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Jaguar Inflation - A Layman's Explanation of Government Intervention

By Robert Prechter, CMT | February 6, 2009

Editor's note: This article is part of a syndicated series about deflation from market analyst Robert Prechter, the world's foremost expert on and proponent of the deflationary scenario. The following article was adapted from Robert Prechter's NEW Deflation Survival eBook, a free 60-page compilation of Prechter's most important teachings and warnings about deflation.

I am tired of hearing people insist that the Fed can expand credit all it wants. Sometimes an analogy clarifies a subject, so let's try one.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing Jaguar automobiles and providing them to as many people as possible. To facilitate that goal, it begins operating Jaguar plants all over the country, subsidizing production with tax money. To everyone's delight, it offers these luxury cars for sale at 50 percent off the old price. People flock to the showrooms and buy. Later, sales slow down, so the government cuts the price in half again. More people rush in and buy.

Sales again slow, so it lowers the price to $900 each. People return to the stores to buy two or three, or half a dozen. Why not? Look how cheap they are! Buyers give Jaguars to their kids and park an extra one on the lawn.

Finally, the country is awash in Jaguars. Alas, sales slow again, and the government panics. It must move more Jaguars, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay their taxes so the government can keep producing more Jaguars. If Jaguars stop moving, the economy will stop. So the government begins giving Jaguars away. A few more cars move out of the showrooms, but then it ends. Nobody wants any more Jaguars. They don't care if they're free. They can't find a use for them.

Production of Jaguars ceases. It takes years to work through the overhanging supply of Jaguars. Tax collections collapse, the factories close, and unemployment soars. The economy is wrecked. People can't afford to buy gasoline, so many of the Jaguars rust away to worthlessness. The number of Jaguars — at best — returns to the level it was before the program began.

The same thing can happen with credit.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing credit and providing it to as many people as possible. To facilitate that goal, it begins operating credit-production plants all over the country, called Federal Reserve Banks. To everyone's delight, these banks offer the credit for sale at below market rates. People flock to the banks and buy. Later, sales slow down, so the banks cut the price again. More people rush in and buy. Sales again slow, so they lower the price to one percent. People return to the banks to buy even more credit. Why not? Look how cheap it is! Borrowers use credit to buy houses, boats and an extra Jaguar to park out on the lawn. Finally, the country is awash in credit.

Alas, sales slow again, and the banks panic. They must move more credit, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay the interest on their debt to the banks so the banks can keep offering more credit. If credit stops moving, the economy will stop. So the banks begin giving credit away, at zero percent interest. A few more loans move through the tellers' windows, but then it ends. Nobody wants any more credit. They don't care if it's free. They can't find a use for it. Production of credit ceases. It takes years to work through the overhanging supply of credit. Interest payments collapse, banks close, and unemployment soars. The economy is wrecked. People can't afford to pay interest on their debts, so many bonds deteriorate to worthlessness. The value of credit — at best — returns to the level it was before the program began.

See how it works?

Is the analogy perfect? No. The idea of pushing credit on people is far more dangerous than the idea of pushing Jaguars on them. In the credit scenario, debtors and even most creditors lose everything in the end. In the Jaguar scenario, at least everyone ends up with a garage full of cars. Of course, the Jaguar scenario is impossible, because the government can't produce value. It can, however, reduce values. A government that imposes a central bank monopoly, for example, can reduce the incremental value of credit. A monopoly credit system also allows for fraud and theft on a far bigger scale. Instead of government appropriating citizens' labor openly by having them produce cars, a monopoly banking system does so clandestinely by stealing stored labor from citizens' bank accounts by inflating the supply of credit, thereby reducing the value of their savings.

I hate to challenge mainstream 20th century macroeconomic theory, but the idea that a growing economy needs easy credit is a false theory. Credit should be supplied by the free market, in which case it will almost always be offered intelligently, primarily to producers, not consumers. Would lower levels of credit availability mean that fewer people would own a house or a car? Quite the opposite. Only the timeline would be different.

