Why Inflation Will Occur

For those of who believe an economic apocalypse is unavoidable, there is disagreement as to what the end looks like. Some very bright people disagree whether the end is the hell of hyperinflation or death by freezing in the depths of deflation.

To understand this issue better, two points are important. First, inflation (or deflation) is always and everywhere a monetary event. Second, monetary factors, at least in a fiat currency system, are not exogenous variables. That is, monetary factors are controllable. The amount of money does not mysteriously grow or shrink. The supply of money is the result of policy variables controlled by the monetary authority.

In this sense, inflation or deflation is not an economic event but a policy choice. Or, to put it more strongly, inflation or deflation, while affecting economic outcomes, is a political event. To determine whether or not this economic crisis ends in inflation or deflation is not an economic forecast but a political one. Judgments regarding political responses must be made in order to know what will happen to the money supply and ultimately prices.

Gary North concisely states the options that the Federal Reserve has regarding massive government deficits:

At some point, lenders will refuse to lend money to the Treasury at low rates. At some further point, the Federal debt will have to be funded by the FED in order to keep rates from rising.

If the FED keeps funding the Treasury, this will produce monetary inflation. This will go to mass inflation: over 20% per annum. If it continues, this will go to hyperinflation.

That will destroy the dollar. The power to inflate is the power to destroy. The FED will transfer massive, comprehensive destruction to the general population.

To stop this from happening, it will have to cease buying Treasury debt. It will stabilize the money supply. That will create the great depression.

At that point, we will see who is sovereign: Congress or the FED. If Congress nationalizes the FED and inflates, then the FED will have failed. It will be proven for all to see that it was not too big to fail.

On the other hand, if the FED refuses to buy the Treasury’s debt, the Federal government will default. It will be proven as not too big to fail.
Mr. North has implicitly ruled out the possibility of the government drastically cutting spending and benefits. At some point that will happen, but not until after the apocalypse. Then government spending and taxes are likely to be halved along with unfunded commitments like Social Security and Medicare.Given the impossible mathematics of the U.S. government’s debt situation, it is unimaginable that politicians could willingly take the drastic actions necessary. Granting this assumption, North reasonably describes the remaining choices that politicians will soon face.

If you believe that the Fed will allow the government to go bankrupt, then you are a deflationist. It might also be added that in order to believe this, you also have to believe that the government would willingly go bankrupt and not nationalize the Fed to prevent (only defer) such an event.
If you believe that the government will (does) behave like a cornered, wounded animal, then you know they will do everything to extend their own life. That means the Fed (acting “independently” or otherwise) will not sop funding the deficits. Then you believe that apocalypse will end in the hell of high or hyper inflation.

Regardless of what you believe, both endings result in Depression and great suffering. The deflationary Depression is preferable to the hyperinflationary Depression for too many reasons to go into here. Suffice it to say that a hyperinflation causes markets to cease to operate (other than barter), wipes out everyone on fixed income and destroys the middle class.

While deflation may be the better of two bad alternatives (they are the only ones left) for the citizens, it will not be perceived that way by the political class. Once again, good politics (surely an oxymoron) will trump good economics (likely also an oxymoron).

I believe this ends in inflation because I have unwavering faith in the political class to look out for themselves only.

This post appeared on American Thinker today.


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