Bill Fleckenstein: Bernanke fears deflation, but stagflation more likely

Contrarian Chronicles10/15/2010 6:00 PM ET

Not your grandfather's deflation

As the Fed frets over the prospect of an overall decline in the price of goods and services, signs of rising prices abound.

By Bill Fleckenstein
MSN Money

Who's afraid of big, bad deflation? It seems like almost everyone, but none more influential at the moment than Federal Reserve Chairman Ben Bernanke.

Given the policy implications of Bernanke's fears (i.e., more money printing), it is worth understanding what his reasoning might be, flawed though it ultimately is.

Inflated worries

In assessing Bernanke, it is important to realize that he has spent a great deal of his academic life studying the Great Depression and is considered by many to be an expert on that period. As such, part of the reason he may be so afraid of deflation is because he assumes -- as many people do -- that deflation equals an economic depression.

The idea fueling this view is that in a deflationary/depression environment, people stop buying, companies stop spending, and, though a dollar buys more, everyone has less to spend because of the overall state of the economy.

Deflation and depression can occur together, but they don't have to -- although Bernanke seems to think they do.

Another reason Bernanke might be afraid of deflation is because of its effects on debt. In a deflationary environment, the money you pay back has more purchasing power than it did when you incurred the debt, so you are effectively transferring something that has increased in value to someone else. The result is that you are, in effect, paying back "more" than you borrowed, and that doesn't even take into account interest payments.

Just think for a minute how much debt the U.S. government owes to countries such as China and you will understand how Bernanke might feel about such a scenario.

As I mentioned the last time I talked about deflation, it is this fear of falling prices on the part of the Fed that practically guarantees the opposite: inflation. (This is why I advocate owning gold, a "hard" asset that historically has offered protection against inflation.)

Yet, Bernanke is presumably a rationale man. Have any of his fears been realized? It is true that certain assets have declined in price to varying degrees -- stocks and real estate, to name two prominent ones. But as for an overall decline in the prices of goods and services, what we are experiencing is certainly not, as I like to say, your grandfather's deflation.

Up the down staircase

The evidence has been all around us lately, starting with the Oct. 14 Producer Price Index, which reported a rise in prices of 0.4% during September, compared with economists' expectations of just 0.1%. After the August reading of 0.4%, folks obviously had thought this gain would be more subdued, but that was not the case. (Those who don't think food and energy matter can console themselves with the fact that excluding those items, the PPI rose only 0.1%.)

The latest Consumer Price Index, which was released Friday, made headlines because inflation came in below expectations -- but it showed a 0.1% rise in prices nonetheless.

On Oct. 8, a slew of commodity prices -- for wheat, soybeans, corn, coffee, sugar, cocoa, hogs and cattle -- rallied at least 2%, with the first four in that list gaining 4% or better. But not to worry: As long as you don't eat, you probably won't notice food inflation.

Two days earlier, on Oct. 6, Yum Brands (YUM, news, msgs), the owners of KFC, Pizza Hut, Taco Bell and Long John Silver's reported earnings and noted that labor and commodity inflation will hurt its fourth-quarter margins.

In my Oct. 8 column, I noted how retailers are trying to pass along higher costs to consumers either in the form of price hikes or through the technique of reducing unit sizes while selling them at the same price. The latter is something traditional measures of inflation aren't very good at capturing.

Almost as foreshadowing, last month's prices-paid component of the ISM U.S. Factory Index jumped to 70.5 from the previous month's reading of 61.5, despite expectations of 59. I would love to hear the deflationist explanation for that one.

Also last month, on Sept. 29, a little company named FedEx (FDX, news, msgs) announced a 3.9% price increase effective in January. One would think that ought to make the believers in deflation scratch their heads. After all, if we were in the grip of deflation, with all the connotations that conjures up for people, how in the world could something as mundane as transporting goods be rising in price?

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Given recent data points like those, along with the persistent high unemployment rates we have seen, it seems obvious that we are in a period of stagflation -- slow growth and inflation.

That, of course, has dramatically different investment ramifications than does deflation. (For more on how to deal with those ramifications, read "Inflation, stagflation and you.") I'm confident the psychology will eventually change toward expectations of inflation, but for the moment we will just have to wait and see when that might happen.

At the time of publication, Bill Fleckenstein owned gold but did not own or control shares of any company mentioned in this column.

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10/27/2010 4:36 AM

This will only be second time that I have made a comment on here, the first time was May of 2009. My view is little changed. From credit cards, to lost home equity, to lost jobs, no one can afford to buy the things that drove everything up to start with. Until new industry emerges with new jobs, we are doomed. We cannot survive as a country where most of the jobs are services, not creators of wealth. So inventories have to come down, less things built because no one can buy it. We are in the tailspin not far from crash and burn......

