Expert Commentary

Deflation Will Persist

We are hearing a lot about deflation. And there was a headline in the New York Times in April that captured the mainstream view on this topic.

The headline reads:

What the Negative Price of Oil Is Telling Us

The subtitle is more interesting. It reads:

“We’re in a deflationary MOMENT that surpasses anything seen in most people’s lifetimes.”

So, first of all, kudos to the New York Times for even recognizing deflation, because it’s been off the radar for a long time. I would change one important word in that subtitle. The word “moment.” This is not a deflationary moment. This is not something that will come and go quickly. This is a deflationary ENVIRONMENT. A trend that has been building for a long time, and deflation will very likely be with us for the foreseeable future. So let’s discuss this with a few charts.

I built this chart because while most people know about the crash in in crude oil. Right we saw that May contract go negative last month.

These other commodities don’t get enough attention. Nearly every energy commodity. Nearly every agricultural commodity has been collapsing. Right. Sugar, Cocoa, Soybeans, Lumber. We’ve got cattle and hogs on this chart. The reason that the press is finally talking about deflation is because prices are suddenly falling. Many investors. Many economists even. They falsely equate deflation with falling prices. This is a complete misunderstanding. The terms inflation and deflation relate to money and credit. Inflation is an expansion of money and credit. Deflation is a contraction of money and credit. Falling prices are merely a symptom of deflation. If you’re waiting to see prices falling, you are behind the curve already. Contrary to that headline, the negative price of oil isn’t telling us anything about deflation.

Now, there are some things that tell us a lot about deflation. For widespread deflation to occur, you need two things: One you need a build-up of money and credit. This next chart shows the money side of that equation.

This is the monetary base in the U.S. We had a gradual rise until 2009 and then a near-vertical spike following the financial crisis. And we may very well have peaked. The credit side of the equation is even more important. Credit utterly dwarfs the monetary base. U.S. Private Credit is around $70 trillion. That compares with about a $3.8 trillion monetary base.

This is an unprecedented buildup of credit, and it’s a big reason why deflation will persist.