Inflation vs. Deflation

Julian Snyder, James Dines, Howard Ruff, and Donald Hoppe debate what lies ahead.


Julian Snyder
It should be remembered, to begin with, that the dictionary definition of inflation is literally an increase in the money supply. That's the number one definition, and if you look in Webster's, that's what you'll find. But by an interesting linguistic sleight of hand, government and economic institutions have begun to use the term to refer to an increase in prices. And most of us now think of inflation as an increase in prices. It used to be when you said "inflation," that meant literally inflating the money supply. I think that's something that's very well worth bearing in mind.

A second point that I want to make is that it is a mistake to think of inflation and deflation in opposition to each other—like, are you a Republican or a Democrat, rich or poor; are you for or against? Almost without exception throughout economic history, wherever you find inflation you will find deflation. And wherever you find deflation you will find somewhere, hanging around the economic corner, inflation. And sometimes you will find them simultaneously in the same economic situation, and most frequently, of course, you will find a deflation following an inflation.

A quick example: take an increase in oil prices. I've said this many times, and I'm always convinced that at least half the audience doesn't really understand it, but I think the point is very important in trying to define the difference between inflation and deflation. An increase in oil prices is inflationary and deflationary at the same time.

It's inflationary because it increases costs and it increases the bill that the company has to pay or that the individual has to pay and it encourages the increase of other prices. And so that creates an inflationary wave. If you want to get mired in the depths of the chicken-or-the-egg aspects of monetary economics, you can say that the money supply is increased because the oil price was increased, or because the government decided to spend the money stockpiling oil and they had to get it from somewhere so they asked the Fed to increase the money supply; or you can go to the other extreme and say, "Well, the Fed created the money, and that enabled the government to buy the oil." And the Federal Reserve chairman always goes before Congress and says, "I can't do anything because, gee whiz, you guys appropriated the money, and all we do is print it." And then the congressmen say, "Well, well, it's the Federal Reserve that's doing the printing, so they're the culprits." But the important point is that an increase in oil prices, for example, is inflationary because it tends to literally increase prices, and price inflation in common terms is what we're talking about.

But an increase in oil prices is also deflationary because it discourages economic activity. The higher you raise a price, the fewer people want to pay it; the fewer people want to pay it, the less activity there is; the less activity there is, the fewer sales, the fewer jobs, the lower purchasing power everybody has. Part of this is the history of the wealth drain by the OPEC nations from the Western world. And that's an important thing to keep in mind.

The other very important thing is that both inflation and deflation are ways of solving a debt problem. Since I don't have a Ph.D. in economics, I gained most of my economic education by studying history, and if you go back and read Adam Smith and before, you find there's a very common pattern of expansion of credit, excess, and collapse that has occurred throughout history. Ever since the banking community discovered that it could lend out more money than it had, there has always been that point at which it could lend out no more. That meant a contraction or a deflation. And you could lend out no more usually because there was a limit to the currency that could be issued based on the fact that somewhere in some vault there was gold or silver or something. Today we don't have that, and somewhere secretly, late at night, there probably are bankers who say, "Hallelujah, brother, print more," because they don't have to worry about that limit.

The reason some of us are "inflationist" in our viewpoint is simply that we know that the Federal Reserve and/or the banking system and/or the businesses and unions that depend on them and/or the government will print or otherwise create money in an emergency. On the other hand, a sophisticated viewpoint says that, yes, you will get deflationary contractions. That is, when prices get too high, when credit gets too far extended, there will be a contraction.

I think that the question finally is, how do you get rid of excessive debt? How do you get rid of excesses in an excessive borrowing? There are only two ways. One is credit liquidation, which is what happened in the 1930s and in 1907 and in 1873 and in most of the major depressions of history, because, as I said, the banking community reached the limit of its money creation, at which point it had to contract or it had to bust. Or you can liquidate your debts by currency depreciation; so that, while you may owe $100,000 this year at 20 percent rate of inflation, it's really $80,000 next year and so on down the line, until finally you may be paying off your debts in money that isn't really worth very much.

