Friday, April 16, 2010

Money Supply

The idea that we may be entering a period of high inflation seems to be the current thinking put about by people at the top of our economy, and I wonder about their pronouncements. Partly I wonder because I have grown to doubt their trustworthiness when it comes to manipulating our economy. If they say we are headed toward a period of inflation I suspect it's because they want it so. Partly I wonder about the likelihood of inflation in the face of a rapidly deflating economy, because our economy is deflating at his very moment.

The conventional view is that if allowed to run rampant inflation will eat away at the value of our currency and wreck any attempt to maintain economic stability. It will bring us to a round of price increases followed by wage increases in a futile attempt to keep pace. The examples of Weimar Germany, Argentina at the turn of this century and Zimbabwe a few years ago, are brought up ad nauseam, as though we too run the risk of wheeling barrows full of money into the street to buy bread. This I simply don't believe. The good news would be that my house mortgage would be reduced in value (just as the national Debt would too which leads me to wonder if this is all wishful thinking) if inflation picks up steam. Prices could increase in cost every day but my mortgage would remain fixed...which is the joy of inflation to those among us who owe money at a fixed rate!

With all the worry about runaway inflation at the forefront of everybody's mind we seem to have lost sight of the fact that at the moment our economy is deflating and even though the Federal Government is trying to stimulate a recovery by pouring trillions into public works after pouring tens of trillions into the banks all the public re-inflation of the economy has still left us with a sagging deflationary balloon. How much more money do we need to print and drop from helicopters to turn our deflationary economy into an inflationary one? I doubt the Fed can print enough fast enough to get that to happen. Here's why: we live and spend by credit not cash.

The classic definition of deflation is a marked drop in prices, though the best definition I have read involves the reduction of availability of credit. It's not an easy mental transition to make but if we consider the availability of credit to be the equivalent of money in our modern world, we see the shrinking of credit lines creating a deflationary spiral. For the past decades we have been living through expansion of credit lines, and most recently until the bubble burst, housing loans. Now that credit is being squeezed you will see deflation start to bite. Ignore prices because they will reveal nothing about the state of inflation. If people (known in our unhappy world as consumers) don't have access to credit they have no money (credit) to spend. In these conditions it doesn't matter how inexpensive items are, if there is no money/credit to buy them.

In classic economic theory an increase in the money supply leads to a spiralling increase in wages chasing rising prices. Now we have increasing unemployment (which traditionally drives down wages) and shrinking credit. How then can inflation threaten our economy? I dunno and I guess we shall see.


Anonymous said...

Nice summary of the inflation vs. deflation debate. We are currently in a deflationary depression. The Fed is deathly afraid because such a deflationary spiral is difficult if not impossible to stop. Thus they are printing money at a rate never before seen in an effort to pull out of it.

I notice that the word deflation is almost never used by the MSM. It's always inflation this and inflation that. Deflation is a foreign concept to most of us because it is a rather rare event in the age of central banks with "print" buttons.

The mortgage default problem is only getting worse and will for at least the next 12 months. More fuel for the deflationary fire. Also, the current stimulative efforts are winding down. Look out below when this temporary effect fizzles out.

Conchscooter said...

It all does look bleak doesn't it? One reason we are planning a low key vacation this year is to try to hoard as much cash as we can. deflation scares the crap out of me.

Danette said...

"Low key"?? LOL How much lower can you get?

I think Krugman thinks the inflation talk is scare talk to get the feds to raise interest rates- not really something anyone really believes. He's commented on this inflation scare quite a few times. Speaking of Krugman- he's got a lengthy article on the Green economy- he seems to think that acting now still gives us time to turn the worst of this around. I found him a bit overly optimistic-- did you see it? What did you think?

Conchscooter said...

I think the climate change situation is well out of our hands and the plaent will do what it will do. I think we are all capapble of thinking in the abstract about making changes but the reality is that the sort of lifestyle changes needed are far more all encompassing than any of us is ready to under take.