Initially it would take a few years longer for the same number of people to own houses and cars – actually own them, not rent them from banks. Because banks would not be appropriating so much of everyone's labor and wealth, the economy would grow much faster. Eventually, the extent of home and car ownership – actual ownership – would eclipse that in an easy-credit society. Moreover, people would keep their homes and cars because banks would not be foreclosing on them. As a bonus, there would be no devastating across-the-board collapse of the banking system, which, as history has repeatedly demonstrated, is inevitable under a central bank's fiat-credit monopoly.
Jaguars, anyone?

……….
For more on deflation, download Prechter's FREE 60-page Deflation Survival eBook or browse various deflation topics like those below at www.elliottwave.com/deflation.


Robert Prechter, Chartered Market Technician, is the world's foremost expert on and proponent of the deflationary scenario. Prechter is the founder and CEO of Elliott Wave International, author of Wall Street best-sellers Conquer the Crash and Elliott Wave Principle and editor of The Elliott Wave Theorist monthly market letter since 1979.

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never in 3000 years of

never in 3000 years of history has a nation who used fiat currency gone down the deflationary path to ruin...

"When governments fear the people there is liberty. When the people fear the government there is tyranny."
-Thomas Jefferson

I am more concerned about the return of my money than the return on my money. --Mark Twain

Stop promoting Prechter

Nystrom -- I don't know who you are, but you must be a paid hack for the Elliott wavers. Prechter has been proven wrong for the last 20 years and many people have lost fortunes following his advice. He's only right now because the market had to turn sometime. People -- don't listen to Prechter! I bet Nystrom uses his pull on this site to remove my message. Check back and see!

"Nystrom -- I don't know who

"Nystrom -- I don't know who you are, but you must be a paid hack for the Elliott wavers."
LOL!!!

Seems as if someone missed the clue train. Let us help him out :)
http://www.dailypaul.com/node/223

"I bet Nystrom uses his pull on this site to remove my message. Check back and see!"

Michael is actually VERY patient with the people that frequent his site. I'm sure your post will be left up for posterities sake, if not for a good hardy laugh.

Hahaha

I suspect you will find out shortly who Michael Nystrom is.

Ĵīɣȩ Ɖåđşŏń

"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln

hahahaha

yep...still laughing...hmmm it reminds me of one guy coming on Obama website raving about how beautiful and smart Sarah Palin is.LOL

(Better) to be confused in the search for truth than fully confident and sound asleep in a dream of lies. ~ Michael Nystrom
http://www.votenader.org/blog/2008/09/10/statement-to-ron-pa...
http://www.flickr.com/photos/57925480@N00/2660779139

LL on Twitter: http://twitter.com/LibertyPoet
sometimes LL can suck & sometimes LL rocks!
http://www.dailypaul.com/203008/south-carolina-battle-of-cow...
Love won! Deliverance from Tyranny is on the way! Col. 2:13-15

Michael, you keep posting

Michael, you keep posting articles warning of deflationary times ahead, while most of us DPers believe hyperinflation is coming. Do you not believe that a massive increase in the money supply will bring the value of it down? Or that oil-producing countries will start to sell their US debt to raise capital because of low oil prices, thus bringing the value of the dollar down? When the market is flooded with something that nobody wants, it loses value.

Do you think this flooding of US debt (bailout bills) will be too much for the world? Somewhere along the lines everyone will say enough is enough, the emporer has no clothes and these bonds and bills are worthless.

How does the US dollar gain in value when it's being printed at an exponential rate? It has doubled in volume the last 5 months.

Will the US have to go bankrupt before we will see hyperinflation?

