Monday, April 28, 2008

Is a Deflationary Collapse Guaranteed?

Over at The Automatic Earth, I was having a conversation with some folks about the price of oil in the April 27th Debt Rattle thread. My concern is that we are not facing a traditional recession/depression at all but rather are facing the leading edge of oncoming waves of scarcity driven by serious overpopulation. Because of that, I felt compelled to expand upon that dialog and it got large enough that I decided to do it here rather than as a reply there. Before I proceed further, if you don't understand the difference between prices rising due to scarcity and prices rising due to monetary inflation then please do not read further. I'm not going to answer basic questions about such things that you can get from multiple other sources on the net.

Now, to continue that conversation from TAE, let's take a look at what is really happening around the globe. At te current time, grain prices are through the roof. Some of this is due to speculation, some to trade barriers being erected (due to food security concerns), but a large fraction of this is due to shortage. We know that UG-99 is causing havoc with wheat in Africa and now the Middle East and it is expected to move into Asia proper this year. The planet has consumed more grains than it has produced for 7 of the last 8 years, reducing the 2000 grain surplus of 110 days global food supply to under 57 days global food supply. Regardless of deflationary pressures, this is going to produce upward pressure on prices (NOT inflation!!) due to shortages until shortages are alleviated.

Likewise, consider the price of gold, which has fallen by roughly 10% (slightly more) into the $890-$900 range. Gold is money and since the global monetary situation is deflationary, gold is sliding somewhat with it. This however will vary over time as people move from fiat currencies back into gold and silver. Which way will these two precious metals go? Beats me! The combined problems of deflation coupled with flight from fiat currency (upward pressure on gold prices) look completely unpredictable to me at this time thus I have zero interest in playing the gold market in any speculative manner.

However, look at oil. Oil remains on an upward trajectory. So long as any global technological civilization exists AND that civilization does not go to war with itself (regions against regions) then energy must continue to flow at some rate. Unless and until rationing sets in, so long as any open market in oil exists AND the global production continues to fall below growing demand we will see rising prices, even in a deflationary scenario.

To alter this we either need increased supply (which is not going to occur) or decreased demand. And despite the observations of the deflation watchers like Mish and others, there has as of yet been no deflationary crash. In other words, so long as the markets continue to ignore the crackup in the financial sector, oil cannot do anything but continue its general upward trend.

Now I agree that in the event of a 1929 style deflationary collapse we would see massive decrease in demand. But are we going to get that? Or are we going to muddle along for the next several years in some financial no-man's land?

Here's a point for people to ponder. The 2001 tech stock crackup was supposed to be "the big one" but the powers that be managed to hide that with a convenient "war on terror" and yet another bubble. Everyone betting on a deflationary collapse now is making the same assumptions but TPTB have proven remarkably resilient in their abilities to rape the planet and its population. Why do you think they won't get away with this again? We had already passed into the realm of fairy tale numbers back in the 2001 crash. This crash is just more fairy tale numbers. And they have a ready proxy waiting in the wings for the next bubble - carbon credits. Note that I am not a global warming denier, much to the contrary, I am quite a believer in global warming. But I don't think that these sorts of policies and actions are actually going to solve anything. Rather, these policies, like carbon credits are more akin to exploiting a legitimate crisis for gain by the elites.

Likewise, given that $750 trillion in derivatives debt was preposterous to begin with, yet we had it, I can clearly see the existing population buying into an even bigger bubble based on something else. Now I am not predicting this will occur but I am warning many of you that betting on a purely deflationary fast collapse ala 1929 is not a guaranteed bet. I fully intend to speculate in oil futures so long as it seems viable to me. And that is the decision that you must make - does such a speculative action seem viable to you at this time? No one can answer that for you except you. Right now global civilization is in no-man's land. Rational thought was abandoned long ago in favor of rationalizing thought. All that matters now is the race to some illusory goal and right before people reach it, the goalposts will be moved again. This technique has worked for a long time for the established families at the top of the world order and they won't abandon it now even in the face of global catastrophe.


Stoneleigh said...

Thanks for the thoughtful reply on your site GreyZone.

At the moment I would describe our trajectory as stair-stepping lower in a series of stomach-churning lurches interrupted by occasional rallies where everyone goes back to sleep again. Positive feedback spirals take time to build up to 'critical mass' before a tipping point is reached, but once that point is reached, things can unravel very quickly. I firmly believe that this will happen at some point, although not tomorrow or the next day.

In my view a 1929-style deflationary crash is inevitable. As it takes time to prepare for an event of that magnitude (or larger, as I think this one will be), there is no time to lose. Advance warnings are the only kind that is useful.

