Could Deflation be a Blessing in Disguise?

There is a piece out tonight from David Rosenberg on Zero Hedge that was a real eye opener for me. For the first time since this crisis began, I heard the word Depression used by a very well respected economist.

I had planned on doing a deflation piece over the weekend and Rosenberg's article fits in perfectly with what I wanted to talk about.

The numbers are now basically telling us that deflation has arrived. Incomes are dropping at a record pace as you can see below:

My Take:

Folks, the numbers here are staggering. Personal incomes have dropped by a whopping $500 billion dollars which is the largest reversal in history. The second chart indicates that government handouts now account for over 18% of personal income.

The problem with the handouts as we all know is they mostly expire after 99 weeks because a good chunk of that 18% are unemployment benefits. The problem here is the government cannot sustain this type of spending without blowing themselves up via default.

Collapsing incomes in a country that has a 70% consumption based economy is the perfect recipe for a depression. I am glad Rosenberg said the "D" word. I think it's time for all of us take our heads out of the sand and say it. As my dad likes to say: "Son, it is what it is".

The depression going away anytime soon so we might as well get used to it.

Is Deflation really a bad thing?

If you are a banker with a few trillion of mortgage debt on your balance sheet it is. However, in many ways deflation is good(more on this larter).

It is pretty clear that Ben Bernanke's obsession around preventing deflation is doing more harm than good at this point.

Someone needs to tell Ben that obsession's usually don't turn out very well. It's not a very constructive emotion. In fact, it's a huge character flaw!

I mean how many relationships work when one person get obsessed with the other? Yeah, I can't think of anytime where it's worked out either. Fatal Attraction anyone?

I just watched the movie "The Fan" with Robert Deniro today where he plays a fan that becomes obsessed with a baseball player that ultimately dies in the end as a result of his obsession. That one didn't work out to well either!

My point here is that when someone becomes obsessed they open themselves up to making bad decisions because they are too emotionally involved with the topic or person they are obsessed about.

This then leads to irrational critical mistakes and then ultimately failure.

I mean any girl or guy that dates an obsessed "stalker" always runs for the hills as fast as they can right?

IMO, Ben is making several crucial mistakes at this juncture as he desperately tries to prevent deflation. Its obvious from the charts above that he has already lost the battle.

The problem is he is not allowing the markets to "revert to the mean" down to affordable levels where people can afford to live in this new deflationary world.

Housing is a perfect example of this. No one will ever buy all of these bubble priced homes because no one can afford them. There are 5 million empty homes in this country!

Yet, Mr. Bernanke continues to keep rates at zero in an attempt to stimulate borrowing and allow the banks to heal themselves. The problem is people can't borrow like they used to because they are losing their jobs and taking huge pay cuts as a result of our collapsing economy!

The only healing the banks did was to their wallets in form of massive bonuses.

Deflation is not always a bad thing. Ben is obsessed with it because he knows deflation will destroy all of his banking buddies because they hold too many overpriced assets on their balance sheets. I say so what? Let them fail. We can create new banks that are actually well capitalized.

Deflation is good for the average person in many ways because it makes living life affordable once again. We can go back to being consumers like we always have been in the past because items will be priced more in line with our smaller incomes!

The government can then reduce their spending because the private sector will be able to replace them as the economy begins to recover. They can then focus on being down our trillion dollar debts.

Living the American dream has flat out gotten too darn expeensive. The examples of our bloated costs of living are endless:

he cost of college is another example of this: How many people moving forward are going to have the $150,000-$200,000 to send their kid to a decent private college for 4 years as their incomes continue and shrink? It's not gonna happen!

As the job market continues to deteriorate you have to wonder if parents will want to send their kids to school at all. What's the point in spending six figures on an education if there are no jobs out there?

How can afford to buy a $35,000 new car when you have to spend 500k for a decent house in cities like Baltimore or Washington DC? How can you then save for your son or daughters education when you are forced to become a debt slave in order to simply live.

Another area where we have severe issues as deflation sets in are the pension retirements for public sector employees:

How can we continue to pay out 70-100k pension funds to retired public service retirees? These people wail like babies if they don't get their 4% raises. NJ teachers had a huge protest regarding this exact subject.

Wait until they are asked to take 20% haircuts as this bubble bursts. There will be blood in the streets! People better wisen the heck up and get used to austerity because its going to take a lot of sacrifice if we plan on saving this country.

These unions need a to drink a seriously large glass of reality juice before they all find themselves fired for failing to be realistic about their expectations moving forward. They need to realize that they should be thankful to have a job even if it is at a lower wage.

I mean the public pensions are absolutely raping the taxpayers in this country"

Police officers are allowed to retire in many states at close to their full pay after 20 years. When they retire a new one is then hired to replace him which then means we are now paying two full salaries for one job. 20 years after that we will be paying for 3 salaries for that one police officer when he retirees. How on earth is this sustainable? Where is the money going to come from?

In a time where salaries were rising along with inflation like we have seen over the past 30 years the Ponzi scam worked just fine. The problem is that it's unsustainable when incomes do a 180 and the economy falls off a cliff.

Bernanke's obsession around preventing deflation is going to lead us to economic ruin if he doesn't alter the course.

The economy will not recover as long as we continue to fight deflation and prop up assets at unsustainable prices. The government needs to just stop all of this bailout nonsense and allow the market forces to set in and cleanse the economic system.

If it leads to a depression so be it. At least then we can then prepare to come out it on the other side and begin a REAL sustainable recovery.

When it comes to the markets the best way to play deflation is to short stocks and raise dollars. Gold will still work and I plan on holding mine but it could go through a severe correction before rebounding. Inflation will be coming when we come out of this, but I am strongly starting to believe that we are going to see a deflationary collapse first.

Disclosure: No new positions taken at the time of publication.