Hyperinflation, inflation, deflation, depression, recession, stagflation… well which is it? I have no clue, but there is a massive monetary inflation occurring, and a looming recession. Hmmm so does this mean a inflationary depression? Yikes.
Last week I took a break from overwhelming myself about the markets and the state of the economy. The timing wasn’t perfect, but I had personal reasons.
Before I start on the quest of exploring our present situation of the potententional…”ion”s I want to make sure we are on the same page. Therefore lets have a defining moment:
Money: Easily exchangeable, is relatively scarce, and is a store of value.
Inflation: An increase in the money supply
Deflation: A decrease in the money supply
Hyperinflation: A self-perpetuating unstoppable (more or less) state of inflation
Recession: A significant decline in business activity, mainly a contraction in the economy or slowing of growth
Depression: A long-term economic state characterized by unemployment and low prices and low levels of trade and investment
Stagflation: A period of time characterized by high inflation and recessionary conditions.
I’ve been looking at calls for the vaious scenarios and needed some clarification as to what happens in the various situations. For the most part it seems obvious, but I’ve been struggling with the increase in the value of the United States dollar. Our national debt is above 10 trillion and rising rapidly as the recent bailouts continue, and the most recent increase in military spending added another $612 billion that we have to pay for.
Why is the risk of deflation so frightening that the Fed, Treasury, governments, and foreign central banks will do anything to stave it off? Deflation is like the grim reaper knocking on your door for a fiat currency. A fiat currency survives on debt and inflation (credit expansion). Too much inflation and it can become worthless, and negative inflation (deflation) and it gains value. That sounds like a good thing but it isn’t. As the currency gains in value debt becomes more expensive, and thus more difficult to pay off. Imagine taking out a $100,000.00 loan with todays dollars and paying it off with dollars from 1930. Good luck! During deflation prices also fall due to the decrease in the money supply and as there is no longer credit being handed out for people to use to consume and invest. The whole system comes tumbling down and the reaper walks in the door to say hello!
When credit is created (a loan) that is an increase in the money supply, and when it is paid off that is a decrease in the money supply. Say the loan is $100.00. That is $100.00 of money put into existance with a very small percentage actually backing it. Now I repay my $100.00 loan and that credit is erased and the money supply contracts. This is the normal situation that occurs daily. However, if people don’t want to lend or borrow then we have a problem.
No credit means no ability to borrow, which means no abilty to purchase goods and services. Everything is based on debt today. The change began in 1913 with the Fed, and the ultimate shift to fiat money was in 1972 during the Nixon presidency when we abandoned the gold standard and thus savers were punished from that day forward.
Okay this leads to me to the strengthening of the United States Dollar… Why I ask is it getting stronger. Many argue that it is because Europe is weakening, which may be part of the picture. However, I read something that made a clear point that because European banks are required to hold dollars for various toxic debt they hold denominated in dollars they normally use the interbank markets based on the LIBOR rate. However, that market is seized up and nobody wants to lend so they start using the EUR / USD credit swap market. As they purchase dollars its value goes up. Notice today that the Euro gained against the dollar when the Fed decided to start purchasing short-term commercial paper. They are stepping in and becoming the new mainstay for that market: which one? EVERY MARKET <Interesting…>
And tomorrow is a new day!
