Flation!

October 8, 2002
The information within is not a recommendation to buy or sell anything.
Do your own Due Diligence

"Flation" by itself is not in the dictionary. However, when adding prefixes to "flation", seven words have been created which appear in various GE editorials and postings. They are:

Inflation
hyperinflation
deflation
reflation
stagflation
retroflation
disinflation
 
 

The flation words "reflation", and "retroflation" are not found in my dictionary. It is thought that "reflation" means a period of inflation whereby banks are made more liquid to avoid bankruptcy after a deflationary period has ended. "Retroflation" apparently means something similar to "stagflation."

In my opinion, the definitions for the remaining five words are very brief in the dictionary and cryptic. When adjectives are attached to the words, the words have further meanings.

The intent of this essay is to define these words more clearly and how they can be useful in one's financial dealings by looking at historical events where possible. History shows "flation' changes from one form of "flation" to another form of "flation" within decades and in some cases within months. Expect the Unexpected!

Therefore, one must be mindful of these impending changes to take advantages of opportunities and avoid financial disasters. I personally believe that the current period of disinflation is about to end rather suddenly within a year. The majority of postings and articles seem to favor deflation as the next form. I have not yet formed a conclusion as to what the next type of "flation" will be, but am leaning towards "stagflation."

In my opinion, one should be aware that these "flation" words are often misunderstood and sometimes poorly used by people communicating economics principles/theory. I am sure some people will disagree with my definitions and attributes. I would appreciate your definitions and attributes so that I might be able to better understand these "flation" economic time periods.

More information can be found in the editorial "Inflation or Deflation?" by Adam Hamilton which is at:
http://www.gold-eagle.com/gold_digest_01/hamilton121701.html
and "Exploding Inflation" by Adam Hamilton at:
http://www.gold-eagle.com/gold_digest_01/hamilton021101.html

Most of the "flation" words are based on changes in a "Consumer Price Index (CPI)." In the U.S., this monthly calculation is continually being redefined as to how it is calculated. As a result, the CPI gauge may give false readings on government figures. As an inaccurate gauge, it may become useless and sometimes dangerous. The purchasing price of gold may be a substitute for the CPI index in many instances.

See the editorial "Lies, Damn Lies, and the CPI" by Adam Hamilton for more information about the CPI calculation changes at:
http://www.gold-eagle.com/gold_digest_00/hamilton061900.html


DISINFLATION

Disinflation is a term to describe a historical period in which inflation was not as high as expected or anticipated at the time. Disinflation marked the U.S. economics in the 1990's.

Characteristics of disinflation include:

  1. Low interest rates that are seen as the springboard to wealth.
  2. Increasing levels of unfettered debt and creation of market bubbles.
  3. Wall Street and financial institutions begin to delude themselves as to the apparent lack of inflation pressures.
  4. Excess growth via acquisitions and mergers becomes commonplace. Companies buy out companies from easy money. Few if any of these acquisitions result in benefits in terms of valuation. The recent AOL Time Warner merger is a recent example and shows in the stock prices. Many of these acquisitions result in mal-investment and fragile balance sheets.
  5. Record government, corporate and personal debt bubbles are created that cannot be serviced.
  6. Fraudulent accounting "new accounting" practices increase and ethical standards are lowered.
  7. Corporations borrow money to buy back their shares in an attempt to improve Earnings Per Share (EPS) and thus improve the stock price.
  8. Creation of a housing, real estate and a refinancing real estate bubble/boom.

INFLATION

Inflation is a term to describe rising prices in the marketplace due to more money chasing fewer goods. Investment advisors during periods of inflation promote the concept that "Cash is Trash."

Inflation in most economic references in my opinion is when the Consumer Price Index is between 7% and 15%.

High Inflation in my opinion is when the Consumer Price Index is increasing by 15% to 100%or more when annualized.

Low Inflation in my opinion is when the Consumer Price Index is increasing by 2% to 7% when annualized. The real interest component of interest rates is 2%. When inflation is zero percent, the real return on the safest investment becomes zero. Other components of the interest rate include, allowances for risk, collateral, and currency exchange changes.

