Depressionary deflation or rampant inflation?

This is the question I'm currently struggling with as regards the future of the US economy.  With asset bubbles popping and citizens, business and government up to their eyeballs in debt I'm inclined to think that there will be a deflationary spiral.  As banks hoard cash and repair their balance sheets we will see bank runs and a contraction of the money supply.  This would depress economic activity and be bad for precious metals and commodities prices.  In this environment cash is truly king.

On the other hand we are in an election year and have a Fed and elected officials who will likely be very easy in their fiscal and monetary policy.  This suggests to me a hyperinflationary crackup boom which of course would be good for precious metals and other real assets.

 Any thoughts good readers on which outcome is most likely?  Can rampant inflation "solve" a country's debt crisis or merely postpone the inevitable deflationary depression?

Thanks,

Dave 

I think at best rampant inflation will postpone a country's recession, though not deflation. Deflation is about as likely to happen in America as a return to the gold standard (i'm sorry to say this isn't likely to happen).

Whenever an economy overinflates, it causes a bust. Yes, since a lot of money floating around is debt based, then you can expect a contraction over a short period of time (as with the beginning of the great depression), but soon after we will once again see more money printed by the government to satisfy increased spending.

Of course, the more pressing concern is when will the world (already happening), and Americans themselves finally realise that their dollars are becoming (already are) worthless. When this happens, the Amero, together with a north american union might occur (if various theories concerning this are actually true). It seems reasonable that given lessons from history, when a currency utterly fails, another will come about with a new name, and be just as mishandled. Though of course, in the short run, things may return to normal and hyperinflation may be further delayed. This can all be summed up in the most foolish statement ever "In the long run, we're all dead". We all know who said it, and this statement is the logic behind what governments do and how they work.

eric lansing:

I can't believe how many people on the Ludwig von Mises website dismiss the possibility of deflation. Deflation is what the very theory suggests will happen in the US... people pretend like Japan didn't happen.

There is already way too much inflation in the U.S. for deflation to be possible. If what you mean by deflation is that the price of real estate will crash, well that is a given, but it is not the kind of deflation that affects the economy as a whole 

http://www.mises.org/story/309

 with all due respect, I just think you have no idea what you're talking about.

Take a look at japan in the 1990s.

They lowered interest rates to almost zero and held it there for years. It didn't stop a deflationary spiral. 

The idea of flodding the market with liquidity to stop a recession forever is silly. It only prolongs the ineviteable and makes the coming correction worse.

Sooner or later the K wave winter must take place. Debt and speculative excess must be drained from the system so the economy (and the debt cycle) can start afresh.

In my humble opinion the Austrians have it right. 

LOL! Ian Gordon's Long Wave Analyst, Jan 2003? Bravo!

PS - Fed cut the FFR by a staggering 0.75% today and Mr Market dropped 300 points. It's over... we're all gonna die.

There's another point that's rarely known.

The public, ultimately, have a part to play in creating inflation. 

They are the ones choosing to borrow, out of greed, or merely not waiting patiently, until they have saved enough.

By doing this, they collectively expand the money supply, by the way bank balance sheets work. Banks are merely the structure.

Please have no bad feelings for banks or bankers. They built the system, but it's up to each person, to use it or not.

I wish to share this so people can better understand what happens when they borrow.

goodAsGold:

Take a look at japan in the 1990s.

They lowered interest rates to almost zero and held it there for years. It didn't stop a deflationary spiral. 

The idea of flodding the market with liquidity to stop a recession forever is silly. It only prolongs the ineviteable and makes the coming correction worse.

Sooner or later the K wave winter must take place. Debt and speculative excess must be drained from the system so the economy (and the debt cycle) can start afresh.

In my humble opinion the Austrians have it right. 

 

what are japan's rates now? are they still staving off the inevitable?

goodAsGold:

The public, ultimately, have a part to play in creating inflation. 

They are the ones choosing to borrow, out of greed, or merely not waiting patiently, until they have saved enough.

By doing this, they collectively expand the money supply, by the way bank balance sheets work. Banks are merely the structure.

 Borrowing doesn't cause the money supply to increase, banks loaning out money that they don't have, or that they got from the Fed, is what causes the supply to increase.  The Fed is in control of the money supply, not the borrowers.

True. The fed controls the money supply by currency issue; reserve limits and by open market operations.

The thing is, the person on the street has their part to play -

they ask the bank for a loan;

they buy stuff on credit;

they buy stocks on margin. 

etc

Let me explain:

The act of borrowing, within the fractional reserve system has an influence on the money supply.

the reserve ratio only puts limits on the how much a bank can lend at a given time

So unless people borrow, the banks won't reach the reserve limit.

