Consumer Price Index Plunges In October
1:50 am November 20, 2008 by Brian J. Ritchey
The consumer price index plunged “by the largest amount in the past 61 years” in October. This may be an indicator of a very deep recession, if not a depression.
A depression is characterized in part by a persistent, sustained, deep, general decline in production. They are typically preceded by a deflationary crash. A deflationary crash is characterized in part by a persistent, sustained, deep, general decline in people’s desire and ability to lend and borrow.
Deflation requires a precondition: a major societal buildup in the extension of credit (and its flip side, the assumption of debt). Austrian economists Ludwig von Mises and Friedrich Hayek warned of the consequences of credit expansion, as have a handful of other economists, who today are mostly ignored. Bank credit and Elliott wave expert Hamilton Bolton, in a 1957 letter, summarized his observations this way:
In reading a history of major depressions in the U.S. from 1830 on, I was impressed with the following:
(a) All were set off by a deflation of excess credit. This was the one factor in common.
(b) Sometimes the excess-of-credit situation seemed to last years before the bubble broke.
(c) Some outside event, such as a major failure, brought the thing to a head, but the signs were visible many months, and in some cases years, in advance.
(d) None was ever quite like the last, so that the public was always fooled thereby.
(e) Some panics occurred under great government surpluses of revenue (1837, for instance) and some under great government deficits.
(f) Credit is credit, whether non-self-liquidating or self-liquidating.
(g) Deflation of non-self-liquidating credit usually produces the greater slumps.Self-liquidating credit is a loan that is paid back, with interest, in a moderately short time from production. Production facilitated by the loan - for business start-up or expansion, for example - generates the financial return that makes repayment possible. The full transaction adds value to the economy.
Non-self-liquidating credit is a loan that is not tied to production and tends to stay in the system. When financial institutions lend for consumer purchases such as cars, boats or homes, or for speculations such as the purchase of stock certificates, no production effort is tied to the loan. Interest payments on such loans stress some other source of income. Contrary to nearly ubiquitous belief, such lending is almost always counter-productive; it adds costs to the economy, not value. If someone needs a cheap car to get to work, then a loan to buy it adds value to the economy; if someone wants a new SUV to consume, then a loan to buy it does not add value to the economy. Advocates claim that such loans “stimulate production,” but they ignore the cost of the required debt service, which burdens production. They also ignore the subtle deterioration in the quality of spending choices due to the shift of buying power from people who have demonstrated a superior ability to invest or produce (creditors) to those who have demonstrated primarily a superior ability to consume (debtors).
Near the end of a major expansion, few creditors expect default, which is why they lend freely to weak borrowers. Few borrowers expect their fortunes to change, which is why they borrow freely. Deflation involves a substantial amount of involuntary debt liquidation because almost no one expects deflation before it starts.
Inflation this year has crept up to a peak in July and has stayed at or near 5% ever since, until October, when it plunged to 3.66%. We all know that the oil prices have been deflationary for the past few months and it appears this is the driving factor in the deflationary prices. I personally haven’t seen prices (other than gas) get lower, especially food.
However, given the above, the question may shift from whether inflation will eat at your bottom line to whether deflation eats away at production and dries up your clients’ ability to pay. Based on the above, the best bet is to hold on to as much money as possible and to the extent you hold assets that are devaluing, consider liquidating to cash. Prepare for lower income for the coming years and offset the loss in revenues by keeping your firm in sound financial condition so that you are better able to help serve your clients without the struggle of wondering how you will pay your employees.
The way to do this is to identify areas you believe will affect your income next year. There are plenty of indicators out there but any prediction is just that. The lower the expectation, the better opportunity to absorb worse conditions.
After you have identified where you will lose and make money, focus on assigning resources towards strategic targets that you believe will improve revenue. Although never a fun endevour, it is time for hard decisions related to re-aligning your staff to optimize your ability to serve your clients during a time when cash flow may be strained.
Implementation must be consistent and applied universally. This of course is the most difficult part of any change, but the future your firm, and/or your best talent, may depend on it.
As always, measure against your forecasts and in this case, worrying about others is irrelevant. Focus on your own predictions and work towards achieving your own goals. What happens with other firms can be compared after the economy recovers.
I’ve never lived through a depression. I am not sure I can even fathom it. However, I do recognize the plethora of signs that our economy is not just taking a temporary hit - it is part of a global downturn marked by the largest expansion of credit in history. Something others have noted invariably lead to deep losses in production. And there is no denying that there will be massive layoffs in the coming year and our auto industry is facing its own collapse. Production can’t improve in this environment.
Plan accordingly.
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