Worse than a Depression

As the economic crisis approaches the two-year point, it is apparent that “this time is different.”  Few analysts believe that we are going to recover from this Great Recession in a fashion that resembles prior recoveries. Most argue about how long it might run (Japan’s recovery is now two decades old), and whether inflation or deflation results. Two years into the problem, these issues are still unclear.

It is understandable why the duration of the recovery might be moot. Less clear is why economists cannot agree as to whether there will be deflation or inflation. After all, these outcomes are polar opposites of one another and critical knowledge:

“I believe that getting the inflation/deflation story right is the single-most important investment decision that needs to be made. It will determine the investment outcome of portfolios over the next decade.” Jim Puplava, FinancialSenseOnline, July 24, 2009

Inflation and deflation proponents have intelligent, reasoned arguments.  Both have some representatives that were not “surprised” by the events of 2008. How is it possible that intelligent people can forecast such opposite outcomes? The differences, in my opinion, arise from two primary sources:

  1. The schools of economics themselves
  2. The time horizon

Schools of Economics



Each school is complex, and not as simplistic as this short treatment might suggest, but here are the basics:

The Keynesian school of economics believes aggregate demand is the driver for economic outcomes. If aggregate demand is too low, an “output gap” (the difference between current demand and demand necessary for full employment) is said to exist. Because demand is ”insufficient,” upward price pressures are claimed to be not possible.

Monetarists and Austrians believe, as Milton Friedman was fond of stating, “inflation is always and everywhere a monetary phenomenon.”  While these schools otherwise differ tremendously, both understand money to be the driver of inflation.

Virtually all Keynesians, as a result of the output gap, believe that deflation is the likely outcome of our current situation. Keynesians did not believe the stagflation of the late 1970s was possible. That period had “insufficient demand” but high inflation, theoretically an oxymoron in the Keynesian system. Their continued insistence on more stimuli suggests that their notion of “output gaps” still plays a central role in their thinking.

von Mises

Monetarists and Austrians disagree with Keynesians on virtually everything and frequently disagree with each other — except on the critical role of money in the economy. Their methodologies and monetary processes differ, but both recognize the possibility of an “output gap” coexisting with inflation.

The Time Horizon

Current data support the deflationist position. Money supply is shrinking and there is no inflation, at least as measured by the government’s CPI calculation. There are few signs of economic recovery despite the “green shoots” melody sung by government and their media minions.

Monetarists and Austrians would agree that price increases in a deflationary environment are impossible. (The original definitions of inflation and deflation were in terms of inflating or deflating money supply.) Those who expect inflation, therefore, also expect a rising money supply at some point.

Reconciliation of the different positions becomes tractable if one allows for different time horizons. In fact, I would argue that both sides of the debate are correct, i.e. we will have deflation followed by inflation.

Argument for Deflation

Financial Armageddon describes government actions thus:

Throughout the financial crisis, policymakers have focused on keeping things afloat until the storm passes. They’ve spent vast sums of taxpayer funds trying to jumpstart growth until the economy is back on track. They’ve encouraged people to keep the faith until businesses start hiring again.

Servicing existing debt is impossible because income levels are not high enough to do so. The economy cannot grow large enough, fast enough to offset this problem. Debt will be liquidated by default/forgiveness.

Government has been unwilling to accept a downturn, adding more debt in hopes of generating a miracle that cannot arrive. The danger, as expressed by Financial Armageddon, is that the presumed “untils” do not happen:

But what happens if all those “untils” turn out to be wide of the mark? What if the carnage we’ve experienced so far is structural, not cyclical? If that’s the case, then Americans are going to find that instead of experiencing better times ahead, they are going to be much worse off than they were — or are.

Additional debt is of little value. Debt’s marginal value, with respect to creating additional GDP, has gone negative. The government has fired all of its bullets. It has nothing left that will affect real output on any sustainable basis.

