More Inflation vs. Deflation

Another in a series of posts dealing with whether we have inflation or deflation as this economic crisis plays out.

I am in the inflation camp, but plenty of people that I respect are in the deflation camp. The article below by Rocky Vega deals with the potential that is already in the system. The Fed has no control over the public’s demand for money (velocity). They have control, not full but significant, over the supply of money. The important point below is that, at this point, they are unlikely to be able to stop inflation if the public decides they do not want to hold dollars (velocity increases).

My position for anticipating inflation is based on what Mr. Vega lays out, but also on what is going to happen to supply in the future. The government will be unable to finance its deficits. Rather than allow the government to stop paying bills, the Fed will have to create more money. Once the public becomes aware of what is happening and must happen, velocity will shoot upward. At that point, there is nothing the Fed can do!

Hyperinflation always occurs as a result of velocity accelerating. Got Gold?

Latent Hyperinflation “Like Lighter Fuel on a Camp Fire”

By Rocky Vega

07/26/10 Alexandria, Virgina — The Daily Reckoningperspective is one of “soft-core deflationism”… where the economy looks likely to experience both less recovery and more deleveraging than most prognosticators probably now anticipate.

Yet, an international panic, political or otherwise, could instead lead the nation onto an inflationary path. Ambrose Evans-Pritchard at the Telegraph, himself a deflationist, looked yesterday at how historical precedents of inflation, and hyperinflation, also offer guidance for the future.

From the Telegraph:

“Each big inflation — whether the early 1920s in Germany, or the Korean and Vietnam wars in the US — starts with a passive expansion of the quantity money. This sits inert for a surprisingly long time. Asset prices may go up, but latent price inflation is disguised. The effect is much like lighter fuel on a camp fire before the match is struck.

“People’s willingness to hold money can change suddenly for a ‘psychological and spontaneous reason’, causing a spike in the velocity of money. It can occur at lightning speed, over a few weeks. The shift invariably catches economists by surprise. They wait too long to drain the excess money.

“‘Velocity took an almost right-angle turn upward in the summer of 1922,’ said Mr O Parsson. Reichsbank officials were baffled. They could not fathom why the German people had started to behave differently almost two years after the bank had already boosted the money supply. He contends that public patience snapped abruptly once people lost trust and began to ‘smell a government rat’.”

If all it takes is the whiff of a “government rat” to snap public patience we could indeed be closer to inflationary times than we’d like to admit. Further, Evans-Pritchard goes on to note the huge increase in the “US monetary base from $871bn to $2,024bn in just two years,” makes for quite the pool of “lighter fuel” in the event the velocity of money suddenly reverts back to more historically common levels. He describes more history of the Weimar inflation, and includes stories written in diaries at the time, in the Telegraph’s coverage ofthe death of paper money.

Best,

Rocky Vega,
The Daily Reckoning

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