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Source link: http://archive.mises.org/14711/has-mish-deflated-the-inflationistas/

Has Mish Deflated the “Inflationistas”?

November 22, 2010 by

I have not been persuaded by Mish’s alternate framework. To be clear, I’m not arguing that Mish’s fans should abandon their hero. Rather, I will simply point out that Mish’s “calls” have not been nearly as prescient as he so often claims. FULL ARTICLE by Robert Murphy

{ 34 comments }

James Dahlberg November 22, 2010 at 10:19 am

Mish did not believe, along with myself, that the rally in stocks would last quite this long. I figured that it would peter out about a year ago. Should the market tank again, it will likely be in conjunction with oil prices. This will occur with rally in the dollar. IMHO, your article will be a contrarian indicator.

http://seekingalpha.com/article/172731-why-magazine-covers-are-historically-great-contrarian-indicators

http://seekingalpha.com/article/172977-why-magazine-covers-are-historically-great-contrarian-indicators-part-ii

James Dahlberg November 22, 2010 at 10:39 am

Did my comment get moderated? I’ve seen a lot worse on here than mentioning that Mish may be vindicated by future developments, something that the article itself mentions the possibility of.

Dan November 22, 2010 at 12:35 pm

The first thing that came to my mind here is: “Mish-Mash.” I’m glad Dr. Murphy didn’t use that for his title. :)

billwald November 22, 2010 at 1:03 pm

Both Mish and Mr. Murphy are wrong. Why? because there are two parallel economies, one for people who work for wages and another for those who cash in capital gains. The worker’s economy is deflating while the stock market and the owners are doing fine with a small inflation.

How can this be? With an international economy and the world being run by the international corporations, the investors make higher profits when US workers are laid off and replaced by workers in China and India. This is Libertarianism at its finest. The people who can pull their way up the food chain do just fine and the losers, lose.

Inquisitor November 22, 2010 at 1:31 pm

“How can this be? With an international economy and the world being run by the international corporations, the investors make higher profits when US workers are laid off and replaced by workers in China and India. This is Libertarianism at its finest. The people who can pull their way up the food chain do just fine and the losers, lose.”

Do you like talking shit? Or did the central banks and governments that created this problem elude your notice? Oh, add in the anti-Chinese/-Indian histrionics too for good effect, bravo.

Government-manipulated mixed economies = libertarianism at its finest.

Go troll someone with fewer brain cells.

Steve Hogan November 22, 2010 at 3:55 pm

Libertarianism? Am I to believe that some of the highest tax rates and most burdensome regulations in the world are signs of libertarian policies in action? Or an economy that uses a central bank to manipulate short term interest rates with money printing…is the manifestation of libertarian thinking?

Good God, Mr. Wald, what planet are you living on? One would be hard-pressed to have a more distorted view of a political philosophy than yours. Time to hit the books, pal.

Josh November 22, 2010 at 3:31 pm

Eh, I’m not down with this argument. Mish has already dealt with the fact that oil and other commodities are up by saying that there’s very limited pass through to consumer prices.

There’s a difference between commodities prices in finance markets and what the consumer will actually pay. Mish says that because consumers can’t pay a certain amount it will keep real prices in check. They can always go to substitute goods.

Mish is also very supportive of Austrian economics, and has mentioned Rothbard several times.

Also, he doesn’t say that hyperinflation is impossible, but that it’s not in the cards immediately.

mikey November 22, 2010 at 3:39 pm

I love to see Austrians get into it. If I understand Mises correctly, in Theory of Money and Credit he says that the demand for cash holdings can influence inflation just as much as the supply of money. My readings of Mish tell me that this book is what is influencing him, convincing him that deflation is possible even as the supply of money increases.Also he sees that lending is indispensible in the inflationary process, as explained really well by Rothard in Mistery of Banking.
Rothbard had never seen a situation where the banks were not fully loaned out…
Predicting inflation or deflation? pretty iffy, you would have to predict the future workings of
millions of minds… unless government expenditure involves replacing taxes with direct purchase of bonds by the Fed, severe inflation is unlikely.