I think it's important to observe in closing that in the great German inflation of 1923 which everyone hears about, and which is referred to frequently by writers, very few people ever say, "And what happened when it ended?" What happened? Was there a deflationary collapse? No, there wasn't. They simply switched to a new currency and went on with the ball game. Meanwhile, all the people who had lost purchasing power during the inflation suffered, but there was not a classic deflationary collapse at that point because it simply was not allowed to happen—although there was great, great economic damage, and Germany certainly did go into a recession.

The next point I'd like to make in conclusion is that in France during the Great Depression they had greater elbow room to create money, and so we had the interesting phenomenon of prices rising in France—in terms of French francs, we had price inflation in France—while throughout the entire rest of the world prices were falling. And the reason was very simple: France was in a depression all right, and France was in economic trouble and France perhaps was worse off than many another country, but France was able to run the printing presses.

So in arguing these two cases I think that the thing to look at is the practical aspect of the thing. And from a practical point of view, our government and their agencies and the Federal Reserve have the option of printing or otherwise creating money. And they will do so if and when the emergencies come.

James Dines
This is a very important, vital debate. Why? Because it affects your strategy over the next months and years. If a hyperinflation is due to come, then the wise strategy will be to borrow heavily to buy common stocks, to be negative on gold stocks because their costs after all are a function of inflation, and to sell bonds. On the other hand, if you see deflation coming, then you should pay your debts off now with cheap money, buy gold stocks because their costs would decline, and buy bonds at the coming interest rate peak. So this is a very, very vital debate within the honest-money movement itself.

I want to stress that everybody debating here agrees that a deflation is coming. The question is, when? You see, if we have a deflation very soon, then you should begin taking deflation strategies immediately. On the other hand, if it's coming after the next cycle, then you should take an inflation strategy. And therefore this is a very vital distinction. What I'm saying is, Don't tell me what to buy; tell me when to buy it. So the debate within our movement is on timing. And I believe, therefore, that the killing question is, Will inflation accelerate first?

Now it's tempting to say yes. Why? Because with the argument that you create more and more money and you have more money chasing the same goods and the fact that the Keynesians are still in charge, it's very easy to say that inflation will continue and actually accelerate. Yet when all think alike, nobody is thinking very much. What is everybody overlooking?

To get a deflation you need a contraction in the money supply. Without a contraction in the money supply, a deflationary argument fails. Now, as an intellectual exercise, what could contract the money supply? One, it must be a surprise; otherwise there would be no debate such as ours where all these very intelligent people disagree. Two, all previous inflations ended by surprise, such as late 1929. Even now, very few people agree on why 1929 occurred, so we are dealing with an inherently surprising phenomenon.

Now I predicted earlier a debt-liquidating depression. Whom do you know who has actual cash on hand in a safety deposit box earning interest? The odds are, very few people. If the market moves generally to foil the majority, the time is ripe to destroy those who are overextended in debt. The situation in Iran could trigger a sharp but temporary oil price boost. How about $100-a-gallon gasoline? Something's going to have to break. It's unreasonable to assume that the Arabs will continue taking all that paper. Somebody's going to have to go broke on this type of thing.

It's hard to say where it'll break. One of the things that must occur is a sharp drop in the Dow Jones industrial average. We must get a drop below 570.01—which is the December 1974 low for the Dow—or my Dines gold contracyclicality theory is worthless, and it is not—it is one of the great principles of the market. Now, a sharp drop in the Dow Jones will contract the collateral of those who have borrowed on stocks. In other words, IBM is now, believe it or not, the same price it was 10 years ago. So if IBM has a good drop, all those people who borrowed on it will need to raise more cash. But from where? Where are they going to get cash? So that's why I say, cash will be king.

The coming scramble for liquidity will be the opposite of what has occurred in the last 30 years, where people have generally fled from cash into things, into collectibles and the like. So we're getting now a change, a shift in polarity. Now that the whistle's being blown, the game's changing. Instead of going from cash into things, now we're going to go from things into cash.

Let's say, for example, we have a failure in a less-developed country. They call them LDCs. I personally call them LDBs—less-developed bankrupts. I include New York City, of course. There's no way that these countries overseas can pay off their loans; they don't even have enough money to meet the interest payments. So the question is, When will it be recognized by the banking system that those loans are worthless? Some big banking failures have come along by surprise, and a spark could start a wave of bankruptcies. After all, when a bank is going bankrupt, the first thing they're going to do is go through their loans and say, "You—we're not going to renew your loan," or, "You—we want your money back right away." And where are you going to get cash? So this is part of the scramble for liquidity.

