Schminflation

Why is deflation bad again?

Today, I had coffee with a smart hedge fund buddy. We chat when he is in town from Hong Kong where he runs a fund investing in stuff.

He’s a smart dude.

We usually chat about life a bit but I like chatting with him about the markets. Macro things.

He was kind enough to recall that I’ve been “bullish” since 2009 and was right and all that fun stuff that people say to friends in conversations when they are nice smart guys.

But the interesting part came later.

I asked:

“So if technology drives down the cost of labor and therefore the price of goods and therefore prices fall and things get cheaper what is wrong with that?”

“Exactly!”

He told me how he’s been thinking this for years. About how “deflation” isn’t necessarily a bad thing. I’m just stumbling onto this idea.

It seems kind of obvious now…

I mean, I would like to have a cheaper iPhone. Wouldn’t you?

The conversation got scarier from there.

“Aren’t the central banks committed to fighting deflation with every weapon they’ve got?”

The answer here is clearly — yes.

From the U.S. to Japan, global central bankers are fighting the d-word like mad.

So how do they do this?

Monetary easing.

And what does that mean?

Make money cheap.

Good right?

Well. It could be good if the cheap money went to more goods being bought. That could create demand and avoid the dirty “d” word (even though I still don’t understand why it is necessarily a bad thing in and of itself).

BUT, in reality what is happening is that this cheap money is facilitating ASSET purchases.

Not only that, the central banks themselves are buying ASSETS.

Hmm…

Assets. Not goods.

So what is happening?

ASSET prices are rising. Like a lot.

Anyone see the stock market lately?

From real estate, to art auctions, to bitcoin, to startup valuations, to global bond markets, the prices of assets are rising.

So what? right?

This is boring…zzzz

But, back to my friend:

“This explains the gini-coefficient doesn’t it?”

“I think it might.”

That is kinda scary.

Like if what is happening is that our global central bankers are fighting an inevitably unstoppable bogeyman called deflation, which might not be so bad, by inflating assets, which are held by wealthy people.

They might be causing real social problems — social tensions.

Like imagine if what happens is that the goods and services that those with assets actually DO consume — like say Uber …or cars…or gasoline…or real estate — actually DO go up in value. Then maybe certain high value goods might become out of reach for people who don’t have assets.

The goal — remember — is to make the prices of everything higher…

But what if it only works at the margin on these goods?

So circling back to the beginning:

What if technology is so powerful that it crushes even these central bankers?

Like, what if Japan didn’t have a “lost decade” because of anything bad but because it had good things. Like what if Japan was the future not because things were “slow” from a GDP point of view, but what if their GDP was low because in the future, when we are all as technologically advanced as Japan, things get faster, more efficient, cheaper…at an accelerating rate?

Today the Federal Reserve said it is going to keep interest rates at zero for a very long time. Like through 2016.

I don’t see technological innovation slowing down between now and then.

So what does all this mean?

I wish I knew. It seems like we could be in for some very strange and very tense times if asset prices continue to rise like they are….

Even my genius buddy just shrugged.

If only the economists were as uncertain.