Inflation and Deflation
The authors suggest that for major economic powers the future is a fairly sharp contrast of two possible outcomes (p. 294):
The future in many parts of the world – the United States, the United Kingdom, Europe and Japan – is fairly binary. Either the forces of deleveraging will lead to long, crushing deflation, or the policy responses will succeed in leading to devaluations and inflation.
They are more specific on p. 295:
Where do we stand on the issue of deflation versus inflation? We think we’ll have both. Deflation first, and then inflation.
Mauldin and Tepper discuss both the deflationary cycle and the inflationary cycle in the end game. In fact, simply by page count, Chapter Seven “The Elements of Deflation” covers 24 pages and is 1/3 longer than Chapter Eight “Inflation and Hyperinflation” (18 pages). By the “dropping of the thesis down the stairwell technique” the discussion of deflation wins hands down.
Both chapters are well worth reading and the stairwell test should not be the readers’ only test of value.
The discussion of hyperinflation draws heavily on the work of Peter Bernholz “Monetary Regimes and Inflation”. The authors state (p. 170):
Digging yourself deeper in an inflationary situation is what economists call the Tanzi effect, after the economist who discovered it.
The actual statement by Bernholtz (which the authors do not reference at the point they make the above statement) is far more nuanced than the quote above indicates. From Bernholtz (p. 84) with emphasis added by the reviewer:
There is, however, one other possible explanation, namely that the budget deficits were caused by inflation. And in fact, there is empirical evidence that budget deficits are increased because of high inflation (the so-called Tanzi (1977) effect, which had, however, already been stated by Bresciani-Turroni (1937, p. 66 ff.). Since government expenditures lag its tax and other revenues, the purchasing power of these revenues is diminished until they are spent, and this the more the higher the rate of inflation. As a consequence the real budget deficit grows, if the amount of real expenditures is maintained.
In other words, Bernholtz suggests that inflation increases government deficits and not the reverse. Recognizing this would bring one to an entirely different set of possible solutions than are suggested by many, including Mauldin and Tepper. At the very least, discussion should center on treating the disease (inflation) first rather than simply addressing the symptom (government deficits). It is perhaps not completely fair to bring this up in this review, since these thoughts are not ones that are found in the main stream of economic thinking which is what the authors are reporting.
But, of course, dealing with inflation is something we have to get to after avoiding the deflation trap. That is a continuing battle, as cited by Joe Wiesenthal at Business Insider:
The problems of Spain, Italy, and Greece are often pointed to as being somehow bleeding-edge, canaries in the coal mine that serve as warnings to other governments of what might happen if they don’t get their acts together. But the real story today is just the opposite. The world is experiencing whatever the reverse of a sovereign debt crisis is, as borrowing costs for government are plummeting EVERYWHERE.
And that ongoing deflation risk has been summarized by the observation of Warren Mosler:
We so fear becoming Greece that we risk becoming Japan.
The Eurozone Crisis
The authors discuss how the modern euro functions in a manner analogous to a gold standard. This creates the addition of internal stresses on local (national economies) because the adjustments available through exchange rate arbitrage are not available.
The discussion of the Eurozone and the larger EU are as good a plain language discussion as I have read. (This comprises almost 15% of the book, Chapters Ten, Eleven and Thirteen.) They correctly include the monetary accounting balance sheet identities for nations (p. 227) – and this is done in a way that anyone can quickly understand. They also have a thorough but brief discussion of the “Latvian Austerity Miracle” (p. 243-44) which has recently been touted by some as a “proof that austerity works” and criticized by others. In material written almost two years ago the authors got a summary of the facts correct, long before the situation was being so widely discussed.
Alternative Economic Thinking
Mention of the work of Minsky’s students and similar thinkers like Randy Wray, Warren Mosler, Steve Keen and Bill Mitchell would have added some further depth to the discussion of how to manage the debt super cycle end game. In fairness to the authors, though, I expect they did not intend to write a book on monetary theory, so I am willing to let them wrestle in a future work with how potential changes in monetary system management might affect the economy and investors.
However, hopes were raised early on that there might be some of this discussion coming in this book when they wrote (p. 17):
Stability leads to instability, and success breeds its own undoing.
This statement reflects on what would be a summation of Minsky’s life work. But there was no direct follow-through later in the book, which was a disappointment for this reviewer.
I would suggest a worthwhile future focus on how and why the end game for many sovereigns is not resulting in soaring interest rates. As pointed out in the quote earlier from Joe Wiesenthal at Business Insider, while Spain, Italy and Greece struggle with Draconian interest rate burdens, in most parts of the world interest rates have plummeted. Perhaps further analysis could address whether the Bernholtz interpretation of historical data (discussed above) has a corollary which reflects on the cause and effect relationships between government deficits and deflation. Yes, as already mentioned, the authors did say deflation first and then inflation, but that overview leaves an infinite number of possible paths open.
Another area of research that I wish had been included is the work of Steve Keen which has concluded that:
(1) the real problem with the debt bubble is with private debt rather than public debt; and
(2) that economic growth is empirically related to the second derivative of debt vs. time (i.e., the acceleration of debt) more than it is to the first derivative (growth of debt).
The implication of this research is that all that is needed to increase economic growth when private debt is contracting (negative first derivative with respect to time) is a decrease in the magnitude of the negative rate of contraction (positive second derivative). This is in contrast to driving as fast as possible to the end of debt contraction, which is a popular position among so-called austerians.
Again I may be opening doors into complicated areas that would have doubled the length of the book and removed much of the mass audience that the authors hope to reach. How many people would consider reading a 700-800 page book on the credit crisis? I dare say Mauldin and Tepper might reduce potential book sales by well more than half if they had doubled the length of their book. The purpose of the book is, of course, to start educating a wider public audience, more than to sharpen the understanding of a few.
However, that doesn’t stop me from wishing that the book did just mention some of the new economic thinking that is outside the neoclassical mainstream.
