reversing The Inflation Tax? So that instead of paying real taxes on illusionary income, you are paying illusionary taxes on real increases in net worth? These are among the many topics covered in the free "Turning Inflation Into Wealth" Mini-Course. More information on the course is available at InflationIntoWealth.com. [The video series is $500, which I ordered and will post my experience with it.]

Examples of hyperinflation

Yugoslavia 1993-1994. Under Tito [who reigned as president from 1953 to 1980], Yugoslavia ran a budget deficit that was financed by printing money. This led to a rate of inflation of 15 to 25 percent per year. After Tito, the Communist Party pursued progressively more irrational economic policies. These policies and the breakup of Yugoslavia . . . led to heavier reliance upon printing or otherwise creating money to finance the operation of the government and the socialist economy. This created the hyperinflation. […] Between October 1, 1993 and January 24, 1995 prices increased by 5 quadrillion percent. This number is a 5 with 15 zeroes after it. The social structure began to collapse.

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