The definitions of inflation and deflation are the problem I think. In "inflationary" times, interest rates rise at money supply growth outstrips the economy's ability to put the money to use. Debtors load up as they can repay their debts with smaller future burdens. In "disinflationary" times, falling interest rates encourage further consumption on borrowed money and continued debt creation.
However, when rates hit zero, the debt creation game ends. If the economy isn't at a *stable* consumption level, the system goes into shock. Debts can no longer be put through the reverse end of the telescope to make the debt look smaller with lower nominal rates. Aggregate economic activity must fall to levels that are sustainable without further debt creation.
Now enter the Fed. The Fed doesn't want the economic adjustment to take place, or fears that if it occurs at anything beyond glacial pace, it will cause a panic. So, they try to create monetary inflation in the midst of the debt-driven deflationary dynamic.
The Fed has nearly complete control over the yardstick called the dollar here - if they want it devalued so that debtors loads look smaller, they can certainly do that. The problem is the unintended consequences:
1. The collapse of the currency hurts anyone purchasing foreign goods with dollars (what percentage of your purchasing power goes toward imports?)
2. This assumes a static system, ie the net creditors are willing to cooperate as the Fed takes their monetary claims away from them for the benefit of the debtors.
This is where it gets tricky. I'm a net creditor. I did well in the bubble. I'd like to think I did well because I have a decent understanding of the markets. Other net creditors are likely to be savvier than average as well. When we see a blatant attempt by the Fed to orchestrate a giveaway to the debtors, we know there's no free lunch: it comes at the expense of the creditors. That's *us*. Being on average financially savvy, the creditors probably refuse to cooperate. What do we do? Park our purchasing power in stable currencies that *are* stores of value. Some in the Euro, some in gold, maybe just hard, non-leveraged assets.
When the creditors don't play along, the system falls apart because the deflationary forces that the Fed is trying to fight are actually overwhelmed by the capital flight produced by breaking the market trust in the currency as a store of value.
Somebody please forward this to Greenspan and Bernanke.
BC |