As the economy continues to devolve, deflationary forces grow stronger. The private sector continues to shed debt. The public sector attempts to offset this with greater deficit spending and more stimulus. The private sector is contracting faster than the government can expand.

How We Get Inflation

Our government is bankrupt many times over (see Spiraling to Bankruptcy) as are the democratic socialist states of Europe (see Welfare States – R. I. P.) are in the same condition. For political reasons, none of these countries is either willing to cut back on their spending or accept a recession.  Mish provided a description of both the US and Europe (my emphasis):

For Europe, $1 trillion is not enough, nor would $10 trillion. There is no plan that can possibly work. But that will not stop politicians from trying. Politicians do not care about math or logic, or the fact that piling on more debt cannot possibly be the cure for a problem of too much debt with no possible way to pay it back.

We are witnessing the death of democratic socialism. No politician wants it to happen, but none can prevent it. We are at the point where the Ponzi concept of “extend and pretend” has been extended beyond social commitments and banking systems to entire economies. We are approaching what Ludwig von Mises described as “the crack-up boom”:

There is no means of avoiding the final collapse of a boom brought about by credit [debt] expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.

Political cowards around the world have chosen Mises’ second outcome – “a total catastrophe of the currency system involved.”

None of the countries have the resources to continue to fund current programs. As their economies deteriorate, they will “print money” in order to continue meeting obligations and stimulating. At some point, the money supply will explode vis a vis the goods available.

We have seen many “impossibles” in the last couple of years. Be prepared for the next — a hyperinflationary depression. It is not impossible, it is not an oxymoron and it should surprise no thinking economist. It is nearly upon us.

Your lifestyle will depend on how prepared you are to meet this newest, biggest and most horrific Black Swan. This beast will destroy economies, overthrow some governments, and alter the nature of the world.

Wake up people! Your politicians have no intention of heading this off.

This post originally appeared on American Thinker.

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  1. Monty Pelerin said………..

    “At some point, the money supply will explode vis a vis the goods available.”

    So then it’s first deflation then hyperinflation. Or perhaps it should be first hyperdeflation then hyperinflation? Zeroing in for now with the future prospect of a hyperinflation event dissected sounds as though somehow money will be falling out of helicopters in order to do this. Which leads me to the next conundrum in deciphering that part of the ongoing vs argument.

    Specifically where I have the problem with the hyperinflation part is that somehow wages will increase to chase after the diminished availability of goods. Outside of wage increases (and of course also commensurate job increases) I don’t see this happening at least in the U.S.A. anytime soon. So that leaves us with really an unthinkable quasi ‘Zimbabwe Event’. That being a currency crisis. A confidence crisis. Better yet, a global currency crisis.

    Cutting to the chase if there’s a Zimbabwe Event in the U.S. then there must also defacto be a global-wide ‘Zimbabwe Event’. (Which as Marc Faber so eloquently and succinctly describes results in us all being, to quote, “screwed”.)

    My tangential bottomline point is this: this so-called hyperinflationary event will not happen. It will not happen in the U.S. It will not happen in Europe. What will happen however is a relatively instantaneous global-wide event. What the Fed does now with the printing machine, what the European Central Bank does with it’s printing machine, conflagrates into this final event not because the ‘availability of goods’ diminish so greatly but rather that credit markets and financial systems lock up for good as they temporarily did when this financial crisis first reared itself on its ugly grizzly-like legs under the Henry Paulson paradigm.

    When no longer the world’s major financial markets will accept any of the other’s currencies then this event will not turn into neither deflationary or hyperinflationary depression as the author opines but a rather complete and utter financial system collapse where currencies are no longer the medium of exchange. To wit, hyperinflation with respect to the major economic powers cannot occur in isolation as it did in Zimbabwe because major currencies are so globally interlocked. Indeed, it is neither deflation or inflation that is the ultimate disaster looming. It is a complete collapse of confidence in all currencies that is the ultimate outcome.

