Deflation - am I completely wrong?

Am I completely wrong about some of my predictions?

I was listening to a Stanley Druckenmiller podcast today while walking my dog and my brain shattered.

He said that investors in 2007/2008 were worried about inflation at that time, but it never got there because the market collapsed.

The market is going to collapse in 2021. That I’m sure of and have talked about extensively on my website.

If the market collapses and money supply disappears, then does inflation still happen?

I don’t think so.

We likely have deflation, similar to the great depression in the 1930s like Ray Dalio has talked about.

Why?

If the stock market crashes by 50%, then 50% of the money supply disappears as well.

All this paper money the US federal reserve is creating disappears.

If all that money disappears, then things can’t be as expensive because the money supply goes down.

Wow.

I’m probably wrong about inflation.

The problem though is if the market collapses and banks are in trouble, the US is going to continue to print money to save the banks. Biden is also continuing to print money through stimulus checks, his infrastructure bill and all this QE.

The only way out of a deflationary spiral is economic stimulus, which is happening at unprecedented rates right now. Biden is proposing a $1.7 trillion infrastructure bill, on top of the CARES act and all the money given through stimulus checks.

What if this is entirely designed because the US government knows the market is going to crash?

Hear me out.

In January 2021, buying was stopped by Robinhood, Citadel and other market makers. They didn’t know how large the squeeze would become, and it could’ve blown up the world financial system. What if the SEC and US government stepped in to stop it?

Why?

The system wasn’t prepared for what’s happening.

Since that time, the SEC has put in place numerous rules (listed here) in order to protect the integrity of the whole market.

There was also an interview with Thomas Peterffy from Interactive Brokers in March.  His firm is one of the companies responsible for maintaining the integrity of the market. He said something in passing where the rules are already being reformed. It’s worth watching the interview because he’s essentially saying those at the top know what’s coming.

When the whole market collapses during the short squeeze, the bad actors will go bankrupt first while the rest of the system stays in place.

My take is the US government and SEC wasn’t prepared in January, shut off buying and put all the rules in place to let Citadel and others die.

When the market crashes, the money supply will decrease. When the money supply decreases, you don’t get inflation but deflation.

Why?

Because money disappears. Money gets redistributed to retail investors in AMC & Gamestop, but everyone else will lose tons of money. 

This is mostly rich people who control the market, and they’ll be pissed.

In the grand scheme of things, this is better because the inequality gap gets equalized a bit more. Not to say inequality is going to disappear but it gets more fairly distributed as the government continues its economic stimulus through unemployment checks and infrastructure bills.

The way out of a deflation is government spending, which we’re seeing now.

This makes sense to me because if the market crashes and banks fail, historically you see periods of deflation like the Great Depression.

I’m not saying market crashes are good for an economy but the US government must realize that there’s no way out of the market not crashing because of what Citadel and others have done. They’re just continuing to print money and get ready for stimulus packages when the money supply disappears in a market crash.

When the market crashes, it will feel like the world is ending but it’s not. The media will make it out to be. A lot of people will lose jobs. A lot of people will lose houses. A lot of people will lose lots of money. But, because of the government spending, and stimulus checks, they can hopefully get out of a depression quicker.

The other thing now that has never existed in history is technology. The technological innovation that is happening is unlike anything that’s ever happened in history. Technology in principle is a deflationary force. Look at phones. As technology has improved over the last several decades, the price of phones has dropped drastically to where now anyone can afford a phone. It used to be thousands of dollars only reserved for the rich but the improvement in technology increased supply and made the price cheaper. Therefore deflationary.

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Wow.

My whole brain flipped on its head because I may have been wrong the whole time. The smartest investors in the world today are talking about inflation because they’re seeing today’s money supply assuming everything is going to stay here.

But if the market crashes ala 1929, then you have a huge deflationary period like the Great Depression.

This still creates a lot of problems and disrupts the world socially and politically. We know what happened in the 1930s when democracies across the world became populist dictatorships that led to the world wars.

It’s also possible that the US could go through something similar to what Japan went through in the 1990s, what they called the ‘lost decade.’ It started with a crash, then spiralled into a decade of slow economic growth where it has since never recovered. 

Austrian economists argued that economic stagnation occurred because Japan’s policies acted to prop up existing firms and financial institutions rather than letting them fail and allowing entrepreneurs to reorganize them into new firms and industries. The reason being the repeated economic and financial bailouts as a cause rather than solution to Japan’s lost decade

Nonetheless, the way to invest in a deflationary environment is completely different from an inflationary environment. In inflationary environments, you want to own equities, commodities, and hard assets. This makes sense because look at the last year – all of those have gone up like crazy.

In deflationary environments, you want to own cash and bonds, as well as quality businesses at discounted prices. Given technology is revolutionizing the future and is only expanding, buy the best tech businesses at reasonable prices.

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It’s fun to be wrong. It’s nice to have your thinking challenged. It’s so refreshing to have your beliefs completely changed. The more you attach your beliefs and opinions to your identity, the more deluded you are into thinking you understand the world. The world is much more complicated and nuanced than you think. 

The world doesn’t revolve around you and doesn’t care about you. The sooner you realize that, the better off you’ll be. Learn about the world for what it is, not what you think it should be.

This entire time I was convinced inflation was going to happen.

But history has shown us market crashes are incredibly deflationary.

Turns out I might be completely wrong about inflation. We’ll soon see.