The most important part of my argument is that when you count the actual dollars in this country, there's only a hundred billion of them—that's actual green dollar bills and coins. That's it. The rest of the $400 billion money supply is all in the memory cores of computers. You've got a bankbook, but you don't have money—you've got a little book that says you have money. That's the strict truth. So, if a bank goes broke and fails to pay its electric bills, they'll pull the plug in the computer and the money's gone. It disappears overnight. And that's what we're going to have. I think we're going to see the worst, the most incredible, contraction in the money supply in history.

Now, some people say, "Well, the government's going to print more." Listen, there aren't enough trees in America to print that much paper! They say, "Not me. My money's in the bank, insured by the Federal Deposit Insurance Corporation of America." And I ask, "How much money do you think the FDIC has on hand to meet its potential liabilities?" Most people have no idea. It's three percent. People aren't ready for what's coming, let me tell you.

Since 1966 I've said there will be no hyperinflation. We are going to have an inflationary evolution that will evolve into a deflationary crash. Those who are prepared are going to survive; those who are not, will not. And I wish to be of service to you by warning you that this is coming. I said we would have an inflation; we've had it. I said the stock market would go nowhere; we've had it. Now the only thing that remains is for deflation. It's the final stage of my prediction, the last piece to fall into place.

You can ignore me, and then after deflation you'll be saying, "You're right." But I don't want to be right; I want to help you! Listen, my predictions are already a legend on Wall Street. I don't like to miss. There's no hedging in my prediction. I see a great deflation.

And remember this: gold is not an inflation hedge. People now understand the function of gold. Gold is going up not because of inflation but to anticipate the deflation that's coming as it did in 1931.

Howard Ruff
Not too long ago Dr. Hans Sennholz sent me a copy of an article that he wrote once and thought I'd be interested in. It was called "The 39 Dirty Tricks of Debate." Jim Dines just used six of them, and I'm going to use the other 33!

I'd like to ask a simple question. Everybody's against inflation—conservatives are against inflation; the liberals are against inflation; even Teddy Kennedy hates inflation. So if everybody's against inflation, why don't we stop it? Good question? Maybe the most important question asked here tonight.

Well, I think the reason's pretty simple. We're having more inflation because, even though we all hate it, the majority of the people in this country have a stake in the programs that are causing it. Fifty-six percent of the people in the United States receive a check from some level of government. Fifty-six percent. And if you add up the Social Security recipients and their dependents, welfare and their dependents, Aid to Dependent Children and their dependents, military and their dependents, military retirees and their dependents—which does not include the defense contractors and their employees and their dependents and their suppliers and their employees and their dependents and all the little businesses that operate around and live off of them—it actually comes to about 73 percent of the people in this country. It is often said that democracies are in the state of final decline when the majority of the people discover that they can vote themselves benefits from the public treasury. And it is a massive majority.

Now, I'd like to make a very careful distinction and definition of inflation. I agree with Julian Snyder. Inflation is defined in the dictionary (and it still is a darned good definition) as increases in the money supply, over and above the available goods and services. If you define inflation as increases in prices, you will immediately start fighting the wrong problem. That's the kind of thinking that has the Carter administration fighting inflation by attacking wages and prices, which is sort of like doctors fighting diseases by pressing for a local ordinance to control thermometers so they won't go above 98.6 degrees, while quietly encouraging the spread of virus A throughout the community. If you think that way about what inflation is, you'll come up with the wrong answers; and you'll come up with the wrong conclusion about where we're headed, because you can build a perfectly rational scenario for deflation if you come up with that twisted definition. So let's take a look and see how inflation happens, but first, a couple of quick points.

First, the argument that you hear from the deflationists basically adds up to the final conclusion that inflations are impossible. They describe events that have occurred in every major runaway inflation since the history of paper money—and call them deflationary. But if you argue that inflations are impossible, then I wonder what it was that they had in Germany between 1919 and 1923.

