Letter Re: Deflation Possibly Followed by Mass Inflation?

I believe that we are in for deflation, not inflation. A simple error that most people make when considering this topic is language related: When discussing actions of the Fed they talk about ‘printing’ money. Well, the Fed (actually the Treasury) hardly ‘prints’ any money at all. In Zimbabwe they print money. Lots of money with lots of zeroes. Here, they just increase the number of zeroes in a computer. The difference is profound. When there is a lot of currency floating around then people use it to buy stuff. More currency with higher values means more currency chasing the same amount of goods and that means inflation. The currency does not go away. If fewer goods are on the market, the same amount of currency is there chasing it and prices go up. The currency doesn’t get destroyed.

In the US the amount of credit used is orders of magnitude more than the amount of currency in circulation. Credit can be destroyed. If the value of your house goes down by $100.000, that $100,000 is just gone. It doesn’t exist any more. It is not in the money supply. This is deflationary. Further, if the bank repossesses your house and then sells it to someone else, the difference in sale price has an effect on the banks ability to lend. If they lose $100,000 on your house then they have effectively lost the ability to lend $1 Million because of the fractional reserve system. That $1 Million is not in the money supply any longer. That is deflation. And, of course, the amount of money that will vanish in exactly the same way as part of the derivative mess is orders of magnitude larger than the amount to be lost due to housing.

As can be seen by looking at virtually anything in the last few years (gas, oil, corn, gold, wheat, houses, cars, the Dow, etc.), prices for everything have gone up while there was credit in the system and banks wanted to lend. Now there is dwindling credit, severe unwillingness to lend, and a Fed that is contracting the ‘money’ supply. Value/dollars/money is vanishing at an unprecedented rate. Prices on everything are coming down hard. This is deflation. Your dollars are becoming more valuable, not less. Hold on to cash.

I know this is counterintuitive, and I am an abject Austrian regarding economics. But, the majority of people (including many Austrians) are fooled by the difference between an expansion of cash and an expansion of credit. Weimar Germany, Argentina, Mexico, Zimbabwe – these places all created lots of currency and had rampant inflation. We cannot use that as a model. In the Great Depression we had deflation because the Fed contracted the money supply. This is well documented, as are the effects. This is the model we need to use now. The effects this time around will be much worse, they have the same genesis and the same result. People will need/want/hoard cash.

Now, once we are near the bottom of a deflationary cycle (I predict 4-to-5 years from now), who knows what the government will do? At that time they may crank up the printing presses because everyone will want dollars and no one will trust the banks. Then all bets are off. Then we could have inflation. But for now, your dollars are getting more valuable not less. Get what you need in order to get through hard times, but, short of a societal collapse a la your novel [“Patriots“].Some FRNs in a fireproof box in your gun safe (and not in some bank that may fail) are your best bet. – Michael W.