Del Lindley November 22, 2010 at 4:47 pm

Not having followed Mish very closely myself, I will take Dr. Murphy’s description of his record as a given. That said, it seems to me that Mish’s financial forecasting errors stem from an overweighting of America’s credit condition (based on internally determined domestic asset prices) in his valuation of assets traded on global markets. Since oil, bonds, and stock prices (and exchange rates) are all determined by global factors on world markets the belief that America’s credit condition plays a decisive role in setting these prices is highly suspect. A more relevant approach would be to compare these asset prices with the level of “global bank credit.”

scharfy November 24, 2010 at 12:04 am

Very good.

The deflationista’s/credit contraction crowd forgot to allow some wiggle room in their models for Chinese/global credit growth.

Not just us any more buying up raw materials.

If and when China slows, the deflationists will have their day.

Matt Stiles November 22, 2010 at 5:38 pm

I’ve been reading Mish and Murph for a good 5 years now. They’ve both been wrong and right on various aspects.

It is dubious at best, with our understanding of price structures, to point to any aggregate price level and claim vindication. But picking and choosing any individual prices is equally as dubious. Depending on the definition, one could always claim that we have inflation or deflation. Both occur simultaneously at all times. Mish has long predicted credit deflation which would lead to asset price deflation, while “inflationist” Austrians have stressed money inflation leading to natural resource price inflation as their primary concern. To this end, they have both been right.

But I think much of the reasoning behind Mish’s logic has gone unrecognized. First, he talks about aging demographics and the deflationary bias inherent in this environment. He also talks about the monetary transmission mechanism used to “stoke inflation” at the command of the Fed. He notes that it requires private banks to originate loans with the borrower who has a higher time preference. According to him, this is not going to happen nearly as much in an environment where time preferences are correcting lower after a debt binge unrivaled in modern times. And he has been correct. Banks are not using their “excess reserves” because they know the valuation of the assets on their balance sheet is exaggerated through legitimized accounting fraud. And individuals are less likely to indebt themselves further if they perceive asset prices as trending downward.

As for “who has been more right”, I would note that for investment purposes, the expectations for future inflation has the most relevance to bond investing – less so for equities or commodities. Those expecting (ca. 2006) the pending financial crisis to be inflationary would have had their clients shorting government bonds – and they would have been annihilated.

Lastly, I have never been of the opinion that anything written by Mish contradicts the overall Austrian message, requiring it to be “dealt with”. There will be consequences to all interventions in the economy, but it is not certain how those consequences manifest. That will depend on the changing preferences of individuals. And it is entirely possible that individuals will “call the Fed’s bluff” and choose to delever further in anticipation of a weakening economy – or perhaps even because of a new understanding of the Fed’s limits (in ability and/or intelligence).

Most Austrians agree that deflation should not be met with resistance – that it is precursor to innovation and creative destruction. We shouldn’t sell ourselves short and discount the possibility that we are proven correct – despite all efforts of the central planners.

Art November 22, 2010 at 11:32 pm

I’ve been looking forward to an Austrian response to Mish’s views. I wish I could say this post satisfied. Unfortunately, what is missing is a thorough analysis of why he is wrong. Arguing over whose predictions are worse is a bit tedious. I look forward to someone taking up the call for a thorough substantive analysis of the issues. Without it, we’re left with theory guys arguing with quants in mutually incompatible languages.

