View Full Version : The Question: Inflation or Deflation

Jim Nickerson
09-29-06, 12:55 PM
For my pea-sized economics brain, this is one of the more interesting articles that I have run across. I do not know that any of these guys know of what they write, but overall I think they offer most of the perspectives pertinent to considering what lies in our futures: INFLATION OR DEFLATION?

I have no idea who is correct. I think the entire article is worth reading.

The quotes below are not posts, but quotes from Rubino's work.

The QUESTION by John Rubino
[url] http://www.safehaven.com/article-5992.htm[/url (http://www.safehaven.com/article-5992.htm%5B/url)]

The answer matters for a lot of reasons. Hyperinflation and deflation favor very different investments, obviously, gold the former and cash the latter. But it also goes to the heart of our understanding of post-gold standard economics: Are today's central banks in complete control of their fiat currencies' value, or do the markets ultimately determine exchange rates and price levels? Is there a point of no return, when rising debt levels make one outcome or the other inevitable? How do you invest to make sure you're covered either way?

I basically believe that the greater risk is hyperinflation. Eventually it will probably end up with some deflation, but not before we go through a bout of infinitely worse inflation.

By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Secondly, I am not so sure that the Fed cannot afford to turn us into a deflationary collapse if it is faced with the prospects of the U.S. dollar becoming increasingly worthless vis--vis other currencies and the U.S. losing the benefits of owning the world's reserve currency. If the dollar tanks, I do not see why we cannot expect a repeat of 1980, when Volcker saved the dollar by stomping on the monetary breaks and causing real interest rates to rise to their highest levels since the Civil War. Had Volcker not done that in 1980, the U.S. would have been toast back then. The same people, or at least the same ruling-elite families who were in charge then, are in charge now. I do not see why they would relinquish their power as "landlords of the world" now by allowing the dollar to head toward zero vis--vis other currencies and gold.

While the elected officials and even the Fed chairman may need to act like they care about the pain and suffering of common, ordinary Americans, their willingness to inflate wealth away from us does not suggest they care two hoots about common people. I believe the establishment will inflate as long as they can get away with it, but that they will once again pull a 180 degree policy turn on monetary policy and interest rates if draconian measures are required to save the dollar as the world's reserve currency and the Anglo-American controlled world economy.

Inflation is an INEVITABLE consequence of the current monetary system.

The issue, therefore, is not whether the Fed will ATTEMPT to maintain the inflation (it doesn't have another option), but whether it will be ABLE to maintain the inflation.

As long as the laws of supply and demand remain in force then someone who can increase the supply of some 'thing' by an unlimited amount will always be able to reduce the value of that 'thing' if that's what they choose to do. The central bank has the power to create an unlimited amount of currency, so those who argue that the Fed will be unable to prevent the dollar's purchasing power from rising are claiming, in effect, that the laws of supply and demand don't apply to money. Such claims are patently false.

What we think the Fed fears more than anything else -- certainly a lot more than it fears deflation -- is an uncontrolled surge in inflation expectations. The dollar's slow-motion collapse can continue almost indefinitely, with the Fed injecting money in response to the occasional deflation scare and pushing short-term interest rates up when inflationary pressures begin to show through, as long as the public doesn't come to believe that the dollar will lose its purchasing power at an ever-increasing pace. However, if the public began to anticipate acceleration in the rate at which the dollar loses its purchasing power then prices would begin to rise much faster than would be justified by increases in the money supply alone, and bond yields would rocket upward. This is why the Fed must keep hiking short-term interest rates until inflation expectations are most definitely under control, regardless of how much damage the rate hikes are perceived to be causing to the economy. If they overdo the rate hikes they can always inject enough new money later to re-energise the inflation trend, but sharply rising inflation expectations would be a life-threatening problem for the current monetary system. The bottom line is, soaring long-term interest rates -- a guaranteed effect of letting inflation expectations get out of hand -- would be far more damaging than any problem caused by overly tight monetary policy.

The truth of the matter, as we see it, is that the Fed has the tools to keep the inflation going and it KNOWS it has the tools to keep the inflation going. The Fed's biggest fear is that everyone else figures this out…

It seems that everyone feels the Fed is all-powerful, and that the Fed can defeat the business cycle by forever printing money. That is the fallacy of the inflationist arguments. It cannot be done. The root cause of the great depression was an overexpansion of money and credit. "Helicopter Drop Bernanke" could no more cure that by printing more money than I could take on Michael Jordan in one on one basketball at his primeBanks can print but they cannot force consumers to either borrow or spend. If bankruptcies expand faster than borrowing, the net of money supply and credit will contract. That is deflation.
Yes, the US is different than Japan. We are far worse off and much deeper in debt. That adds to the deflationist case. Wage fundamentals are much worse now especially with outsourcing and the internet. That adds to the deflationist case. Ultimately it comes down to the question of "will the banks destroy themselves and their wealth" to bail out consumers deep in debt.
The answer to that question is "Of course not. Why would they?"
If housing is the bubble of last resort, what would happen if the Fed turned on the pumps? I suspect money would go into gold and silver, but no jobs would be produced, certainly nothing like the housing boom produced. That last sentence should explain why many deflationists like gold. That answer is also why it would be game set and match for the Fed. Yes the Fed could in theory drop money out of helicopters, but only if they wanted to destroy themselves. There is theory and there is practice. If consumers are finally at the end of their ropes as I suspect, inflationists are in for one rude shock.

So, should we expect today's financing infrastructure of unprecedented dimensions to be willing to moderate and downsize, or will the intense expansionary (inflationary) bias persist? Inflated stock prices - and massive stock option grants and share repurchases - point to the latter. Thus far, rising short-term rates and contracting lending margins have incited a push for lending volume (bank Credit up 11.3% annualize y-t-d). Stagnating mortgage profits have to this point nurtured aggressive expansion in capital markets, trading, international and prime brokerage (hedge fund services) businesses. Until proven otherwise, I will stick with the view that the profligate Financial Sphere expansion will run unabated until it is interrupted - and perhaps terminated - by financial crisis or some exogenous event.

It is all scary to me.

Jim Nickerson
09-30-06, 10:44 PM
John Williams of Shadow Government Statistics http://www.shadowstats.com/cgi-bin/sgs/?ref=234993 is interviewed by Jim Puplava at http://www.netcastdaily.com/fsnewshour.htm in the 3rd Hour segment. This in an interesting interview where Williams discusses the screwiness that will emerge in the CPI data over the next several months because of comparisons being made against the period last year when Katrina caused so much disruption.

Williams does not think deflation will happen, but that disinflation will.

The entire recording is 1:15 and on my Real Player, Williams' interview ran from about 39 mins to 55 mins.