Gold and precious metals do poorly in periods of Low Inflation

Attributes of inflation include:

  1. The payment of debt over the long period becomes easier for those with increasing income.
  2. When inflation is above 5%, Dick Storken suggests Gold, collectibles, and hard assets do better in general (purchasing power wise) than stocks even though stocks are increasing.
  3. People with savings or purchasing of bonds begin to demand higher interest rates of return to compensate for inflationary purchasing power losses.
  4. People on fixed income find their standard of living declining with time.

More discussion on "The Inflation Problem" by Steve Saville can be found at: http://www.gold-eagle.com/editorials_02/milhouse092302.html


DEFLATION

Deflation is a term to describe declining market prices. The technical definition relates to the Consumer Price Index falling or decreasing thereby producing a negative percentage growth rate. There is less money available to chase available goods. Deflations tend to remove poor economic choices.

Rick Ackerman suggests the only two escapes of governmental debt defaults are hyperinflation and deflation. Rick defines deflation as essentially, allowing bankruptcies to take their course, with no help to debtors from cheapened dollars. This would crush debtors, lay waste to tens of thousands of businesses and wipe vast assets from the balance sheets of lenders. But it would have the virtue of leaving our financial institutions -- the banks and bond markets most significant among them -- more or less intact.

How does one secure one's nest egg against the gathering storm? For Rick Ackerman, a good rule of thumb is to make safety a paramount concern. There is only one investment that qualifies as an absolute no-brainer. In a world whose currencies have been gutted and hollowed to the core, that investment is gold: coins, ingots, mining shares and all other forms of the asset that until recently had been shunned for more than two decades.

Attributes of severe deflation after a year include.

  1. "Cash is King" is a term used in the market place during this period.
  2. Credit becomes very difficult to obtain if at all.
  3. Economic activity nearly ceases.
  4. Unemployment rates may exceed 20%, large migrations of people, family breakdowns, soup kitchens, and larger numbers of homeless.
  5. Bartering becomes more commonplace.
  6. Governments experience lower tax revenues and often unable to regularly pay employees.
  7. People have to service debt by selling assets.
  8. When people believe prices are going lower, they put off spending.
  9. A cascading liquidity crisis that spooks enough of the derivative players to run for the exits, which can lead to a financial meltdown.
  10. Enslavement of people by debt.
  11. Lowering of credit rating status for companies and individuals.
  12. The so-called "fixed" rate mortgages give people a false sense of security. Buried in many mortgages are essentially margin requirements that allow the lending institutions to margin call your home if its appraised price falls significantly below your mortgaged amount.
  13. Debtors reach their credit and borrowing capacities.
  14. Personal property by unemployed will be sold at fire sale prices in an effort to raise cash to financially survive until next month.
  15. Pre-owned (used) goods will compete with their higher priced cousins. Of course the used merchandise will be sold first. This will further the decline of retail consumption and spiral into a death curve.
  16. Severe deflations tend to inevitably lead to major wars and wealth redistribution as a means to increase economic conditions for some and for governments to remain in power. The form of government does not change, although many government leaders and politicians fall from power.
  17. Banks may close or fail do to liquidity problems. Physical Gold and Silver coins held in personal possession are more valuable than certificates of such.
  18. Crimes of theft, burglary and fraud become more common.

A GE poster Barnacle Bob defined deflation as:

"Deflation is a general decrease in the price of goods and services. Deflation occurs when the velocity of money produced by inflation and economic activity pyramids then decelerates due to inventory saturation (less demand = over supply) and over consumption. This was initiated from a built up condition of to much money (inflation) chasing to few goods that creates a manufacturing overcapacity, oversupply and an imbalanced debt to sales-profit-income ratio. This in turn prevents the debtor from the ability to service debt that accumulated with a higher accelerated velocity of money.

The supply of money (debt) is destroyed through default such as bankruptcy, capital devaluation. Fiat money is destroyed or devalued faster than demand for debt or the velocity that debt may be created to support price and profit levels. Thus, the previously adopted velocity ratio of 1:1 money = GDP is imbalanced as the demand-supply-profit ratios cannot service the debt.

