Inflation or deflation?

Intuitively, it seems that all the money printing in the US will have an inflationary effect. At a high level, more dollars means lower dollar value and higher prices of assets. The last article I posted explains how this can still result in a deflationary bias, especially as regards government bonds. And in short, money moving out of bonds will to some extent move into gold, which benefits from lower dollar value as as a physical commodity as well as its perceived value as an alternative to money.

However, there are fierce arguments at present about whether we are facing deflation or inflation, mainly because it seems all the new money is not flowing into the economy. The worry is that we have entered a deflationary spiral, much like the Great Depression, and all the money printing is having no effect on this Kondatrieff Winter, in which the economy just gets sucked into a black hole.

I have read endless articles detailing both sides of the argument and providing precise definitions of inflation vs deflation. These are loaded terms, and commonly abused and misused. Inflation of money results in deflated dollars and higher prices. Often what is called inflation is really the end result, namely higher prices. De-leveraging, as we saw last October, results in spikes down of asset prices that can resemble price deflation, and of course house prices are dropping.

Inflation itself, as opposed to price inflation, is an increase in the money supply. This has been the general trend since early in the 20th century as fractional reserve lending mushroomed. Fractional reserve lending is the ponzi scheme that is the basis of modern economies - some capital is used as the basis for loans that far exceed the value of that capital. There is roughly 10 to 1 leverage, so at any time a bank could have on hand 1/10 the capital it lends out. And that is just the first step of the pyramid.

Today, banks are hoarding new capital in an unprecedented way. So this creates a lot of questions about what will really happen in the economy.

If you want to understand this in depth, I highly recommend this article:

http://www.gold-eagle.com/editorials_08/pollaro051309.html

This entry was posted on 15/05/2009 at 05:01 am and is filed under Gold, Dollar Collapse, General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or trackback from your own site.

| Print