Saturday, February 4, 2012

Joseph Salvo is Concerned about My Credibility

Joseph Salvo emails:
Deflationary spike will crush your credibility 

Dude your killing me! I subscribe to an austrian view on the economy, but I know better than to predict prices in the short term (as you are, not to mention you are shouting it from the rooftops). I really hate to see you have to eat crow so I am advising to to halt your aggressive 2012 inflationary expectation. Reason being you are drawing a lot of attention to the Austrian school of thought which is great. However, if there shall be a deflationary spike occur at some moment in 2012 it will not bode well for you. I echoed similar thoughts in the comments section many times, not sure if you caught that so I'll reiterate. According to Costantino Bresciani-Turroni in his book The Economics of Inflation, Weimar had two massive deflationary spikes right in the face of massive money printing (1918, 1920). So please recognize the trillions of dollars in debt, derivatives, and such that is attempting to be cleared through the natural free market process. It takes one non-linear event to occur - one last straw, one last grain of sand - to send the markets into free fall. We are not in a total centrally planned economy so there will be some instances of the free market attempting to cleanse the malinvestment that exists today.

Not a day goes by that I don't read your blog, and I will continue to read your blog, but I just think your going out on a limb predicting (or should I say guaranteeing) that there will be a no doubt, huge inflationary wave in our immediate future.

Kind Regards,
Joe Salvo

First, for the record, I am not "guaranteeing" huge price inflation, I do, however, believe it is very likely.

I get many emails similar to Salvo's warning me about my forecasts and my tying them in with the Austrian school of economics, since the Austrian school of economics recognizes that exact forecasts are not possible in the science of economics. That being said, it does not mean that the Austrian school is completely blind to the future.

Austrian business cycle theory tells us for example that a manipulated boom period occurs when a central bank adds significant amounts of new money into the system. Further, it tells us that during a slowdown in money growth a slowdown in the manipulated economy is likely to occur.

Thus, I am not going to sit here at my computer and play dumb as to what might happen in the economy, when the Fed is pumping and draining money. There are things that are pretty obvious, even though most economists have no damn clue because of their nutty Keynesian view. Let's face it, none of them saw the downturn in the economy coming  and none of them saw the developing upturn. I spotted both and said so clearly.

For my real time warning on the downturn  see herehereherehere,hereherehere and here.

I also was very clear that I expected a manipulated recovery, when most saw only further doom for the economy and I called out the Keynesians for being clueless about the developing recovery. In early November, I wrote:
The Munk Debates quote [Keynesian] Paul Krugman: 
It’s now impossible to deny the obvious, which is that we are not now and have never been on the road to recovery. 
The recovery is a Fed manipulated recovery, but all the numbers that Krugman looks at will signal to him, down the road, a recovery. 
In other words, it's just another quote to hang on him, along with his warnings of deflation
On December 22, I wrote:
The turning manipulated economy is too obvious to ignore at this point, even by guys who have bad (Keynesian) economic models. I expect Nouriel Roubini and even Paul Krugman to crack soon and admit the economy is turning.
Roubini cracked first on January 19.  Krugman buckled a week later:
... there are reasons to think that we’re finally on the (slow) road to better times.... 
Now, admittedly, my forecasts aren't quite as easy to pull off as it looks. The first problem is that it is difficult      to actually get correctly what the money supply is. You need to cross check that against other data to get a solid idea. Second there are other factors always working in the economy at crosstrends to the major trend. One needs to be kept an eye on as much as possible (and you can still miss things). So good luck trying this at home. You need to really understand Austrian theory and watch a lot of data.

But once you have that down, you can catch most of the major trends. Another example is the coming economic collapse of China. I have been warning about it for some time in the EPJ Daily Alert and it appears that some mainstream news outlets are beginning to sense the problems in China. Though there are a lot of clueless still among us when it comes to China, including Carlyle Group's David Rubenstein, Obama buddy Andy Stern and AEI's Jonah Goldberg.

Austrian theory can not help us make forecasts like they do in physics (Put X gallons of  fuel into a rocket and it will fly Y miles). We can't for example say that if Bernanke prints X billions of new dollars the stock market will go up by Y or that the economy will be strong for Z days or that price inflation will be exactly W%. But, on a bit firmer ground and might be able to say, "Hey Bernanke is blasting money out at an annualized growth rate of 25%. This is going to pop the stock market." The world is much too complex to get exactitude in economic forecasts but this doesn't mean we are totally blind. Because of  the complex nature of human action, we are not going to get every trend correct, but it is possible to do much better than many new Austrians believe.

The attacks by Mises, Hayek and Rothbard on the phony science of econometrics are completely justified. Econometricians think they can model the entire damn world to a fraction of a percentage. They are clueless wackos. But because of their popularity, they must be attacked mercilessly as Mises, Hayek and Rothbard did.

