Sunday Musings: The Inflation Scenario

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Lately, the most frequently asked question has been as to when inflation will be a threat again and how it will affect us. Mish at Global Economics referenced an article, which succinctly addressed this problem:

Will this printing create [price] inflation? This is dependent very much on what money will do next. If banks will not lend and banks sit on that cash forever and ever like the great depression because the risk is too high and the banks do not know if the lending will end up in good assets or bad assets, and because banks are in so many bad assets now they probably will not lend at all.

That is the observation that Murray Rothbard made, that during the Great Depression that banks have chosen not to lend because the risk of accumulating bad assets was far too high. So they were sitting on massive reserves. That is what is developing right now.

A good example is what happened in Japan in 2001-2002 where the Bank of Japan pumped 300% at one stage and lending continued to collapse. I expect similar things to happen here. If lending will not increase we can conclude this will not be inflationary.

[My Emphasis]

I agree with the above. However, we’ve seen an incredible destruction of assets and wealth in general over the past 1-1/2 years, which now has been estimated at some $20 trillion. This wealth loss is far greater than the monetary expansion of the Fed and is, at least in theory, supposed to limit the effect of reflation for the time being.

In yesterday’s post, I made the argument that the dollar may not be destroyed to the degree many think because all industrialized nations are following the same theme of attempting to flood their economies with money via bailout and stimulus packages.

In other words, if we’re all doing the same thing, all currencies may be destroyed at about the same rate. If that happens, there is no longer a “reference” currency to measure the destruction against.

Same with inflation. If all major world economies are inflating at about the same rate, how will it affect the U.S. when there is no yardstick to measure against? This is where I have problems understanding the currency devaluation argument.

My conclusion is that we are entering a scenario unlike any in the past. Many comparisons have been made to the 1920s and 1930s. However, the world was not such an interconnected place as it is nowadays. Things that happened in the U.S. back then did not have an immediate effect on the rest of the world and vice versa.

I don’t think anyone has the answer or the ability to somewhat accurately forecast how these current circumstances will play out in the future. Relating these uncertainties to investing, I am more than ever convinced that being disciplined and following trends in the market place is the only way to survive in this potentially treacherous environment.

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Comments 8

  1. There are a lot of reasons it is not a good idea for America to use inflation to “pay” for our “stimulus” programs. One is that inflation will never be even throughout the world, as much as we would like it to be. Another is that, when a Communist dictatorship, like China, owns the largest share of our debt, if we “print more money” in order to pay for our debt, the debt China has purchased from us becomes less valuable to China than the price China paid for it. We have, in a sense cheated them, and they know it. China and Japan, the second largest holder of our debt, are huge exporters. By us printing more money and our dollar becoming less valuable, this causes them difficulty in being able to export; it threatens their economies, and once again, they don’t like it.

    You might be thinking, “So what, if they don’t like it?” Who cares about a Communist dictatorship and the country we bailed out of beating, following World War II? Well, I don’t like a Communist dictatorship, but they sure can cause us problems, economically (and perhaps even militarilly. China can stop buying our debt or unload our debt; both of these would have the effect of causing DEflation and drastically cause our GDP to drop, which could be catastrophic and cause chaos here and reverberate around the world. Also, China’s navy is quite large. I would not put it past them to use it, if they thought they had to protect their national interests. Japan could do the same thing, about stopping or unloading the national debt, which they have purchased, although they do not have a military (they will just beat us in an economic war).

    So, we are in a real double-bind. We have a huge debt, which is mainly owned by countries, which export, and if they want, they can wreek havoc with our economy by causing Deflation, if they stop buying our debt, or if we try to pay off our debt by printing more money and causing inflation, so that our dollar becomes less valuable, we risk these countries continuing to purchase our debt, which would cause economic chaos for us, which would reverberate throughout the world – not to mention destroy other countries’ trust in us.

  2. Ulli,

    On Mish’s website there is a link to a podcast. Mish is interviewed along with Harry S. Dent. In this interview Harry Dent talks briefly about your idea of correlation in terms of industrialized nations ballooning their money supply. It seems to support your assertions.