steve November 22, 2010 at 11:39 pm

Mish is absolutely wrong on his deflationary call. Why? Because he confuses credit with capital! Credit is part of the money supply and is created by banks and facilitated by the Fed. The fed has been filling up its balance sheet with ” junk assets” from the semi-bankrupt wall street institution, thus providing them with the necessary liquidity to maintain their ponzi schemes running. What Misch ignore in his analysis is the ” time factor” that allows money to run through from the early recipient of money to the lower groups of individuals on fixed income. Obviously, if you study the value of the dollar since 2008, it is clear that it has lost a tremendous amount of value in that short time span while commodities and prices have shot up. Now, inflation is simply the increase of the money supply and even a dumb squirrel will tell you that the Fed has been pumping up money and is determined to keep that con running for a long time.
To go back to the business cycle, one must understand that the boom period of the business cycle is characterized by ” the over-pricing” of some assets above their normal market price due to excess liquidity and speculation. Now, the housing bubble was characterized by a rapid increase in home price and the belief that houses can only go up! With the crash of that bubble occuring and the consequential tightening of credit and money ( deflation), the market was requiring the housing prices to be set much lower in order to restore sanity to the market! That’s when the inflationay action of the FED set in to distort the whole price system and maintain an artificial economy that was set to be destroyed!
So, inflation can only be explained by the government intervention into the economy with its aim of preventing the natural effects of deflation from occurring! Mish is missing that point in his analysis and I wonder if he has really studied Rothbard as he claims!
I am not even an economist and I understand that issue clearly!
By the way, don’t tell the man on the street that there is no price inflation, he ” feels it” and “suffer from it”! Wall street might be basking on liquidity; but, the little guy out there is paying the price and will suffer more as things as set to worsen with time!

Brandon Chapman November 23, 2010 at 10:59 am

I find it interesting that you try to pose an Austrian economic argument for inflation an then in the end your evidence is that some things that you buy are increasing in price. Yeah, you can focus on oil and the price of sugar, but neglect to point out that housing prices are still falling. Now you can argue that your budget is tight since your mortgage payment is fixed and you owe more than your home is worth, but isn’t that a deflationary argument? The point being that the destruction of credit on all levels is STILL happening.

You’re right that the Fed has purchased a lot of assets, but it hasn’t been able to fill the void left by the destruction of credit. At present there are too many holes in the dam for the Fed to plug with its ink-stained finger in order to allow the level of money to rise. You may find examples of rising prices resulting from fundamental and dollar movements, but inflation is an increase in the money supply, is it not?

John November 27, 2010 at 12:38 am

Yes, inflation is an increase in the money supply, and rising prices denominated in that particular currency are a characteristic of that. Simply pointing to housing prices declining as a trump to the inflationary argument is a complete farce. I think we can all agree housing prices were bid up to incredibly inflated (read: unrealistic, false, not real, fake) levels…(there isn’t anyone who won’t call it a “bubble”, is there?)

Just because the inflationary actions of the Fed haven’t been enough to completely counteract (i.e. hide) the natural decline in housing prices coming off that artificial peak, does not mean such a decline is evidence to refute an argument of inflation.

pravin November 23, 2010 at 2:50 am

mish is right about hyperinflation though.hyperinflation is a political event. people lose faith in their currency,usually, before the actual money printing. US is heading to a Japanese style slow motion crash.
though, dr murphy is excellent in theoretical stuff, for practical investment advice,i’d listen to Marc Faber -who has actually decades of trading experience to go with his austrian leanings

Prakash November 23, 2010 at 4:14 am

I see a bi-stable system in which either everyone flees the dollar due to an overly dramatic move, or Mish’s hypothesised steady and long deflation.

Could Dr Murphy explain what he thinks will be the mechanism by which the Fed will create a moderate inflation?

I don’t see enterprises taking loans and outbidding other for resources and creating inflation, because almost every enterprise in the world is having unutilised capacity. Speculators with ready access to funds may outbid a lot of people for a raft of paper assets, and even commodities, but the actual consumers of the commodities will be cutting back.

Sean November 23, 2010 at 4:19 am

What does Mish refer to as “…a fiat credit-based financial system…” ? Is he referring to an economy with fiat money and fractional reserve banking, or instead is Mish using some specific and special definition of his own here?

Arend November 23, 2010 at 6:00 am

Maybe I’m too simple in this matter but I think that both deflationary and inflationary factors are in play. The deflationary factors are consequences of persons acting in the credit-industry, the inflationary factors are caused by the Fed and the anticipation of persons that these actions will wreck the dollar and will not clear and reallocate the burst bubbles.