10/26/2010 2:32 PM
these suitsd and ties in the cities are clueless as to whats goin on in rural america..MILLIOINS of jobs lost to one working whole towns unemployed and somehow  maybe dont realize people have NO money...sure at his financial firm they do so he doesnt get it hge is surrounded by to clyde NY drive to lyons NY drive out to rural towns in upstate and you will see why defaltion WILL one has money good will not sell. obama cnt stimulize forver....this is just another msnbc liberal hack job for obama..the economy will not get better, one is working,
BUYWHATYOUCANAFFORD, your statement, "I am spending more at the grocery store and the pump...for the same amount of items." is very true; however, this is not considered part of the cost of living. Our government only counts core items which excludes food and energy. It goes to say that, "figures don't lie, but liars will figure". 
10/22/2010 10:21 PM
Fleck,nobody cares about deflation anymore,it's just another goverment sponsored,media hyped,wall street tool of mass confusion,to induce more fear in what little is left of the American middle class,so that they can steal the final crumbs that they missed in the 01,and 08 recessions.
10/21/2010 7:45 AM
"Higher Prices," says Ben Bernanke at the Fed. He says he will print more money to "push prices higher." Sure that may help banks and the stock market, but it hurts Main Street.

As Fleckenstein writes, this spending madness at the Fed and by our government is the reason Real Inflation is already here. He recommends precious metals like silver, gold and platinum to protect your wealth. He has a good point since the Fed is pushing for more and more inflation while holding COLA for social security folks and retirees at Zero.


We have been trying to inflate our way out of deflationary forces resulting from Asian currency manipulation for the last 12 years.  We disregard deficits, elect drunken sailors to manage our national fiscal affairs, and print more and more money.  Now we've gone so far that the easier, more responsible solutions are no longer possible.


Trash the dollar.  Let's get it over with.  Hopefully, we will never forget the stupidity of the last 12 years.





10/18/2010 3:44 PM
Fleck, after MSN destroyed its Portfolio Manager and essentially turn MONEY into a woman's-consumer website, you're the only reason I come back every couple of weeks.
10/18/2010 2:05 PM

"Maybe if Fleckenstein just keeps talking about inflation, it will finally happen.  So far, if  you followed his advice of the last 24 months, you would not be a happy camper."


You're right, I'm not at all happy with my 70% return in the last 24 months on PM, or for that matter my 4x return in the last 84 months. This Fleckenstein guy doesn't have a clue.

10/18/2010 1:27 PM
Wow, people actually suggesting inflation as a way OUT of this economic problems have a seriously flawed missunderstanding of how economics work.  Get this straight:  If deflation takes hold you will take home LESS DOLLARS, not more.  If you have debts, this will RUIN you.
10/18/2010 12:59 PM
Dam tired of this                                      Guesss the government shouldn't have spent money they didn't  Too bad for them, everyone stop buying, let the deflation begin so that the PEOPLE can survive.

I think you want the price deflation to begin not monetary deflation. I don’t think that price deflation is possible with the world bucket filling. Monetary deflation will be short lived and will quickly give way to a long drawn out stagflation. Best case scenario.


Housing will go lower as ARM’s adjust and inventory floods the market. The lenders halting foreclosures will shrink inventory temporally next year followed by additional serge in inventory when all the pent up foreclosures that have accumulate come on the market all at once.    

10/18/2010 12:53 PM
I also think that the inflation is everywhere, besides maybe real estate and consumer electronics, and is accelerating. Since there are no signs for now for a strong recovery, seems like the things are really going towards stagflation.

One difference with Japan is that their population is decreasing as opposed to here. I don't know if that is good or bad.

10/18/2010 12:49 PM
If prices aren't dropping significantly w/ still atleast 10% of the pop. out of work and  tougher credit standards, I think we are past the deflationary pt.  I think we are more likely to see inflation and it is starting to show in things like gas and groceries.  Buy oil now, gold is over priced, & by next summer you will see oil at 90 to 100 bucks a barrel again.
10/18/2010 12:37 PM

We are the new Japan. The government is doing the same steps so why would we not have the same out come. 20 years of nothing but stagnate no growth economic conditions. Learn from Japan, History is there to learn from. This is different but you still need to look at all options.