The end result is suppliers lowering price structures to deplete and liquidate inventories that artificially create demand forces at some arbitrary price. Once debt and excess inventory is liquidated, the next cycle of economic activity and inflationary growth may occur. "

Mayer describes more types of deflation in "The Imaginary Evils of Deflation" http://www.gold-eagle.com/gold_digest_02/mayer091202pv.html

These deflationary types include; Growth Deflation, Bank Credit Deflation, Cash-building Deflation, and Confiscatory Deflation

Another opinion on deflation is offered by Steve Saville "Gold and Deflation" at http://www.gold-eagle.com/editorials_02/milhouse090902.html

Rick Ackerman offers some thoughts on retaining wealth in "Hedging Deflation" at http://www.gold-eagle.com/editorials_02/ackerman100502.html


STAGFLATION

Stagflation is a term coined in the 1970's to describe the unprecedented combination of slow economic growth and rising prices in the U.S. Many of today's investors and mutual fund managers were still in diapers during this stagflation period.

Stagflation was an economic nightmare (or a dark period) according to some during the 1970s that may just be coming back to cause sleepless nights for American investors. Stagflation is the worst of the worlds of inflation and recession. It is characterized by an economy that is contracting while prices continue to rise.

Stagflation according to others means inflation and deflation are occurring simultaneously. There is inflation occurring for basic essential commodities and services of survivability. At the same time, deflation is occurring for commodities and services deemed to be luxury items and WANTS which are not essential for "basic survival."

More stagflation information can be found in the editorial "The Return of STAGFLATION"
http://www.gold-eagle.com/editorials_00/blanchard123000.html

Attributes of stagflation include:

  1. Debt is an ultimate luxury according to some. Buying debt becomes cheaper and cheaper.
  2. Interest rates may rise to 18% for home mortgages as occurred in 1982.
  3. Rising prices of basics such as food, shelter, clothing, medicine, and fuel.
  4. Decreasing prices of luxuries such as airplane tickets, sports stadium gains, and frivolous luxuries of a wealth society.
  5. An oversupply of cheap labor competing for manufacturing positions.
  6. Increasing difficulties to profitably compete in exporting to international markets.
  7. Foreign imported goods tend to become cheaper in the market place.
  8. Domestic labor become accustomed to a life style that can no longer be supported by corporate profits as there are no real domestic profits to support this lifestyle.
  9. The growth of the money supply evidences that dollars and dollar credits are everywhere and not in short supply, hence they ARE a cheap source of capital.

HYPER INFLATION

Hyper inflation in my opinion is when the Consumer Price Index is increasing by 100% or more when annualized. History indicates that when a government goes into hyper inflation the government and the hyperinflation period won't last long. In my opinion, hyperinflation was a major contributor the French Revolution in the 1800s.

According to Rick Ackerman, U.S. hyperinflation would have the effect of reducing the real burden of debt, but it would also destroy savers as a class. Imagine being able to pay off your mortgage with the $10,000 bills you'd be carrying in your wallet at that time to buy groceries. That might sound appealing, but consider the other side of the equation: Every mortgage lender in the country would be in bankruptcy. Bond markets and all other lending agents and institutions would have ceased to function. The stock of Fannie Mae, whose bankruptcy would dwarf the total of all others up to that point, would be trading in reorganization at two cents per share.

A country currently experiencing hyper inflation is Argentina. This is a response to about 120 billion equivalent U.S. dollars debt default. Gold prices have increased 300% year to date in Argentina pesos. Gold in terms of the Argentina peso is plotted on the chart at:

http://www.gold-eagle.com/goldcorner/goldarg.html

Brazil experienced hyperinflation in the early 1990's which impoverished most of the middle class. It may again turn to hyperinflation in 2003 due to about 325 billion equivalent U.S. dollars of debt that of which about 65 billion is external to Brazil. Repudiating the external debt may cause failure of U.S. commercial banks such as JPM, CitiBank or European banks which hold some of this debt. As such, hyperinflation in one country might cause deflation in another country. The International Monetary Fund (IMF) may also be in peril.

The following table is from a GE poster on the German hyper inflation in the 1920s.

The following are some words of wisdom from a grandmother of a GE poster (Theo_dora) who lived through two hyperinflation periods. I think these words are good description of hyperinflation attributes.

My grandmother was born in 1900. She experienced release of 'new money' twice in her life. while living in Germany.

