Deflation or Hyperinflation
by Douglas V. Gnazzo, Honey Money Report November 24, 2008
Although I have written on this subject before Honest Money: Scylla & Charybdis: The Scourge of Mankind, I would like to revisit the topic, as it has once again become a popular theme. A financial crisis is occurring around the world. Few seem to know why or how to fix it. This paper attempts to answer these questions. First, some definitions are in order.
Inflation is an increase in the supply of money (quantity) over and above the demand for money. A loss of purchasing power or value of money follows.
Deflation is a decrease in the quantity of money (supply) below the demand for money. An increase in the purchasing power or value of money follows.
Either inflation or deflation is constantly occurring in the marketplace as the value of money never remains fixed. It is rare for monetary deflation to occur. Inflation dominates in a world of paper fiat money. This is easily illustrated by the Federal Reserve’s inflation calculator, which shows the dollar losing 96% of its purchasing power since the Fed was created in 1913.
The last period of significant deflation occurred during the Great Depression in the 1930’s. Our monetary system had just come off the gold standard. To compare present times with the 1930’s is comparing apples to oranges. Coming off the gold standard involved the dissolution of complex inter-market dynamics that throws meaningful comparisons out the window.
Purchasing Power
Loss of purchasing power is crucial in understanding today’s financial crisis. Money is used as a medium of exchange to purchase other goods with. Purchasing power is literally the power that money has to purchase. The larger the quantity of goods that a unit of money can buy, the greater is its purchasing power; and the better off the consumer will be.
It is not the quantity or number of units of money that is important. What is important is the quantity of goods the unit of money can purchase. It is the quality of money (purchasing power) that is important. The greater the value of money the more goods it can buy.
The loss of purchasing power is better known as inflation. Inflation is a hidden tax that comes like a thief in the night and steals one’s wealth or power to purchase. It is more lethal than any form of direct tax such as income tax. If you were taxed 96% of your income you would be up in arms. Yet, inflation has stolen the same amount of purchasing power from you over the years.
A financial crisis is occurring around the world. What caused this crisis? The answer is simple: monetary inflation of epic proportions created by excess credit and debt issuance. The tons of paper money created fueled unsustainable bubbles in real estate, stocks, bonds, and commodities – a crack up boom, which has now gone bust.
Savings
Man produces and he consumes. When he produces more than he consumes he can save the excess production. This is known as savings or the accumulation of wealth (purchasing power). Money is saved for future use to transfer back into income when it is needed to buy things. There is a limit to what man can produce. Likewise, there is a limit to the excess production that can be saved over and above consumption.
This means the savings pool is limited. Credit is loaned from the savings pool; or should be in a sound monetary system. This in turn means that credit is limited – in a sound monetary system.However, in a world run by central bankers that believe in excess credit creation spurred on by diminishing interest rates and exotic credit derivatives, savings is actually discouraged – consumption and debt is pushed as the opiate of the people. Central bankers have embarked on a zero interest rate policy in a mad dash to hell. Currency devaluation is taking place at unprecedented levels. Money is being destroyed.
In a sound monetary system, as the savings pool is drawn down through lending, savings become scarcer. A higher rate of interest results to induce savers to part with their savings. In other words – the greater the demand for credit – the greater is the rate of interest. This puts a natural check on the amount of credit extended. In today’s new world order we have just the opposite: greater extension of credit by lower and lower interest rates. This is misguided monetary policy of the highest order. It will end badly if not fixed. There are answers.
Highway to Hell
Savings are at historical record LOWS – yet debt levels are at historical record HIGHS. Interest rates are hitting record LOWS. How can this be? This is not a natural order; it is a man made or contrived order – a new world order: wealth transference from the many to the few. Perhaps this is why there is a credit crisis. Perhaps this is why the U.S. has gone from the greatest creditor nation in the world to the greatest debtor nation.
Total debt in the United States is $53 TRILLION dollars, which is almost 500% of net national income. We owe foreign entities 12.5 trillion or 24% of the total. Does this sound like our standard of living is increasing or decreasing?
We have come to a fork in the road. Ludwig von Mises stated: "There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."
The first alternative is deflation. The second is hyperinflation. Welcome to the new world order, where debt is money and money debt.
Many believe that central bankers have unlimited powers, that they can conjure up not only the supply of money, but the demand for it as well. This is a grave mistake – an illusion of intended consequence.
The Fed is able to increase the money supply, but they cannot determine exactly how or where it will be used in the economy. In a falling interest rate environment the action is in the bond market. The bond market sucks up the badly needed capital that should be flowing to the producing sector of the economy.
Although interest rates are falling, businesses find it difficult to pay off debt borrowed at higher rates. The bond market mugs the productive sector. As interest rates fall, the value of debt rises. If it continues for too long, businesses are forced to liquidate or go bankrupt. We are witnessing this occurring at an alarming rate around the world. These are classic examples of mal-investments gone astray.
Markets and asset prices have been distorted by excess credit and money creation. Global asset prices are mispriced, and this is especially true of the huge toxic wasteland of debt derivatives: about $600 trillion just on the books of the BIS. No one knows how much has occurred on the OTC market, as there is no transparency reporting requirements made public.
