Tuesday, August 12, 2008

No deflation here

Whatever happened to deflation? It wasn't so long ago that numerous commentators were predicting a 1930s period of falling prices and a deep freeze recession.

The inflation numbers have always been the most obvious objection to the deflation story. Despite the collapse of many key credit markets, prices have actually accelerated. In fact, today's inflation numbers confirm that the UK is a long way from deflation. Nevertheless, others pointed to credit numbers as evidence of impending debt deflation. Credit was supposedly collapsing.

Again, the numbers do not bear this out. Take, for example, US total bank credit. The following chart illustrates annual credit growth since 1975. It also shows the long run average growth rate for this period, along with some upper and lower bounds defined by one standard deviation from the long run mean.

As the chart illustrates, credit growth today in the US is very close to the mean. Moreover, in recent years, the growth rate has been significantly above the mean, and often been close to one standard deviation above the mean. In short, since 2005 the US has enjoyed (if that is the right word) a period of exceptionally rapid credit growth. Now, credit availability is adjusting to its long run level.

But what about more recent short run data. The following chart illustrates the outstanding stock of US bank credit. There was a what could be described as a modest credit contraction in March. However, more recently, credit growth has resumed. Overall, the outstanding stock of credit today is significantly higher than the beginning of the year.

Notwithstanding these numbers, US home buyers looking for a mortgage will find that lending rates have not come down, despite the Federal Reserve's manic rate cuts. Banks now ask for 20 percent deposits, and check borrowers income more thoroughly. This, however, could be best described as a return to good banking practices. Some of this "new regime" lending has found its way into the aggregage credit numbers. Nevertheless, the total effect remains limited.

The real danger remains inflation, which has picked up sharply across the world. Unfortunately, central banks have largely wimped out in the face of the enemy and failed to raise interest rates. As a consequence, inflation keeps trucking along, reaching new highs as each month passes.


  1. How about Alice's big economics blog.

  2. Alice: "Whatever happened to deflation?"

    I think we have both! Jim Puplava has been saying we would get both, I thought that sounded a bit like hedging his bets, but it looks like he was right.

    Banks, UBS, Citi, Merryl have all written off billions, other financial organisations Bear Stearns, Indymac, Northern Rock, have become insolvent. On this scale, that amounts to deflation. Deflation is hitting the owners of houses everywhere, and is having a profound impact on each and every budget.

    And yes, in other things we are seeing a rise in the price. Food, oil, etc.

    Don't know how it will play out. But the financiers would prefer inflation rather than deflation.

  3. Alice -- according to Mish, the reason total credit is still expanding is primarily two reasons:

    1. Collapsing of-balance sheet deals reverting to bank balance sheets (and therefore showing up in the stats)

    2. Corporations that had bank credit lines in place before the crunch drawing them down before they disappear (similar to a home owner maxing out his HELOC before is gets shut down).

  4. Steve,

    The second argument is not particularly convincing, since it is still legitimate corporate credit, which expands the money supply. The fact that it is pre-arranged is not terribly interesting. As for the HELOCs, they are down, but not out. In the UK, the last data showed mortgage equity withdrawal is still important.

    As for the second point, there may be something to it, but it is perhaps overstated. In the UK, this shows up in the M4 numbers as money demand by OFCs, it has been growing, but so has household money demand.


  5. Mish has some good insights. That said, when it comes to deflation, Mish adjusts or ignores the facts to fit his conclusion.

    Inflation in needs, deflation in wants.

  6. isn't inflation we've got the result of past event...you are seeing the rear mirror...

    If you look in front, there is/could be a massive risk of deflation.

    If banks slow the debt creation or if people are frightened or acnnot any more take debt...then all asset price will start falling...No wonder why the US central bank has lowered its interest rates to 2%...

    Remember what happened in 1930, while the US was battling with deflation, in Europe we had a ramping inflation that some argue was one of the cause of the 2nd world war.

    It's a like a close system, what gets negative somewhere, need to get positive somewhere else so to have a neutral level...that could explain why the ECB has gone the reverse way and has even raise interest rates...

    I think it's too early to say that deflation is not a threat...one could be sure only in late 2009...

    Another point to look at is the crb index..all commodities are plunging...a worrying sign for the fed i think...

    Right some will shout that inflation is a threat after it's the same marketing strategy as in nixon(?) time with WIN (Whip Inflation Now)...but this time is to anchor inflation expectation (as wired it could sound) and push people to get debt since they will have a sense that price will go up at some point (e.g real estate)