Protect Your Savings: Central Banks, the Inflation Fallacy, and the Mountain of Debt

Since the end of the financial crisis, or some would say that since we entered the eye of the storm, central banks all over the world continued to pursue “extreme” measures to prop up the world’s economy and avoid a deflationary spiral. So far, we can say that the experiment worked, although the underlying problem, debt, didn’t go anywhere, and growth is far from being stellar.


The Balance sheets and interest rates of the major central banks (source:

Stock markets had an eight year bull-run, and they are sitting near their all-time highs as we speak, boosted by the free money that is looking to squeeze all the returns out of every asset class. Still if we look at what the trillions of liquidity achieved, the picture is not pretty, wealth inequality skyrocketed, wages stagnated, and corporate profits surged to historic highs compared to the size of the economy.

Income and wealth inequality in the US in 2016 (source: Marketwatch)

Is Deflation the Real Enemy?

Central banks are still fighting the deflation demon with their policies, as in a deflationary crisis the current global debt levels would cause a massive wave of defaults and probably would force the restructuring of the financial system as we know it. But is deflation as bad, as the “powers” want to world to believe.

First things first, there is “good” deflation and “bad” deflation, although at the end its very had to differentiate between them in practice. Good deflation is the product of technological progress, basically the improvement in productivity, which, by definition, causes prices to fall as less and less work and resources are needed to produce the same product.

Bad deflation happens when the economy contracts, demand falls that causes a decline in prices too, which in turn causes a decline in output… and the vicious circle begins. Couple that with a high nominal level of debt, and you have the recipe for a deflationary credit crisis and a depression.

The Benefits of Deflation

Having said that, it is important to note that deflation also has a more positive role in the economic cycle. In a crisis, those companies that are weaker, have inferior products go out of business, lousy lenders go bankrupt, and the field will be perfect for the more productive and able businesses to shine. If this “cleaning” effect is delayed or interrupted by cheap credit, growth rates will be lower after the end of the crisis, debt levels will remain high, and there will be less “fuel” for the next cycle to expand.

Also, cheap credit that is the direct consequence of low interest rates, discourages saving, and with that, it destroys the very fundament of the free market, while also creating asset bubbles all over the economy. Why? Because, with no real yield in bonds, capital will naturally look for alternatives and, boosted by the forces of momentum and mass psychology, real estate, stocks, and other yielding assets are all suspect to the development of speculative bubbles.

If we look at the recovery since the Great Recession, we see slow growth globally, a very slow labor market recovery in the US, and a stock market that’s being led by record stock-buybacks by the giant companies, not exactly the signs of a healthy productivity cycle.

Inflation Targeting and Price Stability

In theory, the economy needs a certain amount of money to function properly and, to put it simply; if the economy grows it will need more to keep prices stable. Now, in today’s world, price stability in some weird way is, according to central bankers, 2% inflation per year. It is hard to justify this inflation targeting as, and it’s kind of funny to call an exponential function stable (with 2% inflation in 15 years your money will lose more than one-third of its value, get that you stupid savers).

Dollar lost 97% of its purchasing power since 1913, the creation of the Federal Reserve

Also, there is a huge problem with the standard calculation of inflation, as it is based on consumption basket, and it doesn’t take other prices in the economy into account. Why is that a problem? Because to measure the “general” price stability, you should probably count housing and stock prices as well, as they represent a large part of the assets held by the population, and their prices have the same kind of effect as the prices of the goods that are in the inflation basket.

The reason that inflation should include other asset classes is that the economic growth is in part the function of those assets, and that means we are in a phase the measured inflation is slower than the real one, while debt levels are still growing, meaning that the problems that led to the crisis are actually being reproduced rather than healed through the blowing of the bubbles and structurally inefficient spending and production patterns.

Bubbling up the economy

So what’s the problem with the bubbles? The main trouble is that the wealth bubbles create is imaginary, and it will disappear as soon as the bubble bursts. As an example, imagine a stock bubble where your holdings go up 10 times. So investors are happy and they calculate that their wealth went from say 100 to 1000. The huge problem is that the market-price only reflects the latest transaction, and not the price that all investors could cash in by any means. And in a bubble below the last price there might be huge “air-pockets” with no new buyers—this is how crashes occur.

And if the economy is propped up by spending based on bogus wealth, imagine what will happen when (not if) those bubbles pop, deflation will be back in earnest, and the central banks will be forced to start the printing presses again.

Long-term consequences and the Strategies to Follow

So will a deflationary crunch happen or not? It will depend on how the central banks will react to the next crisis, and how far the bubbles grow until then. A good example is the case of Japan where they are still trying to re-flate the economy for more than two and a half decades now without much success. To be fair, the world as a whole doesn’t suffer from the same demographic headwind that Japan, but still not letting the system to clean itself might be a huge drag on future growth, even if technological advance will likely pull the global economy out of the “mud” of deflation.

Until then it will be a hard feat to achieve significant returns. A selective investment strategy to the most promising segments will likely perform well, but the currently popular passive strategies will likely disappoint investors. Also, gold and cryptocurrencies should perform well during credit and currency troubles, while diversifying into international markets with relatively better growth prospects, and buying hard (but not overvalued) assets globally will likely be a good way to go.

All in all, the job of an individual investor will be harder, but more rewarding compared to the majority of passive investors and managed funds based on those. So investing in your knowledge about selective investing and entrepreneurship will likely be the one with the highest ROI in the coming decade.

Trader and financial analyst, with 10 years of experience in the field. An expert in technical analysis and risk management, but also an avid practitioner of value investment and passive strategies, with a passion towards anything that is connected to the market.