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Inflation Is Just A Passing Phase?

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I've been thinking about the issue of the "confusion" about whether we are about to experience stronger inflation or whether we are due a dose of deflation.

There are indications that both could happen, but I think that analysing this is probably a question of determining the correct time horizon for the analysis.

I've been reading a book on Deflation by A. Gary Shilling who believes that we are in a transition to long term deflation but that getting to that long term state will include a period of volatility... which we may be entering.

Link to deflation book on amazon

I like this idea as it seems to explain the co-existance of the global megatrends which all seem to lead towards massive overcapacity in industrial products and also services while at the same time explaining why we are seeing inflationary trends in the short term.

I find his arguments quite compelling. In his book published in 1999 he calls the stock market crash (not too difficult to do at that time admittedly) but without knowing about the future impact of Bush-o-nomics, doesn't forsee the easy money/war mongering policies which followed it and the asset bubbles of the present day. I nearly didn't buy the book as it was a bit old, however its almost more interesting because you can compare his predictions with events. I was surprised with how much rang true today, despite what has happened since the book was published.

One interesting thing about this guy is that although he believes in deflation, he doesn't see this as a re-run of the 1930's depression, at least not if the deflation is "good deflation" resulting from globalisation and free trade building up increasing capacity and resulting in lower prices for consumers and for business. Under this good deflation model, prices drop faster than wages and real buying power increases. This apparently has been a common scenario during long periods of peace in the US, eg: from 1800 to the civil war, and between the civil war and WW1

In his "good deflation" scenario, the current apparent existance of inflation is just part of a volatile transition to a longer term deflation trends which mean that goods and services are permanently cheaper. He also predicted a flat or inverted yield curve which has just come about. His track record for prediction seems generally quite good. Earlier in 05 he predicted the dollar rally we have seen. He is generally positive about the dollar, his reasoning being that its the least bad alternative for holders of currency. He is bearish on the Euro, and recent events support this view, re: europes slow progress to freeing up markets.

He believes that the central banks are making an error in pursuing a strategy of attempting to inflate the economy and that they should instead be trying to make sure we get good rather than bad deflation.

This might lead to the following sort of investment implications...

1) gold etc and commodities are a short term play and will suffer as we transition into long term deflation

2) long dated treasury zero's are a potentially good bet. He thinks long rates will drop to around 3% (they are currently in the region of 4.5% but have just dropped a bit in line with the deflation hypothesis). With zeros this implies good potential for price appreciation.

3) stocks are due another pasting as we make the transition

4) china going into recession is a possible trigger for recession, so be wary of asian equities going forward. This also argues against investment in Japan despite its apparent pick up. Shilling (in a recent newsletter) thinks that China is now due a hard landing due to building excess capacity. He points out that they need a lot of steel and cement factories, just to build the steel and cement factories and that the eventual result will be massive unneeded capacity. While this has sucked in massive amounts of commodities, it will eventually implode causing a big drop in commodity prices.

The global deflationary trends Shilling outlines in his book and newsletter are so vast that even helicoptering money would simply be a drop in an ocean. China is on track to produce 10 million cars by 2010, but it only has a projected internal market size of 5 million by then.

I have a proportion of my portfolio in gold, but I'm pretty wary that this will prove to be a short term spike and only reflects a temporary safe haven for people looking for a safe home. In other words, its buggins turn for Gold.

I guess I find these analyses interesting because they provide a contrary view to a lot of what I read. For example he is bullish about new technology investments (though selectively the ones that produce real benefit and profits). He is bearish on property and believes that a crash is coming in the US and the UK.

Edited by 2MeterBear

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I've been reading a similar book:

Conquer The Crash by Robert Prechter

The book is a good read with a doom and gloom outcome similar to the 1929 crash / depression, but worse due to the even bigger amount of debt the world has got itself into compared to then + the stock market being hopelessly overvalued especially in the US. We're talking about banks going under, companies bankrupt, bonds being worthless etc...

A quick overview of "Do's" and "Don'ts" according to Prechter in a deflationary environment:


  • Own stocks
  • Own bonds (unless pristine)
  • Own real estate
  • Buy commodities (with a couple of exceptions)
  • Believe the government will bail you out


  • Put your cash into the safest banks, as cash is king when you have deflation, as long as the bank holding it doesn't go under
  • Have cash on hand (in case your bank collapses)
  • Own some physical gold, silver and platinum (although these will probably go down in price, but not as much as other things)

Not too sure whether it'll come to pass, as the scale of the collapse seems massive, but it certainly gives you something to think about. Then again, deflation happened in Japan only recently, so you never know...



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To me the cool thing about the Deflation book is that the author is not a cassandra plying a doom and gloom scenario. He sees deflation as potentially beneficial.

Instead of the standard doom and gloom model, he is looking at financial history and seeing how current conditions might resemble past experience.

He does admit to the possibility of a recession as part of the readjustment phase, but thinks it unlikely that it would be as bad as the 30's.

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I'm pretty certain what lies ahead, whether inflationary or deflationary isn't going to be nice or beneficial to the vast majority of people.

Interesting times await us unfortunately...



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