Inflation vs. Deflation

tylerc217 - Its not just about money supply, but also about demand for money. If increasing money supply is met by corresponding demand for money, there is no inflationary impact. Michael is right that the banks have money in the form of bank reserves injected directly by the Treasury via the TARP, but they are not lending it. Why are they not lending? Because there is a relative scarcity of credit worthy borrowers who want to borrow. The problem with banks is that they always want to lend umbrellas when the sun is shining.

It's easy enough to see that rising levels of household and corporate defaults and bankruptcies translates into fewer credit worthy borrowers. On the demand side of the equation it makes intuitive sense why households that fear losing their source of income and businesses in danger of going bankrupt would reign in spending.

This goes hand in hand with the burgeoning fiscal budget defcit, because as the government (i.e. public sector) goes deeper into debt, private sector savings rises. The practical consequence of this is that private sector borrowings go down. Note that when the private sector pays down debt, it is the functional equivalent of saving.

In other words an important reason why banks aren't lending, is because the private sector doesn't want to borrow. This probably means that there are too many banks relative to the quality of their loan assets, and that many more of them will founder and be closed down.

In connection with this, efforts to prop up the banks by using TARP funds to purchase their toxic assets to cleanse their balance sheets and house them in a "Bad Bank" will only prolong the banking crisis, not unlike what happened in Japan in the 1990s and right on up to today.

A good definition of a "Bad Bank" is one that is insolvent, and one should never invest in or lend money to an insolvent bank. If government bank regulators determine that a bank is insolvent, the bank should be seized as was the case with IndyMac and Washington Mutual, not the mention a growing list of smaller regional banks. The good assets should be separated from the bad assets and sold. If the the cost of warehousing the bad assets is estimated to be more than what they could reasonably be expected to sell for at some time in the future when market conditions improve, then they should simply be sold immediately at whatever price that will clear the market, or be totally written off to zero. That's it. That's more or less what the Resolution Trust Corporation did with the banks that went under in the savings and loan crisis of the late 1980s and early 1990s.

When Roosevelt was elected in the Great Depression, Congress passed the Emergency Banking Act of 1933 right out of the gate, which empowered Roosevelt to declare a bank. When the banks came back from vacation, there were about one third fewer of them.

* * * * * * * * * * * * * * * * * * * * * * * * * * * *

Hey Fredo, let's go fishing.

Ed Rombach

Hey Fredo, let's go fishing.

Ed Rombach

Michael Nystrom's picture

Hi Ed!

Nice to see you here.

So where do you come down on the inflation / deflation debate?

As far as I see it, as long as banks continue to hoard reserves (and the Fed encourages that by paying interest on banks' reserves), we will remain in a deflationary environment. Loans will continue to go bad, credit will continue to be destroyed, and it will not be replaced fast enough by the banking and shadow banking systems, which were so active in creating the unsustainable bubble in the first place.

To be mean is never excusable, but there is some merit in knowing that one is; the most irreparable of vices is to do evil out of stupidity. - C.B.

Inflation vs. deflation

Agreed.

********************************

Hey Fredo, let's go fishing.

Ed Rombach

Hey Fredo, let's go fishing.

Ed Rombach

I have a question for you

I have a question for you Michael. What if foreign nations quit buying US debt and the US has to monetize all of it's own debt to finance the empire compounded by bailout/stimulus package one after another? Do you think that will rapidly increase the chances of hyperinflation? What about mid-term things such as the ponzi scheme Social Security/Medicare? I personally don't think there is going to be a hyperinflationary collapse of the dollar at this point in time.

Michael Nystrom's picture

It is a possibility

It is an interesting question. Most of the buyers are between a rock and a hard place. China, Japan, Taiwan - the big buyers - earn lots of US dollars from their exports. Well - what will they do with all that money otherwise? If they sold the dollars and traded them for their local currency, their local currency would go up in value, making their exports less attractive. This is why they buy our debt in the first place. Their economies depend on exports, and that depends on a cheap local currency, as well as the ability of Americans to keep borrowing. It is very dysfunctional.