My  attack is aimed at the same clueless frauds, but from a different direction. Knowing what Austrian economics teaches, it is often easy to spot problems in their faulty forecasts and they should be called out on them. Maybe at some point it will sink in to the average intelligent person that the Keynesians are wrong if they can't get a damn thing straight.

As for my price inflation forecast, I occasionally get emails telling me that money printing doesn't necessarily lead to price inflation and Rothbard said so in America's Great Depression book. Yeah I get that.  And I personally saw Milton Friedman make a fool of himself in the early 1980s, when he warned about major price inflation that never came despite growing money supply. Friedman was off because he didn't understand what Rothbard taught and he had a very mechanistic view of how price inflation developed from money growth. Rothbard's view was much more sophisticated and grounded on a much sounder methodological base.

But if a central bank really prints aggressively, it can over power any increases in productivity and thus the price inflation will come---and the Fed is printing very aggressively right now. Further, the current period, appears to me, as period when the demand to hold cash will reverse from the panic levels during the depths of the recent crisis. A decline in the demand to hold cash has a similar impact on prices that actual money printing does.

Finally, as the government regulation spreads to more and more parts of the economy, this has a  suffocation impact on productivity.

Bottom line: It appears to me that a perfect storm is developing for very strong price inflation. I expected it to develop a bit earlier, in the second half of 2011. The eurozone crisis likely slowed down the serious price inflation arrival as investors sought dollars as a safe haven during the crisis, but the European Central Bank is now in printing mode, so the need for the dollar as a safe haven will decline and money will flow out of dollars (which will be price inflationary).

It's true that the U.S. financial sector is a rickety ship that could spring a leak from many different points and that could cause an increase in the demand to hold cash, which would put downward pressure on prices. But those leaks usually develop when the Fed has slowed printing, not when it is in aggressive printing mode.

Forecasts in economics are not certainties. They are based on looking at factors developing in the economy and what kind of impact theory tells us they should have. The problem is that we can't for certain know all the factors in advance. Thus, forecast in economics are educated guesses. But the more information you have, the more data you watch and, the better your understanding of theory, the better your forecasts are going to be.

With that said, I fully expect a major increase in price inflation, given the amount of money the Federal Reserve is now printing, given that the demand to hold cash is declining as the economy improves. That many prices are already percolating under the surface---which indicates productivity is not strong enough to prevent climbing prices.

The economy is tricky and other factors I haven't spotted may have an impact, but this is unlikely. I fully expect Krugman to look like a total idiot with his deflation warnings.


  1. I really have to agree with Salvo on this one. His critique is not that Wenzel's analysis is particularly flawed but that any analysis must necessarily be flawed. By taking such a strong forward position on the issue of prices in the name of Austrian economics, these predictions are threatening the credibility of the Austrian approach.

    Are we in a Treasury bond bubble? I think we are. If that's the case, a recovery could put pressure on interest rates to rise even while inflationary pressures are still quite modest. Such interest rate hikes could collapse the bond market and produce massive deflation before the public becomes aware of high-level price increases. We've already seen a doubling of the CPI in the last year or so but no one is calling that an inflationary situation. So the credibility of a prediction rests on public perception as much as on technical accuracy, and it seems to me that that is what Salvo is warning about.

    1. The US is backed into a corner with interest rates. If rates spike to even just historical averages the interest on the national debt will skyrocket.

      This will put politicians in the precarious position of having to either 1: drastically cut government spending(I mean cut half the budget at the very least...immediately) or 2: print massive amounts of dollars to pay the interest(this is the death spiral as the more that is printed to pay debt the less willing investors will be to buy US debt and interest rates will continue to rise to juke demand for bonds higher-this of course leads to even higher debt payments and more printing). There is the third option of a plain ole up front default but clearly the most politically palatable option is to print.

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  3. Thanks for being a man, and calling it as you see it, Bob. Your forecast is logical and defensible, and gives subscribers like me a chance -- not guarantee -- to make some money off of this silliness.

  4. I think it was in Mises' Planning for Freedom where he said that a judicious housewife knows more about the purchasing power of money than a host of CPI adherents.

  5. keep up the good work, the only thing i would point out is the increase in M2 also shows people increasing demand for debt

  6. Rob, in a world without the fed I would agree. I just don't see a scenario where the fed would allow rates to rise rapidly. We are levered to the teeth as a country and especially as a government. They would simply monetize more debt until the end game is upon us and the dollar is destroyed. Could the fed allow rates to rise and the sure to follow massive wide spread defaults happen? Yes, they could, but I see that as HIGHLY unlikely as people all across the spectrum would be yelling for the to provide "temporary" liquidity during this time of crisis. Ben will not allow for a 1930s deflationary depression.

