Inflation vs Deflation IX

Nate begins the eighth installment in the series by getting some things factually incorrect. To begin with, Z1 did not begin to decline in July 2008, as it peaked at $52.9 trillion in Q1 2009, a figure it did not reach again until Q3 2011, when it hit $53.8 trillion. 2008 merely served as the warning sign, as total credit growth ceased to keep pace with its 60-year historical rate, thus triggering two quarters of 10 percent growth in the federal debt sector in the latter part of the year. Gold and silver prices certainly did rise during that time, as did the stock market, but this was the result of the near-unprecedented increase in federal spending which was taking place at that time; even as the Household and Financial sectors contracted, the Federal sector expanded by $3.3 trillion.

Merely that Federal expansion, you will note, is considerably greater than the increase in savings over the same period. In fact, it is $1.2 trillion more than the total amount of extant currency plus demand deposits. And note that the government economists appear to have been keenly aware of the warning provided by the debt disinflation, (which you may recall was characterized as the “credit crunch” at the time), as the massive increase in government borrowing preceded the actual debt deflation by three quarters.

As Mises and others have remarked, inflation does not affect every sector of the economy at once. That is the whole reason it is desired by certain economic actors; they expect to benefit disproportionately from being able to spend less expensive money at its previous value. Nate’s tangent into malinvestment isn’t completely irrelevant, as real estate was certainly one of the primary areas of malinvestment, along with the health care and higher education sectors, but isn’t of particular importance because my case is not dependent upon housing prices. I have merely pointed it out because it shows that the inflation, despite massive reinflationary efforts, hasn’t been enough to counteract four years of ongoing credit contraction across the economy.

Nate is looking at Z1 – or to be more precise, L1 – as a whole rather than in its component parts. This is not unreasonable, but unless one looks at the component parts, one cannot understand the importance or the consequences of the shift in the nature of the credit market that has seen the federal element double from 10.3 percent of the entire credit market to the current 20.6 percent.

What Nate sees as evidence of inflation, the modestly higher prices in the gold, silver, and equity markets, is largely limited to the areas of direct federal intervention.  This is why health care and higher education prices are still rising to new heights, while real estate prices are struggling to get back to where they were.  The areas that are reaching new heights are where the outstanding $11.6 trillion in government credit is flowing.  That is where the malinvestment is still being directed.

I will not dig further into Nate’s answers. I don’t know the answer to them either, the point was to direct attention to what Nate sees as significant, which is the total amount of savings and the cash in the various banks. What Cyprus should have sufficed to demonstrate was that the greater part of the “savings” he cites do not exist in any material capacity except as debt claims.  As has been repeatedly pointed out here, deposits are legally defined as debts owed by the bank to the depositor and therefore qualify as credit money even before they are subsequently loaned out, and “multiplied”.

Now, Nate concludes with citing the 56 recorded historical incidents of hyperinflation. It is true that hyperinflation is possible within a nominal credit money system, (especially in the broader sense in which Mises and I question the existence of true fiat money), but that is not to say that all credit money systems are created alike.

I note that each of these hyperinflationary scenarios were very short-lived and tended to be closely tied to serious political upheaval.  The longest period is two years, which happened twice in China during the 1940s.  Note, however, that these hyperinflations tended to take place AFTER the wars or major political upheavals; the frequency with which they take place after independence is gained by a nation is reminiscent of the high inflation that plagued the American colonial currencies and the Continental Dollar.  If any hyperinflation were to take place, history suggests it would likely take place after the collapse and political chaos; it would be a result of it, not a cause.

What Nate omits to mention is that there have been even more sovereign defaults, which he concedes are deflationary, than hyperinflations since the first hyperinflation on his list took place in 1919.

Nate is correct to say that one must be careful not to mistake “can’t” with “won’t”. But his flight analogy fails, because I am not claiming that something must be lighter than air to fly in defiance of the 56 airplanes soaring overhead, but rather, pointing to a particular vehicle, constructed from empty shipping containers and bound together with string, chewing gum, and tefillin straps, watching the pilot repeatedly taxi up and down the tarmac, and expressing my doubts that it is going to take flight.

We have seen massive increases in virtual every monetary measure. We have been told to expect considerably inflation. And yet, we are still not seeing a rise in general prices concomitant with the size of the expansion. Ben and Mario are monetizing the debt like mad. Kuroda is acting even more aggressively. To the extent their efforts to expand the limited amount of inflation they have created in the financial markets and move money out of the bank reserves and into the general economy have failed, the situation appears to be more “can’t” than “won’t”.

Remember, it’s not enough to merely print the money. The amount printed and distributed has to be greater than the continuing contraction of private credit and the evaporation of bank deposits.  And keep in mind that the combined $4.2 trillion decline in outstanding Household and Financial sector credit since 2009 alone exceeds, by a factor of nearly four, the ENTIRE AMOUNT of U.S. currency presently in circulation.

The amount of credit outstanding is simply too great for helicopter dropping of actual cash and coins to be able to compensate for much of it. And simply flipping an electronic switch and adding a zero to everyone’s bank account isn’t going to change anything at all because the entire financial system depends upon inflation working its way gradually through it.

Nate is correct to note that people are becoming increasingly drawn to holding cash in the hand, but he is forgetting that when cash becomes more valuable in this manner, it is strongly indicative of a deflationary environment, not an inflationary one.  In an inflationary environment, one wants to take on more debt and hold less cash. In a deflationary environment, one wants to avoid debt and hold more cash.  The intellectual gymnastics notwithstanding, one’s true position on this matter can be ascertained by one’s material preferences and actions.

“In fact, a money that is continually depreciating becomes useless even for cash transactions. Everybody attempts to minimize his cash reserves, which are a source of continual loss. Incoming money is spent as quickly as possible, and in the purchases that are made in order to obtain goods with a stable value in place of the depreciating money even higher prices will be agreed to than would otherwise be in accordance with market conditions at the time. When commodities that are not needed at all or at least not at the moment are purchased in order to avoid the holding of notes, then the process of extrusion of the notes from use as a general medium of exchange has already begun. It is the beginning of the ‘demonetization’ of the notes.”
– Mises, The Theory of Money and Credit, p. 227