Again and again for years she remained saying "girl," always save your money except when a real inflation is boiling up, then you need to know:

  1. In a boiling (hyperinflation) inflation everything is money except money. Got nails? Nails can buy you bread and butter. Be prepared:
  2. You need to trace the very beginning of a real inflation, so always watch prices and as soon as you suspect unusual moves up, get very fast & very organized, that means:
  3. Spend your savings and buy what you need to earn your living. For instance as a tailor, invest in threads and material. Build up stocks for at least 2 years (and hide a part /half of it for the time after). Same if you are dependent on medicine.
  4. Just do it, even if it hurts, because:
    1. You will not have time enough to search for and buy your essentials,
    2. You will be running and searching for food -
    3. You will need it very dearly once the new money is introduced:
    4. When the new money is introduced and hyperinflation has ended, prices will be low and supply might be stable, but YOU WILL NOT HAVE ENOUGH MONEY TO BUY.
  5. During the highest rates of hyperinflation, do not trade in your raw material or equipment or whatever your essentials for survival are, no matter how much it hurts (unless its a question of life or death). To protect from that:
  6. Make sure you have some valuables, like jewelry or the like to trade in. Got a silver coin? That can pay a doctor. Insist the doctor never talks about it since hyperinflation brings the worst out of mankind (and the best). If you spend a silver coin, there might be more ...?
  7. Try to live 'invisible'. Don't show what you got, don't trigger envy. That is a very important point. You should even go to the point to keep some rags, since you need to move freely in all kinds of crowds.
  8. With hyperinflation, the most important action is to get rid of your money as fast as you can. Buy whatever you can get and then take your time to trade and exchange goods. And that might be at places you don't like."
So, girl, I want you to always remember this.
  1. A currency can expire. When money is in trouble, rules of trade seem to decay: then there is lots of cheating, many fakes and deception everywhere."
  2. Never ever trust your bank. You might wake up one day and the bank is closed and they might not give your money back to you. Rules (banking, monetary, governmental) are changed over the weekend
  3. Always watch prices, you need to know the beginning of hyperinflation.
  4. Always watch shortages, you need to realize the artificial ones, then something big is under way
  5. Never ever get indebted, alway save your money except when a hyperinflation is on the horizon or in process.
Grandmas Experiences of the First Period of Hyperinflation

World War I started in summer 1914, and the Papermark expired in autumn 1923, after a boiling inflation. One monday morning in October 1923 the new money 'Roggenmark' (( transl: 'Rye Mark')) was released. Exchange rate was : 1 trillion Papermark for 1 Roggenmark, imagine! But during that boiling inflation everybody got rid of money as fast as possible. People even used their billion banknotes to light a fire, see, paper was short in supply. So, there was almost no old money left to exchange. Roggenmark survived only a short time and was replaced by Reichsmark (RM) in 1924. After introduction of the new currency Roggenmark, then later Reichsmark, there was almost no money around. Supplies were there, but rarely somebody was able to buy. For many, many years lots of people were jobless, lots of people got indebted, and quite some hanged themselves.

Grandma's Experiences of the Second Period of Hyperinflation

World War II started in autumn 1939, and the RM expired in summer 1948. See, again 9 years later. After that war there was no boiling inflation, but a time of very severe shortages. Food supply was regulated by authorities. Food stamps were issued. And what you had been entitled to was too little to live, and too much to die. Many women and children only survived on care packages sent by US citizens. One monday morning in June 1948 RM expired and DM was released. Exchange rate was: 10 RM for 1 DM. Although there was no boiling inflation prior to that, there was very little money left to exchange. Why? These severe shortages had founded black markets. And the black markets had sucked away all the money, and prices were sky high. So, in my opinion, that was a kind of an inflation too, but a cold one. What was learnt from WW I is: this time everybody got 40 DM to start with. And strange enough, all of a sudden, goods and commodities appeared, turned up, door-to-door salesmen, pedlars, hawkers tried to sell. And again new money was very short.

Remarks : 'Roggenmark': official name was 'Rentenmark', partly backed by bonds, but the public referred to the currency as 'Roggenmark' since it was somehow also backed by agricultural land ( I don't know enough about it). Reichsmark: 1 RM was exchangeable to 1/2790 kg gold (until 1931 only). Deutsche Mark DM: on 21.06.1948 every citizen was entitled to 60 DM as a start-up. But a lot of people confirmed that they only received 40 DM, as my grandma told me.

Wally Bently
All flames, replies, and comments are appreciated. My e-mail address has been changed to: wallybently2@aol
.com

In 1933 President Franklin Roosevelt signed Executive Order 6102 which outlawed U.S. citizens from hoarding gold.