Don’t Buy the Deflation Hype
There is a lot of talk about deflation out there, and I think lots of people in our group take that seriously — and I do too, as one must during crisis times — but our special understanding of the oil based economy allows us to come to different conclusions about the global financial situation. Dollar hegemony is based on the petrodollar system because with a weak U.S. economy and no gold backing, there is nothing else for that hegemony to stand on. This is why we stopped food-for-oil, why we are in Iraq/Afghanistan, why we do much of our foreign policy.
Global dollar hegemony is the method we use to collect our empire tax from the rest of the world, and the petrodollar system is what makes it possible.
Peak Petrodollars?
I’ve been following Brad Setser for a little while now. Check out a recent post of his, “Peak Petrodollars“. Of oil exporting nations, he says:
Oil prices are no longer rising faster than domestic spending and investment. Instead oil prices are falling as domestic spending and investment (and associated imports) rise. That means the oil exporters have a smaller monthly surplus
This means oil producers no longer have the huge surplus of export dollars to plow back into stocks or bonds on Wall Street. More importantly, it means they are not GETTING the dollars from oil exports, which, in turn, means that the countries that used to pay dollars to import that oil will have less demand for dollars in the future.
In other words, the petrodollar system will end once the land-export model kicks in, and the dollar, which has been backed by the petrodollar system (instead of gold) since 1971 will then be backed by NOTHING.
By NOTHING, I mean “Nothing other than the full faith and credit of the United States”, but since we can barely afford the $406 billion it cost in 2006 just to make the annual interest payments on our debt, then we may as well call it “NOTHING”. The 2008 numbers will be much worse, as the debts have gone parabolic and interest rates have nowhere to go but up.
Much of the inflation we will experience in the future has actually already happened, as we bought oil with debt these past decades. Once the petrodollar system evaporates, the dollars are still there but with no value as they are no longer backed by gold, oil or a strong economy.
Deleveraging
Deleveraging is a time of forced selling in the markets because of dislocation. The nuts and bolts of it involve market actors increasing cash to cover margin problems or losses. This is only a short term issue. It is not indicative of a move to dollars as a value play. People were leveraged in other assets because they wanted a high yield, one that stays ahead of the constant inflation in the dollar. Now they are forced to buy dollars because of the current crisis, but they will sell those dollars again once the dangers have passed or the problem positions are liquidated.
While this is deflationary in the short term, it can only remain deflationary if it can stop economic growth for a longer period of time. In fact, it can only remain deflationary if it can keep economic growth negative, and it would have to stay more negative than energy depletion rates.
This math model for inflation vs. deflation seems very simple when I put it that way, but the short-term is much more complicated because of both the petrodollar effects and the current deleveraging. The petrodollar system has soaked up dollar money for decades, but that money will be released into the marketplace at some point. On the other side, deleveraging is creating short-term dollar demand to buttress against risk while commercial paper markets are locked up. So deleveraging today and the prospect of the end of the petrodollar tomorrow greatly muddle the simple equation I just outlined.
You will hear this deleveraging called “deflation” frequently. It is NOT. Deleveraging is merely an event. A market crash is an event. The inflation is an era. An epoch. After the credit crisis, the bankruptcies, and the deleveraging, we will return to the primary theme of the global landscape: the breakdown of the petrodollar system.
Reflation
The inflationary effects caused by the petrodollar breakdown will be intensified even more as we prepare to print trillions of dollars to begin the next reflation of the capital markets. Over the next 6-12 months, under the cover of distress and deleveraging paraded as deflation, the printing presses will kick into high gear using all the Fed and Treasury programs that have been rolled out this last month.
Even if U.S. authorities wanted to choose deflation from here, they could not. The dollars ALREADY exist in the world to make the hyperinflation come to pass once the petrodollar system implodes. The only modifier that Paulson or Bernanke can make is to increase or not increase this inflationary pressure. So far their all of their choices will only increase it.
The chart above tells me that the next big bubble we’ll be talking about will be U.S. Treasury Bonds. I hear hissing. Don’t you?
China’s resource hunger
On a related note, China today said:
We should step up efforts to boost domestic demand, particularly domestic consumption and keep the economy, the financial sector and the capital market stable
The article says that “Economists have cut China’s growth forecasts to as low as 9 percent for the year, down from last year’s 11.9 percent.”
Got that? The LOW side is a 9% estimate.
So, this tells us that worldwide economic growth is likely to continue, even if not in the U.S., which implies that demand for real goods may not decline, despite the financial and economic turmoil we are seeing domestically in the U.S.
Mission Impossible: Deflation
To sum up,
- Deflation is an increase in the value of money or a decrease in the value of real goods
- Oil exporters are growing their own economies and will soon lack surplus energy to export
- When global oil sales dry up, global demand for dollars will dry up with the lost dollar transaction volume
- The inflation we will experience in the future has already happened — all those dollars that are used in global oil transactions today will have much less value than they do now
- The current deleveraging effect is only a temporary blip against this trend
- The Fed/Treasury response is already gearing up to increase future inflation exponentially, even as we prepare to reckon with past inflation that we had previously been able to export to the world via dollar hegemony
- These points imply that the value of money will not increase
- Real goods will remain scarce as population continues to increase worldwide
- Despite domestic slowing, the global economy, on average, is likely to continue to grow, supporting demand for goods
- Energy depletion strangles the supply of real goods, increasing demand against the remainder
- These points imply that the value of goods will not decrease
Given all that, the deflation scenario is utterly absurd on its face. Don’t buy into it.
-Robert
