Inflationomics

Which Will Hit the United States First, a Deflationary Depression or a Hyperinflationary Destruction of the U.S. dollar?

Deflation, of course, is the contraction of the money supply relative to the supply of goods, while inflation is the expansion of the money supply relative to the supply of goods.  Hyperinflation has the added element of a loss of confidence in a currency (as a store of value) and therefore the currency’s hyper-depreciation or quick loss of value

In recent years, the U.S. government has expanded the money supply both through printing and credit expansion.  Thus, the value of the U.S. dollar has declined.  On the other hand, when individuals, corporations, and states default on their debt, this reduces the expanded money and credit supply and has a deflationary effect.  During times of inflation, debtors gain and creditors lose.  During times of deflation, creditors gain and debtors lose.

Because the U.S. government is the world’s largest debtor, it wants the Fed to inflate the U.S. dollar, making it easier for the U.S. government to pay off its debt (and incur more debt in the short run).  In short, the U.S. government and Fed do not want deflation in the United States; they want inflation and they will do everything in their power to create inflation; however, they do not have control over how many people/entities default on their loans and if more people default on their loans than can be bailed out by the Fed and U.S. government, deflation (and ultimately the bankruptcy of the U.S. government) will ensue. 

Now that the stage has been set, the question is which will happen first, debt defaults beyond the Fed’s/U.S. government’s ability to bail them out, or hyperinflation (a loss of faith in the U.S. dollar as a store of value)?

Some people believe there’s a limit to how many entities the U.S. government can bail out.  (And they’re right.)  They also doubt that the Fed will be able to print money fast enough to keep the economy from imploding under the weight of all the defaulting debt.  They continue…a major debt default could drive prices down, lower corporate earnings, and raise unemployment with a resulting deflationary spiral and depression.  (At that point, the Fed would try harder to print the economy into prosperity.)

On the other side of the coin, lower prices would attract buyers from around the world to U.S. markets, and the demand for U.S. goods and companies could skyrocket, pushing prices higher.  It may already be beginning—consider the purchase of the New York Stock Exchange by the Deutsche Börse.  Where will all this demand come from?  Let’s not forget that the U.S. has been exporting dollars (in exchange for imported goods) for many years and that when the people receiving those dollars can’t use them elsewhere in the world, they will become eager to exchange those cheapening dollars for real assets, right here in River City.  Please note that these are dollars that are already in existence.  There is no need for new dollars to be printed for this result to occur (although new dollars will surely be printed, too), only the loss of faith in the U.S. dollar as a viable store of value. This loss of faith could also occur if the U.S. debt problem becomes overwhelming.

Food would be near the top of the list of purchases, with natural resources coming in a close second.  The dollars that were sent out during the past few decades would come rushing back—quickly.  The demand for cheap goods would be overwhelming!  The United States may even experience shortages of everything that is exportable.

Now, let’s assume, for a moment that the Fed can print money fast enough to keep the economy from imploding under the weight of debt defaults, by bailing out the biggest entities first.  This would be the fastest way to reach the hyperinflationary conclusion.

In my opinion, under either scenario, it won’t take much for non-U.S. citizens to lose their faith in the viability of the U.S. dollar (it’s already happening) and when that happens, U.S. citizens won’t have many alternatives but to either sell their assets to people with stronger currencies, or abandon their use of the U.S. dollar as well.  My money’s on hyperinflation, not deflation.

Robert Jackson Smith

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