Expert Commentary

Gary Shilling's Key Deflation Research & Commentary

In 1998, Gary Shilling wrote Deflation: Why it's coming, whether it's good or bad, and how it will affect your investments, business and personal affairs (Lakeview Publishing Co.). The following year, he wrote Deflation: How to survive and thrive in the coming wave of deflation (McGraw-Hill). In both books, he made the case for chronic deflation stemming from a number of factors including the spreading of market economies that increases global supply, ongoing deregulation that cuts prices, increased competition due to the Internet, reduced defense spending in the aftermath of the Cold War, increased productivity due to improving technology and the switch by U.S. consumers from a borrowing-and-spending binge to a saving spree.

Deflation, he wrote, is the norm in peacetime when the federal government isn't creating excess demand and the resulting inflation with oversized spending. And six decades of wartime -- and inflation -- had ended, dating back to the rearmament in the 1930s and World War II, which was followed by the Cold War and its Korean and Vietnam hot phases and, later, by the War on Poverty.

In the January 2001 edition of his Insight newsletter, Gary Shilling forecast 1% to 2% annual deflation rates. "This brand of deflation will be the good variety resulting from new tech productivity-driven excess supply, not the bad deflation of deficient demand, as was seen in the 1930s Depression."

A year later, in January 2002, Gary Shilling again wrote in Insight that deflation loomed, believing it would be the "good deflation of new tech-driven excess supply, as in the late 1800s and in the 1920s." He said the 14 deflationary forces that were featured in his two Deflation books were now at work. Those forces were:

  1. End of Cold War has led to global cuts in defense spending
  2. Major country government spending and deficits are shrinking
  3. Central banks continue to fight the last war -- inflation
  4. G-7 retirements will lead to reduced benefits and slower growth in incomes and spending
  5. Restrucuting continues in English-speaking lands and will spread
  6. Technology cuts costs and promotes productivity
  7. The Internet increases competition and slashes prices
  8. Mass distribution to consumers reduces costs and prices
  9. Ongoing deregulation cuts prices
  10. Global sourcing of goods and services curtails costs
  11. The spreading of market economies increases global supply
  12. The dollar will continue to strengthen
  13. Asian excess capacity will intensify global glut and reduce worldwide prices
  14. U.S. consumers will switch from borrowing and spending to saving

In his January 2004 Insight report, Gary Shilling predicted 1% to 2% deflation. "Despite 9/11, defense spending should continue well below Cold War levels, total saving will grow faster than investment, and central banks will be impotent in resisting deflation. Restructuring persists globally and new tech, despite stock market embarrassments in the recent past, will continue to drive productivity and excess supply. Globalization with persist in turning worldwide excess capacity into deflation, and the shift by U.S. consumers from borrowing and spending to saving will put downward pressure on prices internationally. Deflation will persist until the next major shooting war, and will be the good kind, spawned by excess supply, not the bad deflation of deficient demand. Still, the transition to it may be rough since few are prepared, and a financial crisis that could turn good deflation to bad is possible."

Later in 2004, in a speech to the 42nd Contrary Opinion Forum in Vermont, Gary said that few agreed with his mild deflation long-term forecast, probably because they've only experienced inflation and mistakenly believe that prices are rising on everything they buy. Still, he said that inflation is fading and many powerful deflationary forces are hard at work, including the burst in productivity-soaked semiconductors, computers, the Internet, telecom, biotech and other new tech. Restructuring, inflation-wary central banks, globalization and the likely shift of U.S. consumers from borrowing and spending to saving also promote deflation.

Gary said he foresaw the good deflation of excess supply, as in the new tech-driven late 1800s and the 1920s, not the 1930s bad deflation of deficient demand.

In December 2004, Gary Shilling and Marc Faber, the Hong Kong-based publisher of The Gloom, Boom & Doom Report, took part in a unique e-mail debate on the global economy, its future and, in particular, the question of whether deflation was on the horizon.

The debate took place over the course of a week and was printed in the January 2005 Insight report. Gary restated his belief that "goods and services prices in the U.S. and probably throughout the world will generally decline in the years ahead." He pointed out again that "inflation has always been a wartime phenomenon. In wars, heavy government spending creates demand that exceeds supply, so prices rise to ration scarce goods and services. In peacetime, however, deflation reigns."

"I'm assuming that the world is now essentially at peace, so deflation is likely. Sure, terrorism remains a threat, and defense spending's share of GDP has risen in response to the military costs in Afghanistan and Iraq. Still, I'm assuming that these outlays plus homeland security costs don't rise to Cold War levels."

Gary again pointed to the various forces (listed above) that point to deflation in the years ahead, and noted that "deflationary expectations already exist and are spreading," such as the ever-bigger incentives required to sell autos to Americans. Now they demand early discounts on Christmas merchandise, and when Wal-Mart didn't offer big price cuts at the beginning of the [2004 holiday] selling season, its sales suffered."