Letter Re: Deflation Followed by Mass Inflation?

Dear Jim
I agree with Michael that deleveraging, the reduction in credit, means falling price levels in the short run – but not for 4 or 5 years!
He wrote: “Credit can be destroyed. If the value of your house goes down by $100,000, then that $100,000 is just gone. It doesn’t exist any more. It is not in the money supply. This is deflationary”
Back to basic definitions – inflation is an increase in the money supply, deflation is a decrease in the money supply. Generally inflation leads to rising prices, and deflation to falling prices. The price of houses is the symptom of deflation, but does not affect the money supply.
“Now there is dwindling credit, severe unwillingness to lend, and a Fed that is contracting the ‘money’ supply.”
Whoa there! Check the latest M1 money supply chart which shows a ~45% increase in just two months! This is an exponential “hockey stick” chart that Al Gore did not need to fudge the data on!

Bernanke and the Fed were keeping inflation low, 2% or less, (trying to clean up Greenspan‘s irresponsible inflations). But now the massive bailouts have blown that plan out of the water. Thanks to Gary North to help us to “follow the money”.

Unless this horrific, banana-republic-style inflation of the money supply is corrected, inflation of prices will be back with a vengeance. Remember that in the Great Depression the money supply was anchored to gold – not a good comparison to today’s fiat money that can be created at will.

Of course the timing will be tough to predict as the velocity of money determines prices, as well as just the supply of money. (I.e., how fast is money spent – 10 times per year or 100). And Fed decisions are political and psychological in nature, not just economic, and hence not easy to predict. But overall, in the race between the deflationary effects of deleveraging, and the unlimited ability of the Fed to succumb to political pressure and inflate, I’m betting on Ben Bernanke‘s helicopters. Regards, – OSOM