I only follow Peter Schiff more regularly than others and he is saying the same thing. His point is that inflationary factors will eventually dominate the deflationary factors. The composition of the CPI aside, isn’t it remarkable that one of the greatest credit crunches only caused so much price deflation? Much of the bought-up financial ‘assets’ by the Fed are not even on the market, just as an impressive number of foreclosed real estate. The minimal price deflation already is a direct (counterfactual) example that there is already price inflation. As GDP and productivity numbers are not that good to go on, as they are measured in inflated prices, they should be seen relative to other macro aggregates such as employment rate, unemployment rate, and others that signify real wealth.

If Mish states that gold is money, does he mean to claim that because the rise in the price of gold signifies deflation because in gold terms goods and other assets have become cheaper? If so, that seems like a reasonable statement, but it at the same time means that in dollar terms there is real price inflation going on.

Brandon Chapman November 23, 2010 at 10:43 am

Since Murphy mentioned Peter Schiff, let me tell a story about the so-called inflationistas. I attended the MIses Circle Event in Las Vegas and the luncheon with the man himself. During the meeting he portrayed a very ominous outlook for inflation and predicted a two year timeframe for hyperinflation to take hold of some sort. His only explanation for how this was to happen was that the Fed was going to buy Treasuries at an increasing rate to keep interest costs low (which deflationists like Mish doesn’t seem to think that can happen politically). I approached him afterwards during his book signing and he was taking time with the few people there. I waited for my opportunity and asked him about the timing of his inflationary scenario, given the impairment of the typical inflationary mechanisms, namely the fractional reserve banking system. He pulled up his phone scrolled through his messages and walked away. I went back later when everyone except one gentleman had cleared–which he took a fair amount of time with–and I posed my question again. I mentioned that I clearly agree that inflation will raise its head eventually and posed my question again. He nodded his head, pulled up his phone, and walked away without a word, AGAIN! Not only is the guy a total jerk, he clearly didn’t have any sort of rebuttal.

I’m a logical person, but I find this rebuttal that Mr. Murphy is providing is extremely weak (if there was even a rebuttal). He wants to point to failed predictions as a means to discredit someone, but what I want is a real argument for inflation. That’s what made the Mises Circle event so disappointing. I want strong, logical arguments about RELEVANT topics regarding money and credit to support the outlook for inflation.

I understand the deflationist argument like what Mish is articulating pretty well. The current supply of money and credit doesn’t necessarily affect the dollar in real time. What Mr. Murphy fails to realize is that a collapse in the dollar doesn’t have to happen in order for commodity prices to rise. The price of the dollar is a relative valuation, and the weakness is a result of our attempts to increase the money supply at a faster rate then other developed nations, namely Europe. However, all central banks are trying to inflate, which will cause commodities like gold to rise. The dollar will do whatever it’s going to do, but commodities will continue to outperform other asset classes, not because of what the Federal Reserve is doing alone, but what all central banks are doing. In fact, gold has it’s best relative performance against other assets when the dollar is stronger resulting from credit destruction, then when the dollar is weak.

From an inflation perspective, can you show that the actual supply of money is increasing? Im not talking about the potential supply of money in the form of reserves. That money may not see the light of day for some time, thus the timing of likely inflation. If you read Mish you’ll find that he does feel that inflation will be a problem down the road, but at present the supply of money is contracting as credit is being destroyed or marked down.

Amanojack November 23, 2010 at 11:13 am

If people are not even clearly specifying when they expect inflation to happen, how can there be this much debate? If timing is not front-and-center, where is the debate?

Chris December 1, 2010 at 6:01 pm

Brandon, does this surprise you (about Schiff)? That is the most prevalent approach today among virtually all public discourse, among prpetty much anyone and everyone I hear respond to a pointed question. He’s not even ignoring you. It’s called cognitive dissonance. Most people have this disease. If they hear something that does not jive (contradicts or challenges) their established views, it simply bounces off the brain and goes somewhere else. They literally don’t process it. You might as welll get used to it.