Second, their argument often is that credit collapses are deflationary; that rises in prices generally bring rising long-term interest rates, which means falling bond markets, shrinkage of purchasing power, etc. That means bankruptcies, and all of the money supply that exists in the form of credit disappears. Well, that happened in Germany in the early stages of their runaway inflation, but it was not deflationary. All it did was create a tremendous demand for paper to supplant credit. We have a credit economy. There is a process by which you go from a credit economy to a printing-press economy.

Point number three: If you are arguing that there's going to be a deflation, you are arguing that paper money will become more valuable, because deflation is an increase in the value of paper money. But I find that history records no example of a major inflation by a dominant civilization that ever resulted ultimately in an increase in the value of its currency. I just don't think there's any precedent in history for that argument.

Now, inflation is an increase in the money supply, but not the money supply as it is commonly defined by M1, M2, and all the other Ms. I believe that an increase in money market funds is an increase in the money supply. I have money in a money market fund; our corporate funds are in there. We treat it as an interest-bearing checking account, but when we took our money out of the bank to put it in the money market fund, the figures showed a decrease in the money supply. Was there really a decrease in the money supply? T-bills are part of the money supply. People treat them as the equivalent of cash, and when the money market funds buy them and you buy the shares of the money market funds, you really have money. So in my opinion the money supply is really increasing at a faster rate than the figures show.

When interest rates rise to compensate long-term bond holders, longterm lenders, for the increasing loss of purchasing power of their bonds, bond markets fall. You have a credit collapse, creating a need for more cash, as I indicated. You do get recessions in an inflationary cycle. We're going to get one—it's going to look for the next 6 to 18 months like all these guys are right. It's really going to look like it, because we will have a temporary deflationary scenario.

Jimmy Dines said there aren't enough trees in the country to print enough money. I say, if you put enough zeroes on a bill, you could print it by cutting down the trees in Central Park. When you start getting everybody in trouble and all these deflationary things start happening, is Uncle Sam going to stand there wringing his hands saying, "Bankruptcy"? No! They'll do what they have to. They'll change the bankruptcy laws so nobody can do it. They'll declare a moratorium on debt. The banks will realize that they can't let everybody go bankrupt—they'd be bankrupt. So they'll stop calling loans. In my opinion, they won't let it happen. I think they'll freeze everything until they can print enough money and rush it to the rescue. And all the things that appear deflationary will ultimately be inflationary, because all the fire extinguishers are loaded with kerosene. They'll do what's necessary until they can rush that money out there, because they've got to inflate or die. Inflations are caused, and I believe they've got the tools to do it. They can create money in any amount and they've got a number of sophisticated ways to do it. They could go to a totalitarian government and freeze prices for a while if they have to, until they can rush the money out there.

Now, I believe that eventually it becomes a psychological phenomenon, just like it did in ancient Rome, where people say, "I don't trust that money. I don't know how much base metal they mixed in that coin. I want more of it in return for my goods and services." People refuse to accept credit. They won't extend credit. Why? Because they know they'll get paid back in cheap dollars. They'll say, "I want cash." It creates a tremendous demand for cash, and then they've got to go to the printing press. You move from a credit economy to a printing-press economy. History records no example of a dominant civilization reaching the levels of money creation that we have without its running its course in a deflationary or an inflationary depression.

Now let me make one point. I think you can have an inflationary depression. Most depressions are considered synonymous with deflation. I redefine depression. Depression is a massive loss of purchasing power throughout the community. You had it in the '30s because prices fell but wages fell much faster and 25 percent of the people were out of work. There was the real loss of purchasing power. And you can have it in inflation because prices can rise much faster than incomes, and there is a massive loss of real purchasing power throughout the community. My opinion is that that is what we face, and I agree with Julian Snyder that what we will have at the end of that is not a deflation—which again, remember, means money being worth more. The psychological damage to our money will be absolutely irreparable. No one will want to trust it. Where is the German Deutsche mark of 1923?

So, what will happen? In my opinion, we will have a new currency, a new kind of a system; maybe a couple of wild attempts to find some currency the people will trust, fiat currency—"This is money, or else!" In France during the Great Terror they beheaded people if they didn't accept it, and people were beheaded because they wouldn't. And then sooner or later they will be forced, literally forced by circumstances, to come up with a gold-backed currency that people will trust. That is the day when sanity will be restored, and it will be a brand-new system unrelated to the previous one.