    Visit this page and scroll down to the “Podcast” play slider to listen.

    Unfortunately it is about an hour long but Dent comments I refer to are around the 15/20 minute mark.


  3. Actually, contradicting my own earlier post, somewhat, as to what is best, regarding inflating our dollar, purposely or not, we might not have any choice but to inflate our dollar, to get out of this mess, versus not inflating it, and the possible consequences of each approach, given our massive national debt and the countries who own our debt, particularly China, which owns the most. It is probably the lesser of the two evils, to get us out of this double-bind. However, maybe some bright economist can think of a third way to get out of the double-bind. However, I do not think the even the highly industrialized countries will increase their inflation rates, at about the same time, as we do, if we would increase ours. I just do not think we have that much goodwill, around the world, even among the highly industrialized nations of the world, right now. Secondly, I think this huge economic mess has caused, even in the highly industrialized countries, to look out much more for their own interests, than to engage in a cooperative spirit of solving the world’s problems, no matter what their political leaders say.

    Also, this mess could be not only an economic disaster, but could cause military interventions by countries, who are trying to protect their interests.

    That has been the nature of world history, unfortunately. Many times, when economies are stretched beyond repair, it ends up with blood being lost, along with money. I certainly hope that can be avoided, but this is bad, bad, bad economic stuff the world is facing. Where it will end, I am not at all sure.

  4. Ulli: This is jus an administrative question. For the last two weeks, whenever I visit your webstie,, when I leave an error meessage shows up in my Internet explorer – saying that some script is running and should I abort it?
    This was not happening till about two weeks back.
    Did you make any changes to your website? Are you capturing some thing we are doing in your web site? What can I do to avoid getting this error message every time I visit your web site. Thanks for your guidance.

  5. Anon,

    The blog is hosted by Google (Blogger), so I have no control over any errors that might appear from time to time. Nobody else has mentioned anything, so maybe it’s your IE version?
    If you have problems with my website “successful-investment,” let me know the specific issue, and I will alert my programmer.


  6. Ulli: Last couple of weeks, when I visit your web site and the close my IE version 6.0.29 the following message appears:
    An error has occured in the script on this page.
    Line 53
    Char 3
    Error: Object required
    code: 0

    This is happening for the last two weeks or so. This does not come from other web sites that I visit.

    Could you please look into this.

    There is no need to post this message on your web site.

  7. The flight to safety in US treasuries instead of say, the euro, is no accident nor favor to us. The fact of the matter is we have the favored currency b/c we have approx. 10 times the military of all industrialized countries put together. SAFETY is militarized, yes, even for good ole bonds. In addition, US accounts for one third of world consumption – China needs to lend us the money so we continue to buy their exports. I don’t think anytime soon they are going to pull out on us — all the rhetoric of late is just fear mongering….By the way, notice how the yield curve is steepening – banks borrow short and lend long – this steepening is just what the doctor ordered to SIGNIFICANTLY help pull the banks out of their massive debts. Don’t worry near term of all the spending (thank God for Obama)- the gov. will buy back the bonds at the first indication of inflation “thinking” of rearing it’s ugly head.- I do believe they will be ON TOP of it….

  8. vermcj said:

    “…China can stop buying our debt or unload our debt; both of these would have the effect of causing DEflation and drastically cause our GDP to drop, which could be catastrophic and cause chaos here and reverberate around the world. Also, China’s navy is quite large. I would not put it past them to use it, if they thought they had to protect their national interests. Japan could do the same thing, about stopping or unloading the national debt,…”

    I’m concerned about China as well but in a little different way. I’m not so much concerned about China shunning our debt altogether, but rather, I’m concerned about the rising cost of that debt.

    It’s a little like GM and how difficult it is for them to attract investors. They can do it but it is prohibitively expensive because no one has confidence in them anymore.

    Now, I believe China and other countries that we have grown accustomed to buying our debt are losing confidence so much so that they will require more for our promises.

    This seems to be the real reason AIG was saved from disaster. China, and the almighty PIMCO would have taken the mother of all haircuts.


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