Is Mass Deflation Coming? Of Course Not. But Ambrose Evans-Pritchard Fears It.
Ambrose Evans-Pritchard is a Keynesian journalist. He fears price deflation more than any other economic outcome. He has warned against price deflation for years.
Put differently, he fears a recession that will re-price assets in terms of what the public really is willing to pay. He fears a time of pricing in which the price inflation that has been created by central bank monetary inflation brings prices into line with what customers are willing to pay. He fears customer authority.
All economists do, except for the Austrians. They reject the idea that central bank inflation that distorts the most important prices in an economy -- interest rates -- should ever return to normal, as in "rates left alone by the legalized counterfeiting of fractional reserve banking. They think that central banks must create fiat money in order to lower rates -- forever.
They believe that the policy of monetary inflation, once adopted, must never be abandoned,
Therefore, the headline reads: World risks deflationary shock as BRICS puncture credit bubbles.
Austrians read this: World risks lower priced goods and capital as BRICS reduce legalized. counterfeiting.
He writes: "As matters stand, the next recession will push the Western economic system over the edge into deflation."
Austrians read: "The Austrian theory of the boom-bust cycle is still operating."
He writes: "It is a remarkable state of affairs that the G2 monetary superpowers -- the US and China -- should both be tightening."
Austrians read: "It is a remarkable state of affairs that the G2 monetary superpowers -- the US and China -- should both be tightening."
He issues his warning: "Half the world economy is one accident away from a deflation trap. The International Monetary Fund says the probability may now be as high as 20pc."
Economies are threatened by accidents only when central bank counterfeiting has created an unsustainable boom. All booms are unsustainable by counterfeiting. What happens when they cease counterfeiting at the older, higher rate is not an accident. It is the free market's outcome: re-pricing assets whose prices had been driven up by the counterfeiting.
It is a remarkable state of affairs that the G2 monetary superpowers - the US and China - should both be tightening into such a 20pc risk, though no doubt they have concluded that asset bubbles are becoming an even bigger danger.
Correct analysis on his part. Correct analysis on the central bankers' part.
"We need to be extremely vigilant," said the IMF's Christine Lagarde in Davos. "The deflation risk is what would occur if there was a shock to those economies now at low inflation rates, way below target. I don't think anyone can dispute that in the eurozone, inflation is way below target."
Correct. Let us cheer. Customers are reasserting their preferences
It is not hard to imagine what that shock might be. It is already before us as Turkey, India and South Africa all slam on the brakes, forced to defend their currencies as global liquidity drains away.
Correct. Let us cheer. Customers are reasserting their preferences
If market reactions to tapering are precipitous, developing countries could see flows decline by as much as 80pc for several months," it said. A quarter of these economies risk a sudden stop. "While this adjustment might be short-lived, it is likely to inflict serious stresses, potentially heightening crisis risks."
Popped bubbles are a great evil for Keynesian analysts. Bubbles are a way of life for them -- the way the world ought to work.
What we need then are laws against allowing investors to sell their investments and buy their domestic currencies.
He cites a report issued by the World Bank: the alter ego of the IMF.
The report said they may need capital controls to navigate the storm -- or technically to overcome the "Impossible Trinity" of monetary autonomy, a stable exchange rate and free flows of funds.
As always, the Keynesians hate the free market. They hate the right of people to buy and sell on their terms. They hate liberty.
William Browder from Hermitage says that is exactly where the crisis is leading, and it will be sobering for investors to learn that their money is locked up - already the case in Cyprus, and starting in Egypt. The chain-reaction becomes self-fulfilling. "People will start asking themselves which country is next," he said.
This is exactly what people should ask today.
Emerging markets are now half the global economy, so we are in uncharted waters. Roughly $4 trillion of foreign funds swept into emerging markets after the Lehman crisis, much of it by then "momentum money" late to the party. The IMF says $470bn is directly linked to money printing by the Fed . "We don't know how much of this is going to come out again, or how quickly," said an official from the Fund.
This is nonsense. It did not happen. U.S. dollars did not "sweep" into foreign nations. The dollar is not a currency in those nations. Digital dollars remain in U.S. banks. They do not leave the U.S. All that happens is that ownership of these accounts changes: from foreigners to U.S. residents. I explain this here: //www.garynorth.com/public/7768.cfm.
[Note: He is not talking about Third World nations in which U.S. paper greenbacks, which are not invested, serve as an alternative currency for customers. These are not nations where Western capital has flowed in. In any case, paper money withdrawals in the U.S. reverse the fractional reserve process here. This is deflationary.]
What Keynesians fear is that U.S. owners will sell back their ownership of assets in other nations. The bubbles will pop.
Austrians ask: "So what?"
One country after another is now having to tighten into weakness. The longer this goes on, and the wider it spreads, the greater the risk that it will metamorphose into a global deflationary shock.
Correct. Let us cheer. Customers are reasserting their preferences.
Turkey's central bank took drastic steps on Tuesday night to halt capital flight, doubling its repurchase rate from 4.5pc to 10pc. This will bring the economy to a standstill in short order, and may ultimately prove as futile as Britain's ideological defence of the ERM in September 1992.
Correct. Let us cheer. Customers are reasserting their preferences.
South Africa raised rates on Wednesday by half a point to 5.5pc to defend the rand, and India raised a quarter-point to 8pc on Tuesday, all forced to grit their teeth as growth fizzles. Brazil and Indonesia have already been through this for months to stem a currency slide that risks turning malign at any moment.
Correct. Let us cheer. Customers are reasserting their preferences. This is benign, not malign.
