The clearest one shot idea is that economic processes like inflation and deflation have life cycles, they start off on one note (usually the population feels the good effects of the process first, and once it gets a taste, decides that if a little of a good thing is fun, a lot of the same thing out to be a real blast)…

The idea that follows on this is that as a process “matures” it has a tendency to naturally create more of its own condition, a little inflation gets into people’s minds and creates the expectations that cause more inflation, which really does cause more inflation, causing people to take more and more defensive measures against yet higher inflation. That’s why economists speak in terms of “inflation spirals” and “deflationary vortexes”…

Some benefit from inflation, if, like a good ponzi scheme they get in early with the right investments… inflation is very kind to borrowers, because they borrow with dollars at one value, and they effectively pay back the loan with cheaper dollars, so their real interest rate on that loan may be much less than the nominal rate…

Unsurprisingly, this acts as a powerful stimulant for taking out more loans, watching an asset rise in value, selling it off at a nice profit, and going back to the bank and borrowing more… and more.. and more.. sooner or later inflation changes character from the fun-benign-frat party version to the crazed meth tweaker version… which ought to be a bad thing.. except if say, you happen to be a government with massive debts payable in dollars, such as, say, the United States…

Someone, somewhere, with the necessary authority might just might be tempted to “go for it” and open the floodgates for a period of high inflation which lowers the real value of the dollars it is obligated to pay back.

However, as with physics, there are no free lunches, only transformations of state. High inflation plays absolute havoc with the relationship between generations, as those who have amassed substantial real assets will be able to ride inflation (think a wealthy older generation), while those who are living from paycheck to paycheck will see their earning power eroded and their savings effectively liquidated. Serious bummer and produced extreme political responses if the social imbalances get out of hand. Think Weimar Germany.

China obviously is in a younger, more virtuous, more productive phase of the long term inflation cycle, so surges in money supply and credit can be used to bring a backwards economy up to parity with western standards. We in the west on the other hand are dealing with bloated bureaucracies and overbuilding, so inflation will only add to the misery side of the ledger without contributing the same basic productive improvements it will, for the time being, in China.

Nice day, G.

The United States happens to be in the far more advanced stage of using various policy strategies to try and inflate, disinflate, deflate, and redistribute our way out of various classes of difficulties. This leaves us with toxic residues of earlier strategies that have become embedded in our national character, our tax laws, and our long term investments and lack of long term investment in social goods such as infrastructure and education.

The Chinese are piling on state of the art infrastructure and rapidly upgrading their educational “plant”… so they are able to provide both advanced social goods like a brand new high speed rail system as well as an increasingly education workforce who can maximally take advantage of those social goods.

This is a fundamental global imbalance of opportunities. As the combination of opportunities and capital are moving to China we are probably experiencing a degree of capital relocation, similar to the way the carry trade affected both Japan and the West’s access to low cost Japanese capital during the long Japanese downturn.

Hedge funds found that they could borrow very cheaply at Japanese rates and lend richly at western rates, which had the side effect of increasing the capital flood into the real estate markets, as there wasn’t much else that could have absorbed that excess and provided a worthwhile rate of return. The output gap had been closed and the western economies had been maxed as far as they could significant socially transforming change. We we’re about to get 19,000 miles of new high speed rail track laid here in the USA.

The same dynamic hold with China as the new place where things get done with not much red tape and a highly motivated workforce… capital inevitable chases the best opportunities. When capital leaks out of the US economy, disinflationary forces become felt at the same time that the same capital is flooding into China, where inflationary forces are equally felt.

And that is truly so. Prediction of stock market is difficult. I try to avoid it.

However, as well as the curve on the picture #1 shows tendency to stick to one or several points, the stock market eventually gets to the point of right valuation. I mean, stock market is not efficient every time, but it efficient is most of the time.

And over the long run, I can tell for sure, that dollar, pound, even czech krown , … will buy less 10 years from now. There is no mystery in it, as it was like that every time, since fiat money introduction. And good companies will do well.

I agree, that investors into overvalued equities in Japan in 1990 have still to wait. And that is our task, after all. As investors, we should not buy anything, which is overvalued. We should buy only when the odds are with us. When it is rainig gold, you come with a bucket. But mostly it is not raining gold. And than, we do not bet much.

Thanks again for inspiring article.
G.