I do not believe that deflation is really possible. Although I am still prepared to bet on a short-term, mildly deflationary scenario, I believe that the long run is more and more inflation. And Jimmy Dines is right—it's a crucial issue, because if you don't get it right you'll bet wrong with your money, and you will lose.

Donald Hoppe
I think we should define again. Everybody's defining inflation, deflation. Let me add my definition. Inflation, as I understand it, is simply a decrease in the value of money, and deflation is an increase in the value of money. Now we can't talk about the classical definition of inflation—as an increase in the money supply—because we really don't have any money supply any more. As somebody pointed out, our cash currency and coin is a very small, insignificant part of the money supply, probably something less than five percent. Ninety-five percent of all payments are made with some form of credit. Now you can't say credit is money—not and understand economics. No one can define credit as being money. Credit is a loan of money, not money in itself, and it accounts for 95 percent of all the payments we make.

Now let's look back historically. I agree with the inflationists that if you look back over a long period of history you will find that the normal condition is a moderate inflation. Episodes of deflation and episodes of hyperinflation are relatively rare in history. It's a very unusual phenomenon. You can count the very few examples of hyperinflation on your fingers—the German inflation of 1923 that everybody refers to, the assignat inflation in France, inflation of the Continentals. You can also count the episodes of deflation on your fingers. They're very rare occurrences that only last a relatively short time.

So I'll agree that over a long period of time inflation is the rule, not the exception. Nevertheless, as Keynes used to say, in the long run we're all dead. And our fortunes are made not in the long run but in the short run. The deflation of the last period, 1929-33, only lasted three years; after 1933 it started inflating again. But the damage was to most people who lost their property in 1929-33; they lost the savings of a lifetime in that period. So you have to guess right on these short periods of time. The same goes for the runaway inflation in Germany from 1919-23—a very short period of time, relatively; only three years. So we can't talk about inflation or deflation as something that expands over a long period of time. We're talking about something that happens in a very short time. But that very short time is enough to ruin you.

I would say that conditions right now suggest very strongly that in the next few years, maybe not more than two or three years, you're going to have a severe deflation. Now, after that you have a resumption of the moderate inflation that is typical of history. But you see, if you get caught in the short-term deflation it won't matter that there's going to be inflation in the next seven or eight years. You won't have any money anyway. So we have to guess right.

Now, I agree again that any government would like to keep on inflating forever. It's a great system. But right now we can't. The people debating here act as if the United States is a completely isolated country in the world, that we don't have anything to do with foreign countries. But of course that's nonsense. It's one world, as Wendell Wilke used to say. We're totally dependent economically on other countries. We cannot conduct our financial policy independently of other countries. If we depreciate our currency further, the price of oil is going to rise. They've already told us that. Now in the last 10 years we've gotten by in this country, not by inflating, but by borrowing. Whom have we borrowed from? We've borrowed from foreign countries. We've borrowed from the Germans. We've borrowed from the Japanese. We've borrowed from the Arabs. We've borrowed from everybody else. Now, if it can be proven to me that foreign countries are going to be dumb enough to keep on loaning us money forever, I'll concede that inflation will continue indefinitely. But I don't think they're going to be that dumb.

In fact, they already told us they're not going to loan us any more money. We got $30 billion from them in November 1978, and by July 1979 we were back where we started from. We spent the $30 billion, and the dollar was lower than it was when we borrowed it. I think Mr. Volcker went to Belgrade looking for another handout, and they told him there wasn't going to be any more handouts. Sheik Yamani, the Arab oil minister, says that if the dollar keeps going down they're going to suggest switching to some other currency. And if they do, we're going to have to buy our oil in the spot market, where the price is considerably higher than the official OPEC price. We're importing 50 percent of our oil right now, and without oil there's going to be the worst depression you ever saw, with industry shutting down all over the country. So you can't do what you want. Our foreign policy, our financial policy, is not being made in Washington today. It's being made in Saudi Arabia. It's being made in Bonn. It's being made in Japan.