For the foreigners to quit buying our bonds would be the equivalent of MAD - mutual assured destruction.

I think we may get hyperinflation at the end of the deflation. Remember that the US Fed kept interest rates low for a long, long time. The US took Japan's role as being the font of global liquidity, and there was a huge carry trade going on. People / banks / funds could borrow very low in the US, take the money elsewhere and invest it for a higher return.

Now as their investments collapse, they still have to pay back the money they borrowed. But as you noticed, it isn't as easy to get a loan any more. There is a mad scramble for dollars to pay back these loans, which is pushing up the USD. Not only are trillions of dollars being destroyed through default -- making remaining dollars more valuable -- but demand is high because the dollar and Treasuries are viewed as a safe haven. I know, I know - don't ask me why. Old habits die hard.

As for the Social Security Ponzi Scheme - I have no doubt that the government *wants* inflation to reduce their burden in paying off the pyramid scheme. However, I question their ability to be able to do so. Just as the government can't decree a sunny day, they can't decree inflation. The economy is more complicated than that, and they're clearly not in control.

Do you think we'd be in this mess if they were in control? They're not - that is a fantasy and a myth, and when people figure it out we'll see a real asset collapse.

Gold is a good store of wealth, but at the end of the day, you can't pay your mortgage with it, or -- importantly -- your income taxes. So there will always be built in demand for the USD, at least in the short term.

If you're interested in this, you should seriously download that e-book. It is free, and I guarantee that you'll learn a lot, and see things from a perspective that you haven't thought of before.

To be mean is never excusable, but there is some merit in knowing that one is; the most irreparable of vices is to do evil out of stupidity. - C.B.

gold etc

I'm still figuring this out personally, but here are my thoughts. Do I care about inflation or deflation if gold, food, energy, and guns keep rising:

Gold is outpacing the dollar right now. Assuming there's deflation and it gets worse I still don't see the dollar outpacing gold. As global instability increases the demand for gold is going to be the highest it has been in a long time. I suspect it's going to get so bad all over the world that the demand for gold isn't leaving for a long time. Granted dollars will still be in demand for a while, but more demand than gold? In gold I don't have to worry about timing, and hopefully more places in the line of goldmoney will catch on.
Also I don't see the momentum for nationalized banking changing. Obama's going to get his way for a good length of time. They'll find a way to do it that's harder for the public to decipher. And what about as Gary North suggests the FED just starts charging 2% on deposits

MAD. What does China get from the U.S.? Why does it need to depend on exports to the U.S. moving forward. Just cut their loses and use their own products

To me the safest thing is energy. I don't see the demand for that disappearing unless there's a miracle tech or a >10% global population decrease

Michael Nystrom's picture

I do not believe in group think

Most of us are here because we think for ourselves.

There are massive increases in the money supply, but there is only one way they get into the economy: The banks have to loan the money out. So far that is not happening. As long as that it not happening, and existing credit continues to be destroyed, we will have deflation.

There may be inflation in the future, I do not doubt that. The thing I want to remind people is that the future is unwritten. We all have theories about it, but we don't know until it happens.

I have been familiar with the deflationary theory for a long time, and it is more plausible, imo, than the immediate hyperinflationary scenario, i.e., first deflation (like during the Great Depression), then - perhaps - hyperinflation. But like I said, who knows?

As for how the dollar can increase in value when it is being printed like mad: Dollars, i.e. dollar-denominated credit debt, is being destroyed faster than it is being created by the government. The most recent crash wiped out $26 Trillion in value. The government has so far passed $700 billion, and are working on another $800 billion. No matter how fast the government prints, it won't be able to keep up with the destruction.

This means that the net increase in fiat dollars is negative, i.e., the amount of existing dollars is falling. Since there are fewer dollars in existence, and there will be a mad dash for dollars as people scramble to pay off their loans, this will lead to an increase in the value of the dollar.

