Here's the note, from Jonathan O. He goes a step further, suggesting not merely that inflation rather than deflation will do us in, but that inflation is about to make all of us homeowners even richer - infinitely rich, if I haven't misinterpreted his argument. He writes as follows:

"I've been reading your stuff on 321gold with interest over the years. I find your hidden pivot methodology especially interesting. I do find your deflation issue puzzling though. (This is probably the millionth time you've had to answer one of these questions!) Inflation is defined as an increase in the supply of money. Period. A symptom of inflation is a rise in prices. Just which prices rise depends on many things. Currently it is house prices that are rising, along with commodities. You can have inflation with falling prices (i.e., M3 growth, but with computer prices falling), or vice versa.

"Too many people confuse inflation with the CPI. The CPI is just one measure of the symptoms of inflation. It is not inflation itself, just like rising prices is not inflation. Inflation is an increase in the supply of money. Deflation is a decrease in the supply of money. Over the last few years, M3 has exploded. That's one reason why house prices have gone up so much (along with low interest rates). I don't see that stopping. Greenspan has stated on more than one occasion that he will inflate when necessary. And boy is he good at it!

"So how are we going to see deflation (i.e., a decrease in the supply of money)? Bear in mind, even in this sort of environment you can still have rising prices in certain items."

My reply:

Others have used the same definitions for inflation and deflation that you've used, but those definitions will no longer suffice to explain how the real world works. This was starting to become clear about ten years ago, when monetarists freaked after the Fed deployed an M3 gusher to get us out of the 1990-91 recession. M3 did indeed go bonkers at the time, but the inflationary spiral that nearly everyone expected to result never arrived. Or rather, it did -- years later, in the form of a stock-market bubble -- but few thought to call that inflation.

Mr. Greenspan himself described this accretion of vapors as wealth, and although the ostensible riches vanished with the dot-com boom, it seems not to have unsettled the Fed chairman's bizarre notions about how the economy works. In his mind, the "wealth" has simply shifted into real estate, there to remain until it is urgently needed to grow the nation's stock of capital goods, as he evidently believes is happening now.

If Mr. Greenspan someday usurps Professor Irving Fischer's place in the economists' Hall of Shame, it will be for reasons of something he said about the nature of today's "wealth." Until then, though, and most unfortunately, tens of millions of Americans living in homes whose prices have doubled or even tripled in recent years will continue to believe they are rich, just as the Fed chairman says. But to return to the point: Suppose the Ms were going wild but there was no observable inflation in the consumer sector. Would economists and pundits still worry about inflation? The answer, as we saw in the early to mid-1990s, is yes, at least for a while. But if the symptoms were so insidiously seductive as a dot-com boom, or so politically incorrect as a rise in the price of gold, who in a policymaking position would deign to acknowledge that inflation even existed? Moreover, although calling an increase in the money supply "inflation" may be technically correct, who cares? It is only the severity of the symptoms that matters. So let's put M3 aside and imbibe the more tangible dangers of the real world.

Most perilous of all, of course, is the housing boom, and I vehemently disagree with your blank assertion that prices in this sector will continue to rise - I paraphrase here - forever. A significant portion of the inflation in real estate is being squandered on consumption, and that simply cannot go on. The supply of greater fools ultimately depends on a push from below, and I somehow doubt that the economy, such as it is, will enable Gen-Xers to push me into a $2 million home. The game is over, and even if a still-rosy statistical picture of the housing market makes this difficult to see, there are other indicators that suggest a credit deflation lies just around the bend.

To support this view, I have reproduced a series of charts below from Bob Bronson of Bronson Capital Markets Research. (Please note: The charts can be viewed, along with this commentary, by going to Rick's Picks. While you're there, I invite you to visit my subscription page, where you can get free, immediate access to my archive of detailed forecasts, recommendations, charts and archives. If you would like to try the service at no risk, there is also a place where you can sign on to gain access to all paid-subscriber areas. ) As you scrutinize the charts, keep in mind that Mr. Greenspan's ability to promote inflation has depended entirely on the eagerness and ability of Americans to keep borrowing. If you think this trend will continue more or less forever, and that it will wax sufficiently to create economic growth over and above the rate if inflation, then I would surmise that you are as out of touch with your friends, neighbors and business associates as Mr. Greenspan evidently is with the physical world.

Make no mistake: K-wave winter has begun, and debt is about to shrink precipitously as forced saving increases commensurately. Anyone who wants to bet against this prediction need only trade up to a much bigger house. As those of us who are now beginning to hunker down would profess, it is still all too easy to do. Regarding your question of how the money supply will decrease, the answer is elemental: An epic wave of bankruptcies will cause zeroes to disappear from the global balance sheet much faster than the central banks can get us to borrow those zeroes back into existence. Or maybe I'm wrong, and my house will actually be "worth" $1,000,000,000,000,000 someday. After all, it's happened before. Just not recently. Or here.

Rick Ackerman

October 11, 2004

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