    In the meantime before the final event, the interlude is sprinkled with both sides of this argument. But they will be for the most relatively localized and dealt with accordingly. The final big event that I speak of will not be hyperdeflationary or hyperinflationary. It will be a simple but total global-wide hypercollapse of fiat currency and the governments and societies that supported and relied upon them to go with them. What comes after is anyone’s guess. But I can guarantee you this, it will be a single global-wide ‘currency’ whether denominated in paper or electronic digits, will nonetheless be controlled from a single and central authority.


  2. American’s disastrous drift toward neo-conservatism,
    global military adventurism and empire, unbridled
    expansion of the financial and military sectors at
    the expense of the public sector, and other ruinous
    processes culminating in the collapse now underway,
    can be dated approximately from the founding of the
    Mont Pelerin Society.

    The Austrian school of thought that packs a
    massive political punch
    August 13, 2003
    The godfather of the neo-conservative
    movement would have been delighted with its
    progress, writes Wilson da Silva.
    “If there was a global godfather of [the]
    neo-conservative movement, it would be
    Friedrich von Hayek…. in 1947, he set up
    the Mont Pelerin Society, a secretive group
    that met annually to map out a
    neo-conservative counterattack against the
    growing socialist character of postwar
    economies. It played midwife to scores of
    neo-conservative think tanks, among them the
    Heritage Foundation (1973) and the Cato
    Institute (1977) in the US and Australia’s
    CIS (1975)…. Von Hayek…died in 1992, but
    not before Thatcher rewarded him with a
    visit to Buckingham Palace, where he was
    bestowed with a Companion of Honour – a
    tribute to the most successful, if
    unheralded, political puppet-master of the
    past century.”

    1. Alan,

      I read history quite differently than you do. I also read Hayek, Mises and other Austrians quite differently.

      The Mont Pelerin Society was formed for like-minded individuals interested in freedom to have a means of communication right after the war. Socialism was in full flavor at that point, especially as a result of the war-time mobilization.
      Hayek was not a neo-con. In fact, he was not even a conservative. He wrote a rather famous essay entitled “Why I am not A Conservative.” Mises was neither a convervative nor a neo-con. He and Hayek both believed in very limited government. If anything, they would be more libertarian in today’s parlance. They considered themselves “classical liberals.”
      The founder of the libertarian movement was Murray Rothbard, considered to be Mises’ most outstanding American student. Many Austrians rejected Rothbard’s views as too extreme. He believed in no government. In the end, he could be called an anarchist because he believed anything done by government could be better provided by the free market.
      My suggestion is that you read some of these people before you accuse them of being neo-cons.

  3. Do you think a good dog and pony show will bring clients to Our homes? And if we don’t compete as a community we will deflate unnecessary? As far as my reply to your blog; Deflation may be mostly in the housing market. That’s where it started and that where it will need to need.

  4. I think Burke describes this well, even though he was describing the French Revolution at that time.

    “By following those false lights, France has brought undisguised calamities at a higher price than any nation has purchased the most unequivocal blessings. France has not sacrificed her virtue to her interest, but she has abandoned her interest, that she might prostitute her virtue.”

    Or, when finding your self in a hole, keep digging.

  5. “Your lifestyle will depend on how prepared you are to meet this newest, biggest and most horrific Black Swan.”

    What preparatios would you recommend to protect “lifestyle”?


    1. Lisa,

      For most people, I would advise getting out of debt. While creditors benefit in an inflation (paying off debt in cheaper dollars), the road will not be smooth and I think most are advised to avoid any debt they can.

      Tangible assets (land, real estate, precious metals, etc.) should benefit in terms of holding their purchasing power. Hyperinflation will likely cause markets to cease working, at least in the conventional sense. Thus, we might find ourselves back to a barter economy, at least for a time. You might want to have some items that you can barter with. A supply of other necessities might also be prudent.

      These questions are really very difficult to answer and I don’t want to appear as if I store food, guns, etc. I do not, although there may come a time …..

      I posted the same article on American Thinker today. There were about 40 comments from readers that you might find worth reading.

      Good luck,


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