Matt Stiles November 23, 2010 at 11:33 am
Del Lindley November 23, 2010 at 5:25 pm

Mish appears to have borrowed a page from the Hulsmann playbook by accusing Murphy and North of a sort of inflation-production consequentialism. Must an increase in the Fed balance sheet necessarily lead to a general money/credit expansion within a specified timeframe? Murphy/North seem to be saying yes while Mish clearly says no. Given freedom of individual action lenders are not forced to lend and borrowers are not forced to borrow. Furthermore bankers have no incentive to lend so long as they see the value of their capital assets contracting. In fact they have every incentive to call in old credit in this circumstance. An asset value based fractional reserve system is thus susceptible to deflationary instability once the preceding (inflationary) money illusion is exposed.

BTW, do any of the Mish followers here know where he gets the $35 Trillion value for total bank credit? Given that the credit level for U.S. commercial banks is $9.2 Trillion (derived from the Fed graph in Dr. Murphy’s article), I would assume that Mish is referring to a global level of bank credit.

The Kid Salami November 24, 2010 at 7:19 am

“Mish appears to have borrowed a page from the Hulsmann playbook..”

If Hulsmann has said something to this end, can you provide a link please, I’d like to read it.

Del Lindley November 24, 2010 at 3:59 pm

I was referring to Hulsmann’s paper on error cycles where he criticizes the standard ABCT as being “consequentialist,” i.e. it assumes that entrepreneurial error follows necessarily from an expansion of fiduciary media (i.e. bank credit as money). Mish takes an analogous position by arguing that an increase in bank credit does not follow necessarily from an increase in the monetary base. (Mish in fact claims that actual data analysis gives greater credence to the view that increases in the monetary base tend to follow increases in bank credit.)

Beefcake has put up this link so many times I figured everyone would have read it by now.

http://mises.org/journals/qjae/pdf/qjae1_4_1.pdf

Beefcake the Mighty November 24, 2010 at 4:07 pm

Del, here’s another important paper by Huelsmann (HT to newson) that further refines this argument, distinguishing two kinds of entrepreneurial errors (roughly, trying to lenghten the structure of production when it should just be widened, and trying to widen the structure of production when it should be lengthened):

http://www.guidohulsmann.com/pdf/Time_Preference_Investment_Expenditure.pdf

Del Lindley November 24, 2010 at 8:45 pm

Beefcake,

Thanks for the reference. I’ve just finished reading the first half of this paper (the critique of Rothbard’s analysis) and my mind is slightly boggled over the woeful state of Austrian theory. It took until 2008 to recognize that there is no definite relationship between changes in social time preference and changes the rate of interest?

I became aware of Austrian economics in early 2007 and as part of my self-education (since I have had no formal economics/finance training) I worked out (in 2008) many of the mathematical consequences of Rothbard’s ideal” ERE” production structure. Perhaps the most elementary of these consequences is the relationship between the social time preference (θ = C/S) with the pure rate of interest “i” (i.e. where complete production certainty exists):

θ = iT + F/S

Here T is the period of production and F/S is the ratio of the original factor income to gross savings. Given the independence of the terms on the rhs, this expression tells one immediately that Δθ and Δi need not be correlated. (This is one of the reasons I regard social time preference, in its more general form outside the ERE, to be much more useful than the interest rate for theoretical applications.) So regardless of what Rothbard said explicitly, the implications of his model are not at odds with Hulsmann’s analysis and this fact should have been recognized by someone over the past fifty years!

So anyway, thanks again and have a happy Thanksgiving. (At least try to resist the GWARish urge to take a chainsaw to the poor bird!)

Beefcake the Mighty November 24, 2010 at 10:35 pm

Del, indeed, it is very surprising that this point has been overlooked for so long. Figure 1 in the paper (taken from MES) is the classic picture-worth-1000-words. Time preference schedules even for an individual consist of a supply *and* demand component, the demand portion need NOT stay fixed while the supply portion moves. Indeed, a number of possible co-movements are conceivable. A very simple, but deep point. But it is refreshing: Austrian econ is certainly no cult, trapped in the past, it is truly an open and growing school of thought.

“So anyway, thanks again and have a happy Thanksgiving. (At least try to resist the GWARish urge to take a chainsaw to the poor bird!)”

