This is a graph of the four primary debt sectors from 2008 through Q3 2010, which between them account for 90% of the total credit market debt outstanding in the USA. The red line represents the total of federal debt plus state and local debt; $9 trillion belongs to the federal government while $2.4 trillion is owed by the state and local governments.
So, while Z1 reports a quarterly increase of 0.43% in overall credit, the first increase after five straight negative quarters, this meager increase almost entirely consists of swapping financial sector debt for federal government sector debt. This is consistent with what I described was likely to happen in The Return of the Great Depression and is also consistent with the Misean definition of inflation that includes credit as opposed to the Friedmanite one that does not. The $52 trillion question is how long this debt transference process can be maintained. If it can go on indefinitely, then there will eventually be hyperinflation. If it cannot, there will be deflation. High metal prices notwithstanding, I still maintain that it cannot go on indefinitely, and the fact that the Fed and the Treasury are limiting their credit expansion to approximately the level of the private sector credit contraction tends to suggest that this is the case. Three years is impressive, but it is neither infinite nor conclusive.
I don’t deny that we have seen what looks like inflation due to the steady increase in M1 and M2. But keep in mind that we know beyond any shadow of a doubt that the mortgage banks have not been accurately accounting for the bad debts being incurred by defaulting homeowners and that they may not even hold title to many of the homes that supposedly back those home loans. This means that the yellow line should be declining more rapidly than it is. Also, we know that the insolvent nature of many of the large financial institutions means that the light blue line is going to decline dramatically once the first one fails and sets off the chain reaction that the Fed has been so desperately attempting to forestall. Those debts are not going to be inflated away, they are going to be deleveraged through default as has been happening on a smaller $3.1 trillion scale since the 4th quarter of 2008.
Since the government now accounts for 21.8% of all debt, up from 14.6% in only 27 months, the government looks to be facing a choice between assuming ownership of all debts owed in the economy within two decades or to stop fighting the deflationary process that Austrian theory dictates is not only necessary, but inevitable. Those looking to the historical example of the Great Depression should keep in mind that the federal government had a good deal more leeway at that time because it was not already saddled with one-fifth of the debt in the economy. And don’t forget, this accounting doesn’t include the very large debts imposed by off-budget pension plans at the state and local level and entitlements at the federal level.