Empire of Dunces



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I have usually in the past commented that the economic crisis is going to lead to inflation. And that at the rate at which the various governments and central banks in the world are trying to ‘stimulate’ their economies, even hyperinflation. However, I have to clarify this. Understand that the massive expansion of the money supply is accompanied by a vastly more massive contraction of credit. And in the end, it must be remembered that the US economy is debt based. There is 53 trillion USD in total credit in the US, but the total money supply is only about one sixth of that. The odds of deflation are far higher under such conditions. The current confusion about what exactly we are going to be faced with comes from the fact that we are having actual, current deflation in some areas (such as real estate, mortgage backed securities) and actual, current (though still moderate) inflation in other areas, such as general living expenses, in particular, food. In essence, for inflation to take over, the ‘money printing’ by the Fed will have to outstrip the shrinking in credit right now. Theoretically, this is possible. However, it entails the additional factor that the Fed is not really ‘printing’ this money. The whole point of the exercise is to remember that the US economy is CREDIT based. Which means that all this newly created money has to be converted into debt. Which means the Fed has to buy Treasuries. On a massive scale. By which I mean, massive like never before seen or imagined. Like I said, theoretically possible. But at some point, the other holders of Treasuries, worldwide financial institutions (eg pension funds) and foreign governments, will have to realize that they are participating in a sucker’s game, in which it is THEY who will pay the final bill. Unless they sell beforehand. A process that is already ongoing. Witness the Chinese. The Chinese have been acting very smartly indeed, by converting more and more of their ginormous reserves into gold, and actual resources that they know their economy requires.

So which is it now, deflation or inflation? Frankly, I still see no other way out of this, than for hyperinflation to at some point take over. It is really the only way for the US to get a handle on its debt. Other than a default, which I believe would simply be too damaging for the US ( or its political elite, at least) to even consider. But until that time, we will probably experience continued deflation, no matter what the Fed does. It is far easier to fantasize about that technology, called a printing press, as Bernanke did a few years ago, than to actually use it for the prevention of deflation. In particular, when said deflation is coming about not on account of an expanding amount of products and services chasing the same amount of money, but because a drastically increasing amount of money is still not anywhere close to an even more drastically shrinking supply of credit. Eventually, however, there will come a time when most of the excess credit has been written off or paid down (HA!). And then, we will have the scenario where deflation has run its course, while at the same time an insane amount cash is floating in the economy. Which spells I-N-F-L-A-T-I-O-N, in any language, other than Keynesian apparently. But at this point, the Fed has really painted itself into a corner. It requires all this excess money, so as to pay back its debt. Without such hallucinogenic amounts of money creation, the only other way is for the US government to default on its debt. In the end, it WILL come down to a decision for either default or inflation. No amount of tax increases, spending decreases, or GDP growth will be able to handle this debt load.


Written by gloege

August 12, 2010 at 13:29

Posted in Uncategorized

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