Thank you, you too. Don’t worry, GWAR doesn’t use chainsaws on the bird, we have other tools, but I’ll spare you the gory details.

The Kid Salami November 25, 2010 at 8:49 am

OK thanks – yes I have read it, I just thought he may have made a more specific comment on this topic.

spectator November 23, 2010 at 5:06 pm

For more than five years I’ve been reading a lot of the writers (most of them Austrian) that foresaw a crisis. In my opinion Mish has the best record so far about the big trends. I still think we’ll have our impoverishing inflation at some point, but so far Mish’s deflation call has been the best guide to macro trends out of all the pundits on the web.

Chris Donabedian November 29, 2010 at 10:46 am

I am surprised that I do not hear or read any Austrians point out that simply looking at the change in the CPI as a measure of inflation is simple-minded and inaccurate. Just because prices are relatively unchnaged does not mean we do not have massive inflation. Prices should have dropped significantly, but the combination of TARP and Fed actions have prevented the fall from occuring. All that matters is that prices are HIGHER THAN THEY OTHERWISE WOULD BE, and that is inflation. Even in a non-crisis environment, using the chnage in price level alone is absurd. In a free market, prices naturally decline due to improvements in technology, scale economies, and ever increasing import competiton. This is NOT deflation, it is simply a change in the price level as a function of supply and demand. As such, the CPI alne is useless anyway, as it does not isolate changes in price as a function of supply and demand from changes in price as a function of monetary inflation. Heck, I am more Austrian than the Austrians. It’s dissapointing and it is one reason you are all losing this battle.

Henry November 29, 2010 at 8:33 pm

What’s funny is that Mr. Murphy chose to criticize someone who has no credibility whatsoever and is nothing more than a blogger. Mish is a follower not a leader. And he is by no means an analyst. Instead of focusing his attention on clueless follower and marketer like Mish, I am wondering why he has not patched into a real expert like Mike Stathis. Could it be because Stathis has been virtually 100% correct with his forecasts and possesses a far superior understanding of things than Murphy? Of maybe it’s because Stathis has been banned by the media so he does not attract a large audience that Mr. Murphy can attempt to steal. As long as people keep paying attention to clowns like Mish, they will remain in the dark. Have a look for yourself avaresearch (dot) com

The Kid Salami November 29, 2010 at 8:54 pm

“a far superior understanding of things than Murphy”

Maybe this guy has indeed made some good predictions and will turn out correct in the inflation/deflation flame wars, but these paragraphs aren’t filling me with a desire to jump on his wagon. He is not saying why things are different now but is just ignoring the history of money entirely.

Mike Stathis:
“What this means is that gold has no inherent value whatsoever. It doesn’t generate a cash flow based on fundamental economics so it doesn’t generate earnings. There’s no way you can produce an income from gold other than if you are a gold dealer and you sell it to people, unlike silver, which has inherent value. Silver is used extensively throughout industry, so it’s an income-producing asset. Gold is not. Gold is kind of like artwork.

One big difference between gold and artwork is that gold is pretty much the same wherever you buy it; it’s considered a commodity. And it trades on global markets. Therefore, unlike artwork, which can command a certain price from one prospective buyer and a different price from another, gold is invariable and trades on a huge market made up of buyers and sellers.

And because gold is the same wherever you buy it, the price reflects what the world wants to pay for it. Because the gold market is global, it’s bought and sold with more efficient or uniform pricing than artwork.

On the other hand, you can get a kid to paint a picture and claim it was painted by an eccentric artist who died last year, take it to an auction in NYC, and it might sell for $100,000.

That same painting, if auctioned off in Europe or China might sell for $500, or maybe even $50,000; no one really knows what it might sell for. It depends a lot on how it’s marketed. It’s also based on individual taste.

Gold pricing is similar in some respects, unless of course people detect fake gold, which I can assure you is all over the globe. Excluding this scenario, because gold is the same wherever you buy it, and because it’s traded on large organized markets around the globe, the price is fixed at any point in time. This is the main difference I see between artwork and gold. Neither has inherent value. They only have perceived value based on supply and demand, but not need or utility. “

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