Stuff needs to be re-priced. Markets need to be settled. The problem is no one knows what (if anything) the stuff is worth. That’s why certain assets are illiquid – no one wants them. The Fed and the Treasury are now the lender and buyer of last resort – robbing Peter to pay Paul. This is simply wealth transference. The productive sector of the economy is being pillaged and plundered by the financial sector via structured finance. Capital is looted from the former and given to the latter.
In a paper fiat system the supply of money tends to increase more than the demand for it. In other words – monetary inflation is the “norm.” Bernanke has said that the Fed has the ability to create as much money as needed. This means that an unlimited supply of money is paired off against a limited demand for money, even if demand is increasing.
As monetary inflation occurs, debasement of the currency takes place and loss of purchasing power results. Our money is continually becoming worth less and less. It requires more units of money to buy the same amount of goods. Because more units of money (supply) are needed, the demand for money increases. Bernanke has said: no problem, we will create all the money you want.
As the money supply (quantity) increases to keep up with the rising demand for money, even more purchasing power is lost, which requires further units of money (supply) to make up for the loss of purchasing power; and the cycle keeps repeating. It becomes a self-fulfilling prophecy of currency devaluation and destruction.
Soon it is discovered that the purchasing power of money is falling faster than the demand for money is rising. What was an unlimited supply of money meeting a limited demand for money suddenly becomes an unlimited demand for money meeting a limited supply of money. Money cannot be created fast enough to make up for the loss of purchasing power.
Suddenly interest rates start to rise, as do prices. But the rise in interest rates does not support the currency. The purchasing power of the currency falls in spite of higher interest rates. Slowly panic sets in. People can’t spend their money fast enough – before it loses more purchasing power. The race to hell begins.
Now the monetary beast of inflation turns upon itself: suddenly what was an unlimited demand for money meeting a limited (although ever-increasing) supply of money, now becomes no demand for money, as the market correctly perceives that no amount (quantity) of money can make up for the loss of purchasing power (quality) destroyed by the debasement of the currency.
The gig is up. The fraud is seen for what it is. The currency is no longer accepted as the common medium of exchange. The use of the currency ends. The creature destroys itself by suicide – by hyperinflation. Hyperinflation is the death-knell of paper fiat debt-money.
Staring Into the Abyss
Deflation and hyperinflation are different in form, but are identical in substance – two sides of the razor sharp edge of debt. On either side lies the abyss. Deflation destroys debt through defaults and bankruptcies, hyperinflation by debasement and loss of purchasing power.
Which fork in the road will the economy take? One thing is certain: the decision is no longer in the hands of the producers as it should be. It now rests with the financial sector – the bond market: the debt market. In paper fiat land we live and breathe and have our being in a world of debt.
History is replete with bouts of deflation and hyperinflation. One distinction that history shows, however, is that hyperinflation ends the life of a currency – it no longer is accepted as the medium of exchange. Although deflation is wrought with pain and suffering, defaults, bankruptcies, job losses, depressions, etc.; the currency is not destroyed. The slate of debt is wiped clean and the game begins anew. Deflation prolongs the life of the currency; hyperinflation destroys the currency. The first allows the game to continue. The second ends the game. Bernanke and company have said that they will not allow deflation to occur. The only way to stop deflation or hyperinflation is to stop the inflation that comes first. Since the day the Fed was created it has repeatedly increased the supply of money. Subsequently, inflation has been baked into the cake.
If Bernanke holds true to his word then the Fed is going to attempt to stave off deflation by increasing the supply of money via inflation, which means further devaluation and loss of purchasing power for the U.S. dollar.
The Fed is going to try to walk the high wire act above the bottomless pit. The odds are against them winning such a dangerous game. Delicate balance and a deft touch are required. One wrong move can tip the scale in either direction.
Asset deflation is presently occurring. The Fed has responded by increasing their balance sheet 125%. There is more to come. Once the new credit plugs the hole in the dam of asset deflation – the increase supply building up will cause greater pressure until the dam finally bursts.
At the rate things are going a new cycle of excess credit creation will filter through the economy later in 2009, precipitating the final leg up of monetary inflation run out of control. Hyperinflation may be here by 2010. If and when it hits, the death of money will not be far behind. Steps need to be taken now – before it’s too late. The clock is running out.
The cause of the financial crisis is the paper fiat money system itself; and all the baggage it brings with it: inflation, debasement of the currency, mal-investment, devaluation, and loss of purchasing power. It is nothing more than a wealth transference mechanism that takes from the many and gives to the few.
I have written a book titled Honest Money that explains the history of our monetary system and how the Constitution mandates that our money is gold and silver coin – not paper money. The Constitution even goes out of its way to disallow paper money (bills of credit).
The answer to the financial crisis is a monetary system of gold and silver coin as mandated by the U.S. Constitution. Nothing less will affect any change in the present mayhem. Free samples of the book are available both in audio and text at my website: Honest Money Gold & Silver Report.
Come visit the website: Honest Money Gold & Silver Report
