One Response to “Some basic points on inflation and deflation”

1. TM
   August 16th, 2009 at 12:45 am

   

   Two clarifications:

   First, inflation is the result, not a cause of higher prices. The cost of a service, or manufacture, rises (inflates) as demand for it rises until sufficient supply meets demand.

   Second, fractional- reserve lending pre-dates the FDIC and the emergence of the Federal Reserve Act of 1913.

   Now, the consummate concern.
   I suggest, inflation may result not only by an economic expansion dictated by monetary growth through easy-terms, but may even in an environment of economic contraction when easy-terms become less so.
   Let us explore how.

   We know the US Federal Reserve Note is not a commodity-based currency. It cannot be redeemed for gold, silver, or even, toilet paper, for that matter.
   It is only paper, a fiat - currency that has achieved hegemony over the world through our long, glorious economic expansion, but that has also become debased in the process.

   There may come a time, however, when this de-basement becomes internationally recognized. When our beloved Treasury obligations no longer sell without a steep-premium to Libor rates. Or, when business conducted in US currency throughout the world demands another, safer currency. That, even, the trade of most commodities, goods and services move toward the next hegemon.

   My friend, when a nation-state has nurtured uninterrupted deficits in its private and public houses of business thirty-five years and running, you are bound to arrive at a point, beyond which, your creditors are no longer willingly finance those deficits, or at least, in a fiat-currency.

   It is not hard to imagine then what would happen to the value of the USD, as we struggle to buy currencies of our trading partners to finance our own debt. Or, what would happen to it should the demands of interest become so onerous our obligations swell.

   Yes, demand and supply, as in any other good or service provided, cannot be escaped. The value of the USD would plummet without a foundation in a redeemable commodity, and may do so in a domestic environment of aggregate contraction for goods and services.

   Too much currency around and a slumping demand for goods and services. Sound like a recipe for price inflation ?

   Indeed, it can get you to a place rarely visited by developed nations, but once: The Grand-Inflationary terminal. Where most world economic- powers do arrive., eventually. It only requires a few stops along the currency de-basement highway from a commodity currency to a baseless, politically- driven currency motivated by the feckless demand of its citizenry and government alike.

   Therefore, do not be mistaken. Should the debt of our nation become repugnant to its creditors, its currency will too. Then, shall you see inflation!