That is the theory. I'm not telling anyone to believe, however, this is what I believe.

To be mean is never excusable, but there is some merit in knowing that one is; the most irreparable of vices is to do evil out of stupidity. - C.B.

Deflation is more correct right now

Despite what others think. Michael Nystrom is right.
Long time viewer, but first time poster here.

I have worked for a bank for 2 and half years and worked in credit cards and also close to home equity lines. Even banks that are relatively conservative and didn't get into subprime messes (like the one I worked at) still suffer hard. Everyday credit card lines were getting decreased from 20k to 1k. Home equity lines were being decreased as well.

The number of artificial credit lines closing was numbered in the double digit trillions. All this was done in a flash. It takes awhile to print money and get it circulating through the economy, it only takes a micro second for a computer to erase the zeroes on your credit line.

This is why we are in deflation and the dollar is stong. Credit is being destroyed faster then we can inflate. It could take a 8-10 years before politicians can have the guts to circulate over 10-20 trillion dollars of newly printed money, which is why this could be the start of the new depression.

The only way we can see hyper inflation is if by some miracle the government finds a way to get the banks lending again like they were doing 2 years ago.

Personally I don't see how they can do that unless they nationalize all the banks and have full control and do it themselves.

When our government does this it will have full control of the economy just like zimbabwe and other governments had full control. Only then we will see hyperinflation because then the government would be able to print AND loan out money through all the banks, which would be easier then throwing money in the form of stimulus packages.

Uh, Bob is 7 years late.

The government did this very thing in 2001-2002 in response to the tech-bubble burst and 9-11 attacks. They dropped interest rates to 1%, turned Fannie and Freddie loose, forced lending institutions to sell homes to minorities who couldn't afford them.

So the previous "stimulus" implemented earlier this decade totally created the credit mess we're in now. The current stimulus package(s) being passed today will cause exponentially more grief down the road.

This time (as Dr. Paul has stated repeatedly) it will be the dollar, which contradicts the deflation scenario. When this happens, the term "your money is no good here" will take on all new meaning.

Michael Nystrom's picture

Encore?

The government did this very thing in 2001-2002 in response to the tech-bubble burst and 9-11 attacks. They dropped interest rates to 1%, turned Fannie and Freddie loose, forced lending institutions to sell homes to minorities who couldn't afford them.

Correct. Now what can the government do for an encore? They've lowered their target rate to 0%. Like the article says, they're giving money away -- or at least trying to -- without success.

So the previous "stimulus" implemented earlier this decade totally created the credit mess we're in now.

Correct. We saw a huge inflation in housing prices and commodity prices. And when these bubbles deflated, it nearly brought the global financial system down. It still might.

The current stimulus package(s) being passed today will cause exponentially more grief down the road.

We'll see about that. That's what this debate is about. Banks got burned last time by being fast and loose with their lending. Once burned, twice shy. This time around, they're not lending. And lending is the only way that money can get into the economy via the private sector. Yes, the government can spend, but they can never, ever, EVER spend enough to compensate for the loss in spending power of the entire private sector. Perhaps in theory, but politically, it would be impossible. Look at how hard it was for them to pass the TARP!

This time (as Dr. Paul has stated repeatedly) it will be the dollar, which contradicts the deflation scenario.

I have the utmost respect for Dr. Paul, obviously. But I reserve the right to think for myself, something I'm certain that Dr. Paul approves of. I may be wrong, but I'm not a robot.

To be mean is never excusable, but there is some merit in knowing that one is; the most irreparable of vices is to do evil out of stupidity. - C.B.

What's scary is...

we are only at the phase where the government is deciding that we need to produce more Jaguars and provide them to as many people as possible...

**“The man who does not read good books has no advantage over the man who cannot read them.” ~ Mark Twain **

"...there is no doubt that it (socialism) could not possibly have affected us so widely and so deeply as it has, had it not been heavily financed". - B. Carroll Reece