Others are in better shape - mostly because their current accounts are in surplus - but even they are losing room for manoeuvre. Chile and Peru need to cut rates to counter the metals slump, but dare not risk it in this unforgiving climate.
Correct. Let us cheer. Customers are reasserting their preferences.
Russia has a foot in recession but cannot take action to kickstart growth as the ruble falls to a record low against the euro. The central bank is burning reserves at a rate of $400m a day to defend the currency, de facto tightening. As for Ukraine, Argentina and Thailand, they are already spinning out of control.
Notice the phrase: "Spinning out of control." It means control by the central governments.
Correct. Let us cheer. Customers are reasserting their preferences
China is marching to its own tune with a closed capital account and reserves of $3.8 trillion, but it too is sending a powerful deflationary impulse worldwide. Last year it added $5 trillion in new plant and fixed investment - as much as the US and Europe combined - flooding the global economy with yet more excess capacity.
Correct. Excess capacity is a Keynesian code phrase for "capacity that was not needed in the first place. It was a bubble induced by central bank inflation. Now the central bank has ceased blowing bubbles as fast."
Let us cheer. Customers are reasserting their preferences.
Markets have a touching faith that the same Politburo responsible for a spectacular credit bubble worth $24 trillion - one and a half times larger than the US banking system - will now manage to deflate it gently with a skill that eluded the Fed in 1928, the Bank of Japan in 1990 and the Bank of England in 2007.
Memo to Evans-Pritchard: "Bubbles pop. They do not go away slowly."
Manoj Pradhan, from Morgan Stanley, says that China's central bank is trying to deleverage and raise rates at the same time, which "amplifies risks to growth". This is a heroic undertaking, like surgery without anaesthetic. It is the exact opposite of what the Fed did after 2008 when QE helped cushion the shock. Morgan Stanley says that 45pc of all private credit in China must be refinanced over the next 12 months, so fasten your seatbelts.
China's Communist rulers are like the West's Keynesian rulers. They want to defer political pain. They will demand that the central bank returns to its previous policy. They hate customer authority.
Moreover, China is struggling to keep its industries humming at the current exchange rate. Patrick Artus, from Natixis, says surging wages - and falling productivity - mean that it now costs 10pc more to produce the Airbus A320 in Tianjing than it does in Toulouse.
"China is struggling" means "China's politicians are mercantilists who subsidize China's export sector by imposing price controls on currencies. This policy drives up domestic wages. Costs rise. Mercantilism reduces output for other sectors through rising costs. David Hume described this process in 1752. It is still true.
The implications are obvious. China may at some stage try to steer down the yuan to hold on to market share, whatever they say in the US Congress, partly to stop Japan stealing a march with its 30pc devaluation under Abenomics. Albert Edwards from Societe Generale say this may prove the ultimate deflationary shock, dwarfing the 1998 Asia crisis.
All Keynesians are mercantilists. They want to subsidize exports by inflating the domestic currency unit. Evans-Pritchard is no exception.
Europe has let its defences collapse behind a Maginot Line of orthodox monetary policy. Eurostat data show that Italy, Spain, Holland, Portugal, Greece, Estonia, Slovenia, Slovakia, Latvia, as well as euro-pegged Denmark, Hungary, Bulgaria and Lithuania have all been in outright deflation since May, once tax rises are stripped out. Underlying prices have been dropping in Poland and the Czech Republic since July, and France since August.
But not Germany. That is what enrages Keynesians in Europe. Not Germany.
The ECB's Mario Draghi talked up the need for a "safety margin" against deflation before Christmas but now seems strangely passive, as if beaten into submission by the Bundesbank.
Correct. Let us cheer. Germany is in charge.
Right now we are nearly five years into an old cycle - already long in the tooth - and 80pc of the global economy is tightening or cutting stimulus. As matters stand, the next recession will push the Western economic system over the edge into deflation.
Let us cheer. Customers are reasserting their preferences.
The Fed is surely courting fate with $10bn of bond tapering each meeting into the teeth of incipient deflation, as Minneapolis Fed chief Narayana Kocherlakota keeps warning.
Good news! The FED has announced a further degree of tapering by $5 billion a month. Why, it is only counterfeiting at a rate of $780 billion a year. Deflation, FED style!
Those who think deflation is harmless should listen to the Bank of Japan's Haruhiko Kuroda, who has lived through 15 years of falling prices.
No, he didn't. Prices did not fall for 15 years in Japan. It's a Keynesian myth that they did. Prices were flat. The evidence is here: //www.garynorth.com/public/7225.cfm
Corporate profits dried up. Investment in technology atrophied. Innovation fizzled out. "It created a very negative mindset in Japan," he said.
Japan ran a trade surplus for three decades, ending only in 2011, the year of the Fukushima disaster. It now runs a slight deficit, but not with the United States. How is it that Japan could do this until Fukushima, given the Keynesian version of Japan's weak economy?
Japan had the highest real interest rates in the rich world, leading to a compound interest spiral as the debt burden rose on a base of shrinking nominal GDP.
Translation: "Japan rewarded savers."
Any such outcome in Europe would send Club Med debt trajectories through the roof.
Club Med is not Japan. Club Med residents did not save. They borrowed. They all ran balance of payments deficits under the euro, just as the euro's critics predicted before 1999.
Ambrose Evans-Pritchard is as much a Keynesian as Paul Krugman. Neither he nor Krugman understands the Austrian theory of the boom-bust cycle. Krugman is merely more open about his ignorance.
We can safely ignore both of them.