 How about giving the 98% of hard working Americans raises, we will spend it back into the economy. No, this economy with 2% owning 58% of all wealth in the U.S. is better, they are getting everything going, aren't they ?  They need their tax breaks so we the 98% on the bottom need to supplement the top 2% with our taxes going up. Tax the poor and give to the wealthy please tea baggs, koch bro's and republic-ans tell me how this works again !!!! The 2001,2003 tax breaks have done nothing !! look at the economy. All the corporate tax cuts they have done nothing but went to the bank accounts of the extreme wealthy and stayed there collecting dust, just like the idea that giving the wealthy tax breaks and corporation would help the country as a whole...NOT.......

10/18/2010 12:28 PM
Working Monday

Gold, oil, food grains, cotton, and strategic metals are going up, up, up!


Deflation is in real estate --- everything else is increasing.


When does inflation hit?

What you are describing is the level rising in the World Currency supply of dollars. Commodity prices are being driven by world wide inflation of dollars while domestic inflation is being masked by price deflation in housing (a major component of the index).  

10/18/2010 12:17 PM

Maybe if Fleckenstein just keeps talking about inflation, it will finally happen.  So far, if  you followed his advice of the last 24 months, you would not be a happy camper.


Individual instances of price increase, particularly where tied to the price of oil (Fed Ex) are not good barometers.  Individual instances of price decreases exist as well.  In order to diagnose inflation, some broad measure, however flawed, is a must.


That said, some inflation may finally be in the cards, though probably not the cataclysmic variety he seems to expect.

10/18/2010 11:40 AM

Gold, oil, food grains, cotton, and strategic metals are going up, up, up!


Deflation is in real estate --- everything else is increasing.


When does inflation hit?


10/18/2010 11:32 AM

The difficulty with fed policy is how to restore the middle class in the US. End demand is the driver. The answer is government debt reduction, jail the crooks ie.wallstreet,political hacks,greedy interest groups etc. Wages need to rise or prices need to fall for end demand to increase. Voters do not have a choice this fall. Buy American and support our Troops.

10/18/2010 10:41 AM

Let me see if I can help some of you understand this.


Price deflation like we have in housing is a symptom of a deflating economy. The root cause is the continuing loss of manufacturing caused by neglecting to deal with the trade deficit and the ownership transfer to foreigners that occurs as a result. As our national bankruptcy liquidation continues unemployment will continue to add unemployed to long term rolls crushing demand for goods and services. Of course there is an important inverse relationship to demand for social services. Consumer spending is such a significant part of the economy that dropping demand reverberates throughout the entire domestic economy.  


Monetary deflation is also a problem right now due in part to the carry trade. The FED is adding to the money supply and as soon as new money is available to loan it heads off shore to fund their economies. Think of the domestic money supply as a leaking bucket. The FED is trying to keep it filled, to spur growth, by pumping money into it, but the holes (carry trade, etc) are bigger then the pump can handle. If any of the holes get plugged or restricted the bucket fills too fast because the pumps are on high and sinks into a bigger bucket (world currency supply). If that occurs, it will take the dollar down with it.


The FED has been walking a tight rope trying to balance the volume. Unfortunately, there are limitations. Foreign central banks and governments cannot allow unlimited capital to flood their domestic economies because it can cause inflation if not restricted.


What we have seen recently is the limitation being implemented. Brazil raising taxes on only new foreign investment to dissuade too much foreign capital is a good example and most of the central banks and governments are considering some form of limitation.


What they are doing is adjusting the valves on their buckets pumping less out of the world currency bucket and the currency in the world bucket will rise. As the world money supply raises higher then a hole in a bucket the currency equalizes and starts to flow slightly in the opposite direction at that level in the bucket. Once again there is a danger that the FED pumps will over fill the bucket sinking it and the dollar.


There are thousands of possible scenarios here but I think you can get the basic idea of bucket theory from the above examples. The anxiety that Bill and others feel is that Ben will hesitate to turn down the pump in time because of domestic economic pressures sinking the dollar as the world currency.


IMO, China doesn’t want the same problems and so they are considering two Chinese currencies. One free floating currency to be traded world wide and another less convertible currency for domestic consumption and control. In essence, they are also betting that Ben can’t get the pumps off in time. Ether way they have the bases covered.   


Economics has NOT gotten simpler.  Bankers have not become less greedy.  And now our caculations need to depend not on unit prices but basic measurements of pounds, ounces and metric measures.  Lies, damned lies and statistics.
inflation is a problem in extreme poverty:  poverty is why printing money is all that is left.  but that isn't stagnation, that's no more middle class caused by putting all costs on the poor.  if you play amoral, and the poor can just be, graduate to Mexico's condition, if no conscience says third jobless is now the new norm.   rich people create poor people.  and then blame the poor.  cannot get into heaven with the view that poverty is okay for other people.  true living wages = healthy business = healthy mony markets = permanent surplus.
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