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In a Democratic world as well as in undemocratic nations
the political and social consequences
of deflation are considerably
worse than those of inflation.
But the concept of inflation
is poorly understood. In today’s
world it is thought of as simply rising prices due to shortages. In economics there are several forms of inflation that appear in different circumstances.
Overall governments favor
low inflation because it gives the appearance of rising wealth as prices rise, provided that these levels
are restrained around, say 3%. Above that and savings are visibly damaged and consequently the economic power
of a nation.
But we are moving far away from such
a concept now. In today’s world the bulk of
inflation has come from rising
oil prices [an insidious, usually imported inflation] and the like.
At the moment, we are at a time when inflation is at very
low levels, so low they
no longer represent a fear
or concern.
Deflation is now the
global fear, far more so
in the developed world than
in the emerging world. But the deflation
we are talking about is not simply an economic slowdown. Today’s deflation is a decay of trust, of
confidence and consequently, hope.
Deflation breeds prudence,
caution, discouragement, which
attacks growth. Banks
slow down their lending, delay the processing of loan requests, take only very
secured collateral for their loans. Individuals save in the hope that they
can manage those rainy days they
see coming.
As the current type of deflation persists, it accelerates slowly but surely. Central banks [particularly Mr. Bernanke] are aware of this and try to simply promote an expansion of money that
replaces lost asset
values and no more. It is critical
that no more than has
been lost to asset/debt deflation, be added.
There is a point where adding too much
by way of newly issued money, that it is inflationary,
cheapening the price and
value of currency itself.
This inflation is a very different animal to the one the public perceives it to be. As deflation rises, so there
is a point where inflation takes off and becomes much more difficult to control. In fact, that point becomes ever more mercurial as deflations spreads and
confidence continues to sag, as it
continues to do in the States and in Europe right now.
It is probably a misnomer to call it inflation because it is a cheapening
of the value of money.
Since 2008 we have seen
the process of money creation
happen first through QE, then as the European Central Bank
used swap arrangements with
the Fed to do the same, through
the unlimited window of credit to European banks. This has left the banking system relatively solvent, when it would have collapsed without it. But what looks to be a set of now relatively healthy balance sheets ignores the continuing asset/debt deflation
that goes on unabated. The reason it becomes mercurial
in nature is because new
money issues have less and less
affect as the deflation progresses. As this ineffectiveness in producing greater economic activity grows, the only answer appears to be to defer, or seemingly halt, more deflation and recession, so more money is issued. This is where the current impasse between Germany and the weaker members of the Eurozone are in conflict now.
But more new money can only provide
a temporary solution, because it is
only greater economic activity that can resolve
the problem. It is growth that produces
economic health and the ability to repay debt.
As debt mires such growth reliance on new money at some point exacerbates the problem giving rise to a greater and greater demand for more money. Money cheapens
during the process, but
if governments can act in concert to stop that from being seen
in falling exchange rates, then
an atmosphere of normalcy
is maintained. This does fool most
people for a while, but its
fragility grows. We are now seeing
an exchange rate between the dollar and the euro moving so little
that it is hiding the real extent of the Eurozone crisis!
At some point politicians
and bankers have to make an extremely difficult choice. Do they let the economy suffer the full range
of symptoms of deflation,
or, for the sake of political
stability and civil calm,
do we keep patching up the mess with
bandages of ‘new money’. With votes needed to continue their careers, politicians are likely to go for the soft option of ‘new
money.’
Loss of asset value hits cash too
During this time the value of savings are destroyed either through providing no, or nearly no real
return, as we see now in the States and almost in
Europe, or all [except cash holdings] drop in price. As interest rates are unlikely to rise for the next couple of years, cash yields are nearly zero.
You would think that
savings wouldn’t drop in value during deflation and that with asset prices
falling, the old adage that “cash is king” would hold true. It doesn’t, because in this global world of ours, exchange rates can easily decay
and lower the international value of cash. As this happens, imported goods increase in value giving cash less buying power. So we have to re-define what we mean
when we say “cash is king”. What cash? U.S.
dollars [it has a coming debt crisis that
dwarfs that of Europe, postponed by the system of monetary
and fiscal union it has] or the Swiss
Franc [the government is
holding the exchange rate down, killing it as a ‘safe-haven’
or the Yen [they are doing
the same as the Swiss]? Many investors are turning to property in the belief that that
will hold value in the most cosmopolitan of nations
and cities. But will it? The evidence is that only
in relatively exclusive cities
is this happening, but in
many nations property has
failed to retain value.
Demand for liquidity blossoms
Then there comes
a point where the demand
for liquidity continues to grow
and overwhelm the liquidity
available [remaining
stagnant in favored pools, in banks
and balance sheets, too fearful to venture outside].
At this point we
see the “Black Hole”
of deflation sucking in
more and more money. So just to stand still and hold what economic activity there is, the demand for money
continues to grow and overwhelm
whatever is thrown at it,
but still not producing
greater economic activity.
And this is the trigger point, when cash deflates in value.
This is the start of runaway inflation, producing no
good at all. Money itself
has lost confidence and ceases
to be an expression of value as its
issuance accelerates. At its worst
this process becomes hyperinflation.
By this time businesses are collapsing,
banks failing and the only people who are thriving are those who avoid money, changing it into
some asset or goods immediately it is received.
For example;
One must own the farm that produces food, own the transport that takes it
to market, own the market stall and have access to asset into which to change it before its
value is depleted.
Meanwhile, social extremes are being seen in politics, at community levels when stress takes a firm grip on ordinary citizen’s lives. The
social consequences of the process
scar entire generations.
Right now it is
that fear that is holding back Germany from loosening the reins on its solvency as memories of the Weimar Republic
and its hyperinflation in
1923 re-surface in the following
generations.
During this entire
process of deflation, fuelling growing inflation, politicians come under greater and greater pressure to
do something. But the system of Democracy
itself mitigates against their ability and willingness to take effective action! It takes
a collapse of the monetary system and political system, before there is sufficient
will in people to rectify
matters.
You, the reader, have to decide not just where we
are in this process but can it be
halted now? Is there the political and financial will to halt the process or are we silently watching
that point pass in the calming waters of media and political
reassurance? How close to such
extremes happening are we
now?
What happens to
gold and silver during this time?
The joys of both silver and gold are that they are both cash and an asset at the same time.
- Gold and silver
can’t be printed.
- They have always
been internationally accepted
cash.
- More importantly
they are acceptable in the world’s
monetary system as money in the form of reserve assets.
- Gold becomes
collateral that facilitates loans at cheaper interest
rates.
These qualities grow
throughout the above deflation and subsequent
inflation.
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