That's one reason why the money supply is unstable - loans are being issued and paid off all the time. 

Sean_M:

what are japan's rates now? are they still staving off the inevitable?

The system collapsed in 1998. The fallout lasted years!

They are still at near zero (0.5%) 10 years later !

In the early 90s, Japan had 21 large banks. Now they have 14!

Links:

The banking crisis of the 90s - BIS

 So much bad economics.

eric lansing:

Inflation, Deflation, and the Future

By Frank Shostak

http://www.mises.org/story/309

 with all due respect, I just think you have no idea what you're talking about.

Who? Frank Shostak? I think he has a far better idea of what he's talking about than most people here do. 

Well I think that was eric's point.  

 Here is a quote from when comes calling that sums things up:

... For now, we are living a
systemic episode with all the hallmarks of an epic event and the policy
response will ultimately decide our economic fate. Early devaluations helped
countries in the past to relocate some of the pain to lenders, it may become
an attractive policy option again. The devaluation of the USD may well
become the chosen path of least resistance for the current monetary and
fiscal authorities of the USA.

No amount of monetary resuscitation will restore consumer spending or
aggregate demand, the term used by the FED, when debt saturation prevails.
Further ruthless debt stimulation via monetary policy will end in currency
failure. Currency failure can manifest in hyperinflationary payment mechanism
failure (Weimar Germany 1923); or deflationary payment mechanism failure
(USA 1929); or in deflationary stagnation (Japan 1990-2007). That is the
message from history.

There's a lot of blame-gaming going on here, and I'd like to set the record straight on who's to blame, because every member of the game has their share of responsibility.

 The Players:  The Federal Reserve, Commercial Banks, Businesses, Consumers, the US government, and various foreign players.

 New American Standard Credit Cycle 101

    -- The Federal Reserve sells newly-issued US notes and bonds

    -- The Federal Reserve flushes the liquidity into the market in one way or another, ending up in commercial banks eventually

    -- Commercial banks lend that liquidity on their 10% reserve rate, recycling the debt back into the market as it is continually borrowed and redeposited

    -- Businesses borrow from commercial banks to fund business investments (and others "stuff") as well as to refinance existing debt

    -- Consumers borrow from commercial banks to buy consumable goods and real estate.

    -- US dollars leave the US economy en masse to purchase imported goods from foreign economies (mainly stuff that doesn't retain value for long).

    -- Foreign central banks must keep the credit cycle moving to ensure the largest consumer of their national products continues to have spending cash, so they "give back" the dollars by lending the US more money.

    -- This completes the cycle with new debt from foreign countries providing the liquidity needed by the US to continue its insane consuming habits.

 (Feel free to correct/add missing links to my credit cycle system; I have a pictorial aid that I have created, and I'm always looking for ways to make it more complete)

Eventually, the credit cycle will be unable to continue as commercial banks are unable to find suitable investments and their past lending mistakes pile up to create an unsustainable balance sheet.  While the commercial banks write off their bad loans, the Fed will continue to dump in extra liquidity, thinking that this Keynesian strategy will save humanity (or at least their banker friends) from the ills of Scarcity.  But the commercial banks will stop accepting liquidity, basically refusing to take on more deposits or, as happened in Japan, offering negative interest rates on deposits, requiring people to pay for the bank to hold their money.

Once the credit cycle stops moving, there's only one more way for the Fed to inject liquidity into the market (that I know of, anyway) to keep fueling the fire.  They have to monetize it and pump cold, hard cash into the system.  Once this starts happening, you might as well throw your cash in the fire to stay warm.

However, after any hyperinflation occurs and a currency dissolves, there is a period of extreme deflation as the transfer of goods and services virtually freezes.  This is the perfect opportunity for the elite rich to mop up valuable assets at pennies on the dollar, just as they did in Germany after the German mark collapsed, just as they did after the 1908 (?) bank run, just as they did after the 1929 market crash and ensuing Depression, and many, many other incidences of collapse/ruin.  The elite make the most money from collapse and ruin; they arguably cause it for those ends, but I will not digress into that discussion.

So, the answer to the question, provided this follows the same pattern as any previous inevitable collapse, is that first hyperinflation will occur followed by a stark and terrible deflation.

Regarding responsibility and blame, however, every single player in the current credit cycle is responsible for the credit cycle because each member is essential for it to continue.  The American people, myself included, will have no basis for complaining (though they will anyway) when the tightening economic spring snaps to their destruction.  We had the power to stop it all along, but our Bellies were too big and our Wills too shriveled and weak.