Inflation vs Deflation Debate
I’ve spent a lot of time over the last few months following the discussions around whether the current environment of Fed policy and government stimulus will lead us towards a hyper-inflationary event, or whether the Fed’s actions have been necessary in order to stave off a major deflationary spiral.
The deflationist’s argument is that our entire economy today runs on debt. Banks create money by lending it out. Major corporations are all running enormous deficits in order to pile on debt and outspend their competitors. But when society is borrowing at these rates, you’ve effectively set up a system that makes everyone “short” the U.S. Dollar.
This means that if the dollar increases in value then *everyone* will have a hard time paying back their debts, leading to massive defaults, which leads to corporate insolvencies, which leads to a demand for more dollars to pay back debts, that leads to higher borrowing rates, which leads to a more expensive dollar, which leads to more defaults and corporate insolvencies…
The result is a March 2020 like event where the equity markets sell off like mad. Except, this time, there is no V shaped recovery.
The inflationists argue that money printing has a long history of blowing up governments and societies. They point to the fall of the Roman Empire, and more recent examples like Weimar Germany, Venezuela, and Zimbabwe.
They make the point that almost no societies in history have blown up due to massive deflation, while inflation has taken the lives of more societies than we can count. The Federal Reserve, for its part, has printed 22% of the existing money supply this year alone, and has publicly stated their target to overshoot 2% inflation for the foreseeable future.
Inflationists and deflationists seem to agree that one of the major factors in the dollar’s relative stability over the last year has been its position as the world’s reserve currency. Because of this, Americans are not the only people using the U.S. Dollar: nearly everyone on planet Earth is in some way interacting with the U.S. monetary system.
This allows for inflationary money printing to be absorbed at a global scale, instead of a local one.
The way I see it is that due to our massive debt burdens — both corporate and governmental — we have enormous deflationary pressures exerting themselves on the U.S. Dollar. The events of March 2020 show us this much: when sh*t hit the fan the stock market saw it’s steepest drop in history.
Without outside interference (i.e. new Fed policies), the deflationary spiral could have seriously torn our economy apart. However, the Fed came in to save the day and began creating money in amounts that we’ve never seen. The result was a re-inflation of the stock market.
Moving forward I think we will continue to see deflationary pressures. The underlying issues that have caused these pressures have only been made worse. There are more debt-burdened, cashless companies today than there were in January. On top of that, the government has begun to suggest that it will not require businesses to pay back the PPP loans they took in April. The bad corporate behavior will continue unabated.
However! The next time the markets crash, the Fed and the government will be ready to step in and support the markets in order to prevent deflation. My prediction here is that the proactive actions that our governing bodies take in order to keep deflation from wreaking havoc on our economy will ultimately lead to a stagflationary environment that teeters on the edge of hyper-inflation.
This is why owning any equities or other assets is such a strong play.
And this will continue until the United States loses its world reserve currency status.
At that point the Federal Reserve will no longer be able to backstop the equities market or our bankrupt corporations or government. And then you’ll see a level of wealth destruction unheard of in modern life.
