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Thursday, January 9, 2014

Inflation Vs Deflation – The Ultimate Chartbook Of 'Monetary Tectonics'

by Tyler Durden on 01/09/2014

Financial markets have become increasingly obviously highly dependent on central bank policies. In a follow-up to Incrementum's previous chartbook, Stoerferle and Valek unveil the following 50 slide pack of 25 incredible charts to crucially enable prudent investors to grasp the consequences of the interplay between monetary inflation and deflation. They introduce the term "monetary tectonics' to describe the 'tug of war' raging between parabolically rising monetary base M0 driven by extreme easy monetary policy and shrinking monetary aggregate M2 and M3 due to credit deleveraging. Critically, Incrementum explains how this applies to gold buying decisions as they introduce their "inflation signal" indicator. has done a great job of summarizing the key aspects (and the full chartbook is below)...

The authors introduce the term “monetary tectonics” as a metaphor for this war. Similar to tectonic plates under a volcano, monetary inflation and deflation is currently working against each other:

  • Monetary inflation is the result of a parabolically rising monetary base M0 driven by the central bank monetary easing policy.
  • Monetary deflation is the result of shrinking monetary aggregates M2 and M3 because of credit deleveraging.

The following chart clearly shows that 2013 was a pivot year in which the monetary base M0 grew exponentially while net M2 (expressed on the chart line as M2 minus M0) declined significantly.

deflating credit vs inflating monetary base 2000 2013 money currency

The chartbook shows several trend which confirm the deflationary monetary pressure:

  • Total credit market debt as a % of US GDP has been shrinking since 2007 (“debt deleveraging”).
  • US bank credit of all commercial banks is stagnating (close to negative growth), similar to the period 2007/2008. See first chart below.
  • Money supply growth in the US and the Eurozone is trending lower. See second chart below.
  • Personal consumption expenditures are exhibiting disinflation .
  • The gold/silver-Ratio is declining. Gold tends to outperform silver during disinflationary and/or deflationary periods.
  • The gold to Treasury ratio is declining. See third chart below.
  • The Continuous Commodity Index (CCI) has been in a steep decline since the fall of 2011.

US bank credit commercial banks growth 1974 till 2013 money currency

money supply growth M2 vs M3 1991 till 2013 money currency

gold to bond ratio 2002 2013 money currency

On the other hand, inflationary pressure is present through the following trends:

  • An explosion of the monetary base M0. See first chart below.
  • US households show signs of stopped deleveraging. See second chart below.
  • The currency in circulation keeps on expanding.
  • Commercial banks have piled up an enormous amount of excess reserves which, in case of a rate hike by central planners, could flood the market through lending in the fractional banking system. See thrid chart below.

US monetary base since 1918 money currency

US households stop deleveraging 1971 2013 money currency

excess reserves 2000 2013 money currency

How is gold impacted in this inflation vs deflation war? The key conclusion of the research is that, due to the fractional reserve banking system and the dynamics of the ‘monetary tectonics’, inflationary and deflationary phases will alternate in the foreseeable future. Gold, being a monetary asset in the view of Austrian economics, tends to rise in inflationary periods and decline during times of disinflation.

The key take-away for investors is to position themselves accordingly and consider price declines as buying opportunities for the coming inflationary period. How comes one can be so sure that inflation is coming? Consider that the government must avoid deflation; it is a horror scenario for the following reasons:

  • Price deflation results in a real increase in the value of debt and a nominal decline in asset values. Debt can no longer be serviced.
  • Price deflation would lead to massive tax revenue declines for the government due to a declining taxable base.
  • Deflation would have fatal consequences for large parts of the banking system.
  • Central banks also have the mandate to ensure ‘financial market stability‘

inflation deflation US Fed 200 years money currency

Interesting to know, Stoeferle and Valk developed the “Incrementum Inflation Signal,” an indicator of how much monetary inflation reaches the real economy based on market and monetary indicators. According to the signal, investors should take positions according to the the rising, neutral or falling inflation trends.

monetary seismograph incrementum inflation signal 2013 money currency


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