I fully accept your point about over-population leading to shortages, high prices and general mayhem. I don't doubt for a minute that oil and food in particular will harder to come by and much less affordable than they are now.

When I call an approaching top in the commodity complex I am looking initially at the effects of driving speculation into reverse, which has the potential to overwhelm the fundamentals temporarily. This can happen very quickly in a world of free capital flows.

Among the effects that will take longer to to felt would be a huge decrease in general demand due to the collapse of the money supply (where demand is what one is ready, willing and able to pay for), a countervailing increase in military demand mediated through resource wars, and the collapse of supply due to economic upheaval and war.

I think the initial effect on demand will begin when we reach the tipping point and credit deflation begins to accelerate, proceeding to develop from there over the next several years of wide-spread impoverishment.

The timing military adventures is obviously difficult to predict, although I can imagine a crescendo effect beginning sometime after a crash, as the-powers-that-be may well be occupied with domestic crisis management initially. I think it would be a long time before demand from this quarter would compare to the loss of demand due to the on-going loss of a middle-class.

I also think the collapse of supply will take time to unfold, as economic upheaval, warfare, infrastructure decay, and movements intent on sabotage do not develop overnight.

In my view, the likely net effect of conflicting pressures will be an initial price decline in nominal terms, followed by substantial increases in the longer term.

The Automatic Earth

Matthew said...

I think you hit on an important point. Many fail to understand the difference between price increase due to scarcity versus price increase due to monetary inflation. Seems to be going over the heads of a lot of very smart people. Operating on a false premise, they then go on to draw all sorts of erroneous conclusions.

Also, re: the race to an illusory goal, only to have the established families move the goalposts, even in the face of global catastrophe. Makes me wonder whether something similar played out on Rapa Nui. Upon completion of the latest moai, the goalposts would suddenly be moved, workers directed to the next, bigger and better goal. Which was repeated time and again, right up until their civilization and ecological base collapsed beneath them.

foss said...


i agree that shortages are a major contributor to recent commodities increases & that population is the largest factor.

i think though you underestimate monetary inflation & it's power ala the feds[central bankers]. these guys seem to me to work more closely as a team than any diverse group in the history of our planet. This plus computerization will allow monetary inflation to be the dominant force until there is some type of monetary collapse. As a computer specialist friend says; 'in a matter of hours dollars can be placed in our accounts'.So hyperinflation when we have to buy our own treasuries & not likely ever significantly deflationary because the US $ loses it's reserve status. I don't think the amero will fly. i think this fits with you're next bubble thoughts as the bubble will likely be commodities themselves[we ain't seen nothing yet!].

So gold/silver & oil all look like the best investments with spare $ after preps[including safe???, arable land] which are the very best investment that can't evaporate in a collapse.
thanks for your work!


i can't get my head around why you think '29 style deflationary. I appreciate your work at TAE.

Beach Boy said...

I am really amazed at the fact that intelligent people are still playing with the idea of deflation and moreover deflationary collapse.

You can go to
and run a report from Feb 4.

During the 1st week of February total sloshing REPOs were 15 B, mostly backed by Treasuries.
Today they are 111 B, 80 B of which backed by MBS.

How can you have deflation with the Fed monetizing garbage like this?

For a brief counter-factual analysis, if the Fed had not created the 100 B thru REPOs, some banks would have fell (cheer up!), the price of oil, grains, metals could be 20-30% lower than today (but no way for oil to go below 70), and the price of stocks and houses would have plunged, for sure.

The point is, either you have loose monetary policy, asset price stability, and commodity prices going wild, as is happening today,


you have a tight monetary policy, asset price deflation, and commodity price stability.

But 1929 deflation, no way. The world was too far from the physical limits to growth back then. Now it's hitting them.

Stoneleigh said...

There has never been a credit bubble that didn't implode, and I'm not betting on this one - the largest ever - being the first. Considering that credit has been by far the largest component of our effective money supply, it loss will be highly deflationary. Fed liquidity injections, which may look substantial, cannot keep pace with the destruction of credit even now.

Contrarian positions always sound like lunacy when their message is most timely. Too often people simply extrapolate current trends into the future without looking for evidence of looming discontinuities. The more widespread the consensus, the later it is in the trend, and the closer that trend is to reversal. When the inflationary consensus is at its strongest is when deflation is most likely to be the real danger.

Deflation generally lowers prices across the board, at least initially. After that initial phase, many competing factors play a role in determining prices and availability. Over the long term, energy and food will be scarce and expensive in real terms, whatever happens to nominal prices, but in the short term market moves could bankrupt those who bet correctly (but too soon) on the long term trend.

foss said...

thanks stoneleigh

twill ponder!