So we're in a crisis situation where we simply cannot inflate. Not that we wouldn't like to bail everybody out, but we can't do so. If we attempt to do so we are simply going to start another panic run on the dollar, and we're going to be cut off from our very essential trade with the rest of the world. We import not only 50 percent of our oil but a whole host of vital industrial materials. In order to buy something, you have to have good money to pay for it. And if you depreciate your own currency, you don't have any good money. Of course, they do it in Argentina, they do it in Brazil; but in 1978 Argentina had an $8 billion surplus in their foreign accounts, and we had a $40 billion deficit—that's the difference. And we cannot keep inflating because our deficit will simply get worse, and they'll cut us off the first time we try it. The price of oil is going to go right through the roof. And the price of oil is the single most important thing today for the American economy. This economy runs on oil. It shouldn't, but it does. If you think Chrysler's going bankrupt is bad, think of all the other industries that are going to go bankrupt if they don't get a steady supply of oil. You'd have the worst chaos in the world if you tried to inflate today.

Now everybody points to the example of Germany in 1923. But to go back 50 or 60 years and look for an example of inflation in a totally different historical context is really, really unfair; it's an unsound argument. The Germans inflated in 1919-23 for one reason only—they wanted to get out of paying the reparations. And they did. In fact, they borrowed more from us than they actually paid in reparations. The Germans admit in their memoirs that the inflation of 1919-23 was a put-up job so they could get out of paying the reparations.

With World War II, the destruction of Germany was far greater than with World War I, and there was no runaway inflation. Why? Because there was no advantage to it. The old Reichs mark of Hitler was exchanged for the new Deutsche mark at only ten to one—which is no worse than the dollar is today. Ten to one, as opposed to a trillion to one after World War I.

So runaway inflations, like deflations, are very rare things and only occur under unusual situations. And there's not going to be any hyperinflation in this country. If there is, we might as well throw in the towel right away, because the American economy will collapse.

And if the American economy collapses, the Russians will be washing their socks in the Atlantic in 48 hours. They're sitting there waiting for the American economy to collapse. So runaway inflation at this time would simply be an act of national suicide. We are not alone in the world. We exist in a world of very frightening forces with a powerful opponent out there waiting to knock us off. And if we simply think we can buy our way out of this with a printing press, that's crazy. You can't do it—not unless you want to commit suicide.

One more thing. The bond market in this country is 10 times the size of the stock market. And if you inflate, what happens to interest rates? They go up. If interest rates go up, what happens to bond prices? They go down. You could have the worst financial crash in history, 10 times the size of the stock market crash in 1929, if interest rates keep going up. Already, bank portfolios are jeopardized by high interest rates. Has anybody tried to sell a bond lately? You can call up your broker and tell him you've got 100,000 bonds to sell and see what kind of a bid you're going to get. You may not get any bid at all.

So we definitely have the potential for a deflation. We have a credit economy; we have an enormous amount of debt outstanding in the form of bonds, and mortgages, and consumer installment credits, that could be wiped out by further inflation. Inflation is a self-destructive phenomenon, a self-limiting phenomenon—the more we inflate, the more we ruin our credit markets. It's not a question of replacing the credit with paper. You can't do it that way, because if you print more paper you drive interest rates up, and if you drive interest rates up you destroy credit. Whose credit are you destroying? Our credit; all of ours. We all have insurance policies. We all have bank deposits. We all have money market funds. We all have credit. As I say, 95 percent of our financial assets are in some form of credit. And rising interest rates destroy all these assets. It devalues them. Every one percent that interest rates go up, a $1,000 bond goes down $100.

That's why inflation will have to be ended. And that means a period of deflation.

Julian Snyder is a foreign exchange money manager and the editor and publisher of International Moneyline. James Dines is the author of Technical Analysis and The Invisible Crash and the editor of the Dines Letter. Howard Ruff is the editor of Ruff Times, host of the TV interview show Ruff House, and author of How to Prosper During the Coming Bad Years. Donald Hoppe is president of Investment Services and editor of the Donald J. Hoppe Business and Investment Analysis. The debate presented here is adapted from these speakers' remarks at a debate at the 1979 New Orleans Investment Conference sponsored by the National Committee for Monetary Reform. Copyright © 1979 by the National Committee for Monetary Reform.