    1. What you are suggesting is an alternative scenario in which the Fed actually abets more inflation. Then you run in to the prospect of inflationary expectations which will also lead to higher interest rates and a collapse of the bond market. The only question here is how high the inflation would have to get and how long. My guess is that it wouldn't have to get too high before the collapse occurs. But I'm not really into making predictions. I was simply suggesting a scenario in which Mr. Wenzel could be basically correct and still come up with predictions that don't pan out in detail, and I think that's what Mr. Slavo is worried about.

      At what level do inflationary expectations kick in? Do investors start to worry about it before or after the general public does? Who knows? It depends on a lot of other things. That's why Austrian theory says that precise predictions are not possible. In some respects, merely making these predictions is misleading with regard to Austrian theory because that theory says the successful predictions are not the proper test of a theory.

      Besides, there are other developments that could lead to a collapse of the dollar or of the bond market that could kick in before inflation ever gets a chance to.

    2. Well I believe the fed can spew enough rhetoric and print enough to keep rates low, even if inflation is rearing its head. Yes, eventually they will have to give way to market forces, unless of course they wanted a Zimbabwe style collapse, but that isn't for a while I am afraid. There are already enough dollars circulating, especially in foreign countries, that if faith is lost in our currency, goods will cease to come on shore and instead it will be dollars. Then you have the banks who will not sit in their dollars at the fed for .25% with rates moving higher. Those dollars will flood the system. Can the fed really suck in all the money they gave out over the last few years, while bonds prices are falling(possibly collapsing)? I doubt it. There are more variables than we are aware of, and it will certainly be interesting to see how it all plays out. All I know is I feel safe buying gold and silver.

  7. I think this discussion gets lost in over-generalizations and differences in perspectives.

    "We've already seen a doubling of the CPI in the last year or so but no one is calling that an inflationary situation." While it may be true, it matters less to my portfolio. Increases in the CPI necessarily mean that more money is flowing into the goods that make up the CPI whether anyone chooses to label that an inflationary situation or not. My portfolio doesn't care what anyone calls it. My portfolio only cares that more cash is flowing into those assets and, thus, my investments in those assets will do well.

    While in aggregate, it is possible for gains in productivity to outstrip the money pumping, I think that is unlikely in the world of oil, precious metal production and, to a lesser degree, agriculture. Moving to a higher ends of the production chain (electronics, medicine, clothing), I believe it is much more likely that gains in efficiency will outstrip monetary inflation. The upshot being that the Austrian insight into the structure of production yields a much more robust analysis than mainstream analysis and, wisely applied, is more likely to yield a good investment portfolio.

    All that said, I do worry a bit about the bad PR leveled on Austrian Economics by people who don't make the same distinctions that we do. Although we ultimately cannot control how the mainstream perceives our views, by being as clear as we can with terms like inflation (ie, which end of the production structure?) and being appropriately modest about predictions (ie, timeframe and probabilities), I think we can go a long way toward influencing others.

  8. If the ECB is in printing mode, why would demand for the dollar as a safe-haven decline? That's backwards. Maybe you're saying that they were having a debt crisis, but now it's being inflated away so they aren't panicking anymore. At the end of the day none of the problems have been solved in either the US or Europe. If you see bank lending picking up, chances are price inflation is on the way.

    1. dollar demand isnt declining at all... the euro is on the verge of breaking up & the UK economy is currently doing worse than it did during the Great Depression so banks will not park their funds in either of those economies leaving only the US... I dont see price inflation picking up in any way (other than commodities but those are decided by world demand & the quantity supplied)

  9. Could this be a case where there is both? For instance, while the market for real estate is on the up say in San Francisco and Manhattan pushed by cheap interest rates, other places like western Florida and Las Vegas, where there is a huge overhang from the previous bubble, price still decline so in aggregate things can be balanced from an overall perspective but on the ground, not so hot.
    In the case of Weimar, there was still massive money printing by the newly elected socialist to carry out there agenda meanwhile there was the usual switch from wartime expenditures to peacetime that every combatant went through.

  10. Mr. Wenzel, can you clarify something for me please? When the steep price inflation hits would that put an end to the improving economy?

    Do you think the price inflation will put us in a depression?


  11. I would add one additional note from an academically critical perspective: Mr. Wenzel, please disregard any post beginning with the socially dependent fad-chasing and grammatically incorrect "Dude your killing me!"

    Nothing worthy will follow. Although it may provide a marginally entertaining diversion with your inserted analysis. However, on second thought and with forgiveness of both social dependence and grammatical error, if taken literally, may be worth regard and your effort to respond after all.

    May your efforts continue to produce valuable and lucid analyses in ever-increasing quantities to the benefit of all but your detractors.

  12. Thank you for this article. As a subscriber to EPJ I found this article very useful in filling in a context I was lacking in my understanding of your work. Thanks again!