Will We Have Inflation, Deflation, or Hyperinflation? Part 4 (Final)

Will We Have Hyperinflation?

Is hyperinflation possible in America? The proper question to ask is if it is probable. To that question I would say no. Hyperinflation would result in the destruction of our monetary system and Ben Bernanke and just about everyone at the Fed and the Administration’s economic advisors understand this quite well. I believe they understand the mechanism of printing money as the cause of hyperinflation.

I am also aware of the implications of runaway Federal debt and the political choices the government has to pay it: higher taxes and/or inflation. The third method to pay it would be a thriving economy caused by a reduction of government’s heavy hand, but free market capitalism is out of favor right now.

To prevent runaway inflation the Fed would raise interest rates, increase reserve requirement, and sell assets to stabilize money supply. The hit to the economy would be worth the risk. This is essentially what Volcker did back in 1979-1980. If it really got rough, price and wage controls would be instituted on a temporary basis to cool things down. I am aware of the implications of such controls and the massive price distortions they cause, as is Mr. Bernanke. But it would politically acceptable on a temporary basis. That famous Republican, Richard Nixon, did this in 1971. We all understand that such controls only further distort the economy because only market prices enable us to make economic decisions, which is why such controls would be short lived.

Summary

1. Inflation or deflation is a monetary phenomenon. An increase in money supply causes inflation. A decrease in money supply produces deflation. (Ceteris paribus.)
2. Price increases are a result of inflation, not inflation itself. The main impact of inflation is malinvestment.
3. The Fed has been trying to inflate the money supply to end the credit crunch.
4. The Fed’s inflation efforts have been mixed. Most banks are still not lending and credit and money supply have been declining.
5. Banks are not lending because their balance sheets are loaded with bad CRE debt which has caused them to be concerned about their financial viability. In addition they have difficulty attracting viable borrowers.
6. The government has enabled banks to postpone the inevitable write-downs of bad debt which has drawn out the credit crunch and has impeded economic recovery.
7. Monetary stimulus has been achieved by the Fed’s Open Market Operations which has injected almost $1.25 trillion of new money into the economy.
8. The impact of such stimulus has served to benefit the large money center financial institutions, and does not appear to have aided liquidity or to have stimulated economic growth other than the financial markets.
9. Government fiscal stimulus has had little positive economic impacts on the economy, and, as the effect of government spending winds down, we are left with wasteful spending of no lasting economic benefit and high public debt.
10. Recent increases in consumer spending and consumer lending are temporary blips caused by government stimulus programs and are having no lasting effect.
11. Money supply has increased since the October, 2008 crash, but there are signs that it is beginning to decline again.
12. While the CPI has been increasing, increases are modest and are a result of the Fed’s less inflationary OMO purchases of MBS.
13. The current trend of the CPI seems to be declining.
14. It appears that economic activity is slowing down as stimulus runs out and money supply declines, and that we are headed for a double-dip decline.
15. Until banks’ balance sheets are cleaned up by resolving the overhang of bad CRE debt, they will continue to restrict credit and thus constrain the growth of money supply.
16. The deflationists’ analogy to Japan’s experience from 1989 to 2003 is only partially applicable. The American tradition is to allow banks and businesses to fail.
17. This cleansing process is ongoing but is slow because the government has given banks incentives to delay the process.
18. The deflationists have yet to show that deflation has occurred as they say. While asset values are declining, mainly real estate assets, money supply has not crossed the deflation Rubicon yet.
19. The deflationists seem to conflate the concepts of deflation and deleveraging, which aren’t the same things.
20. A double-dip decline will put political pressure on the government to take any steps they can to thwart the decline.
21. An inevitable increase in unemployment will be politically unacceptable to the Administration and Congress.
22. The government will renew attempts at fiscal stimulus on a grander scale.
23. The Administration and Congress will put pressure on the Fed to counteract the decline. All politicians and most Keynesians and Monetarists believe that price inflation is preferable to price deflation.
24. Inflation destroys real capital which will limit future economic growth.
25. The Fed has limited options to create inflation but they will attempt to do so by injecting money into the system through OMO.
26. One option is to buy Treasury paper, thus monetizing federal debt, which will ultimately create price and monetary inflation.
27. Another option is to buy CRE debt from smaller banks to clean up their balance sheets and allow them to resume lending activities and expand money supply which will result in inflation.
28. The problem will these alternatives is that they will serve to reduce economic growth by causing malinvestment and the further destruction of real capital while at the same time create price increases, which is called stagflation.
29. If inflation gets out of hand, it is probable that the government will impose temporary price and wage controls while they counteract inflation through increased interest rates and other restrictive monetary policies.

After Part 4, I will publish the entire article as one downloadable PDF.

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