An Argument for the Arrival of “Terminal Deflation”

The Federal Reserve cannot stop deflation.

The Federal Reserve cannot stop deflation.

Indeed, an April 29 Foreign Policy article titled "Terminal Deflation is Coming," points out "the Fed's inability to hit its inflation targets."

At least one sure sign of a deflationary psychology at work is the plunge in oil prices.

Here's an excerpt from that article:

Given the enormous scale of the Fed's monetary interventions, why is deflation more likely than inflation?

The world has been enduring deflationary pressures since at least the 2008 crisis. In August 2008, the Fed's balance sheet was less than $1 trillion. By November, it had doubled, even before the Fed began its first round of quantitative easing. Four rounds later, in late 2014, it stood around $4.5 trillion... [I]t was paired with another $2.3 trillion in quantitative easing by the European Central Bank, plus close to a combined $2 trillion from the Bank of Japan and the Bank of England. This sustained and concerted monetary expansion was among the most astonishing feats in the history of central banking and had prompted a wave of scholarly and policy thinking about the new role of central banks in managing the global economy. They already pale in comparison to the monetary efforts since this March.

But the results from the last financial crisis are instructive. All those trillions kept banking systems functioning and stock markets rising, but they produced rates of inflation that ran the gamut all the way from "nonexistent" to "anemic." The Fed undershot its 2 percent inflation target every month for several years. The eurozone was also consistently below the European Central Bank's target, usually falling below 1 percent. Japan had been locked in a deflationary trap for most of the latter half of the 1990s, and it returned again after 2008, with only a few moments of very weak inflation in between.

Well before the pandemic, it appeared that the relation between the money supply and inflation was breaking down. Central bankers had been running as fast as they could just to stay in the same place. Economists (and the Economist) began to wonder if inflation was over or had lost all meaning.

...Consumer demand never fully recovered from the 2008 crisis. Too few jobs were created too slowly... The 10 million Americans who lost their homes were unable to recover their lost wealth and the safety it brought. The same was true on a smaller scale for the millions more who found themselves underwater on their mortgages or whose home equity took a sharp hit. The Fed saved the banking system, but it took a decade to translate that effort into jobs and wages. Quantitative easing supported asset prices, but most Americans do not own assets. The Fed is not designed to affect wages and employment directly: It does so through credit markets. Fiscal stimulus is supposed to directly affect incomes and jobs, but the global mania for austerity in general and the failures of the Obama administration in particular meant that credit markets recovered while workers and households did not. The resulting inequality undercut the ability of monetary policy to stimulate the economy as a whole rather than just banks and assets. Hence the slow recovery and the Fed's consistent inability to hit its inflation targets.

The explosion of the coronavirus economic collapse into that already weak monetary environment almost certainly means that deflation is already under way, even if the overall consumer price index has not yet turned negative. Commodity prices are falling. At the time of this writing, it is still physically possible to fly from Washington, D.C., to San Francisco, and you can get a round-trip ticket for a little over $200. The fall in oil prices has been even more spectacular.

Indeed, on that point, Elliott Wave International's U.S. Short Term Update showed this chart and said:


The U.S. Federal Reserve claims it can create inflation at will, but markets don't follow the Fed. At EWI, we've been making this point since our founding. Today, the May futures Crude Oil contract plunged to -$40.32 intraday, as the CME allowed the contract to be priced below zero. It is truly a historic crash. Even the June contract dropped to $20.19 intraday and is down 66% over the past four days. This chart shows the daily continuation contract. This is a picture of the effects of a deflationary psychology.

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