Tuesday, July 28, 2009

The Flation Debate

The 'Financial Blogging Commentariat' is deeply divided over the issue of inflation and deflation. It seems to be the most acrimonious battle out there. The crux of the debate is whether the U.S., specifically, will witness inflation or deflation in the coming months and years. It's then further subdivided into those calling for hyper-inflation, hyper-deflation, stag-flation and a few less noteworthy types of 'flations'.

The two apocalyptic views are held by the hyper-inflationistas(HI's) and hyper-deflationistas(HD's). The latter generally take a more intellectual approach to understanding monetary dynamics while the former tend to be more crass. This of course doesn't make the HI's wrong per se, but it allows for a number of successful rhetorical assaults against their position. They tend to be marginalized, fairly or not, as 'gold-bugs' and monetary ignoramuses.

The HD's though, in an attempt to understand all the technical aspects of monetary policy/dynamics often lose sight of the bigger picture, especially the political dynamics. Many hold the claim that the monetary system is inherently deflationary as money arises from credit expansion where P+I continually grows in respect to P, or in other words credit grows faster than money and eventually debt service starts increasing money-demand whereas a drop-off in credit expansion doesn't allow for a concomitant rise in money-supply. This is true, but misses the big picture. The idea that politicians will insure bank-credit-money (e.x. checking, savings accounts) through things like the FDIC and bank bailouts or will attempt massive, inflationary Keynesian counter-cyclical policies is overlooked or dismissed. They assume that the credit-money relationship is completely mechanical and fail to realize that un-sterilized, fed monetizations in the secondary market or debt defaults can break down this mechanism of forced debt repayment and shrink the credit-to-money ratio.

The HI's conversely have a better view of the big picture(political-economy) but are often times ignorant of much of the details of monetary/fiscal/economic policy and dynamics. They'll often be heard bandying about phrases like "they're printing all this money, that's inflationary". While there is some truth to this, especially from the larger political perspective, they fail to understand exactly how money is being "printed"(if it is at all) and that just because the supply of money increases the price of money(the reciprocal of the money prices of goods and services) does not necessarily have to fall.

It's my contention that while both apocalyptic views have some merit, more than likely the truth lies somewhere in between. We'll continue to discuss this topic - in much more depth - going foward...