The Upside-Down Bell Curve

You’re right that we’re facing deflation in the short-term, Paul.

But it’s hard to ignore the massive amounts of debt and stimulus that the government is throwing at the problem. I’m sure you’ve seen the charts showing the expansion of the central banks’ balance sheets in response to the financial crisis.

If not, Cumberland Advisors has some great charts on it:

  • Here for the U.S.
  • Here for the ECB
  • Here for your beloved Bank of England

Combined with massive fiscal stimulus from the government side, you can see why people might worry. The feds are running the virtual printing press nonstop, and the only question is whether they’ll undershoot, overshoot or (somehow) thread the needle.

In a recent interview on, economist Donald Luskin talked about the future being an “upside down bell curve.” His point was that the most likely scenarios are either that the Feds come up well short in their stimulus attempts, and we get strong deflation, or they overshoot — and we get runaway inflation.

The least likely scenario, according to Luskin, is a continuation of things as usual. That sounds about right to me.

Luskin goes on to argue — I recommend that everyone read the interview — that the Fed (at least in the U.S.) is strongly inclined to err on the side of inflation rather than deflation.

“The Fed regards deflation as a worse thing than inflation. When it contemplates controlling risk, it would rather err on the side of controlling deflation and permit error on the inflation side,” Luskin says. “The argument is that while inflation is pernicious — it gradually destroys savings, it corrupts the price discovery process and so on — at least in inflationary scenarios you don’t normally see cascading defaults. You do see that in deflation scenarios.”

He thinks that, in the long term, inflation is likely to win out.

Which is not to say that sustained deflation could not happen. It certainly could.

I think it’d be awful if it did. The economic repercussions would be pernicious and long-lasting. In that environment, I think I’d probably end up wanting to own cash.

And maybe a bunker with a stockpile of canned food.

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