No Winners When The Inflation Balloon Pops

As the economy slowly grinds to a standstill, the expectations of worsening inflation continue to rise. “Stagflation”, you say? Possibly; but, there is another risk that is greater than stagflation. And, the prospects are much gloomier than those envisioned by a scenario which features an ordinary recession accompanied by marginally higher prices.

THE EFFECTS OF INFLATION 

Inflation is the debasement of money by government. As governments (via their central banks) create money by expanding the supply of money and credit, it cheapens the value of all the money in circulation and causes a loss of purchasing power in the currency (dollar, euro, etc.). The loss of purchasing power results in higher prices for goods and services.

All governments purposely inflate and destroy their own currencies. Over time, the inflation takes its toll and its effects are cumulative, volatile, and unpredictable. The Fed and other central banks think they can control (“manage”) the effects of the inflation which they create, but they end up spending most of their time reacting to and trying to contain those effects.

Today, the U.S. dollar is worth less than 1 penny compared to the dollar of a century ago. Theoretically, the dollar’s decline in purchasing power can continue indefinitely. Hence, some predict the inevitability of hyperinflation and complete repudiation of the dollar. (see Two Reasons Hyperinflation Is Unlikely)

RISK OF DEFLATION AND DEPRESSION 

There are dangers to the world economy which transcend those of hyperinflation and dollar destruction. Those dangers include wholesale deflation and a full-scale depression. The onset of deflation and depression could be triggered by a credit collapse. Or, we might continue to sink slowly and less obviously into a pit of financial quagmire. At some point, recognition of the awful reality would be obvious, but, too late for a reasoned response.

A certain amount of inflation is necessary to keep things from cascading downward. Over time, the effects of inflation are less obvious, so, additional money creation is required periodically in order to maintain the status quo. Beyond that, there is less of the stimulation that was intended. It is very similar to the vicious cycle of a drug addict.

The dependency on the drug (money) is heightened over time. The drug’s effects wear off more quickly and the dosage needs to be greater just to maintain stability, let alone get the desired effect as originally intended. The symptoms of withdrawal are often so bad as to prompt further addiction, rather than endure what is necessary stop the habit.

THE END OF INFLATION 

Historically speaking, periods of entrenched inflation always end in economic collapse. There are examples of ridiculously high inflation rates which ended up at dramatically lower levels after a collapse. And, the economic collapse can happen either with, or without, experiencing runaway inflation.

Weakening economic conditions and a stubbornly strong U.S. dollar are not indicative of worsening inflation. Credit market problems and liquidity issues shift the emphasis from the supply side (too much money) to the demand side (not enough money).

As the demand for cash increases, people begin to sell things – anything and everything. It will require a deflationary collapse to heal completely and to recover from the ill effects of Fed inflation over the past century.

Deflation means that the dollar would buy more, not less; however, there would be fewer dollars available. The demand for money would supplant the fears and concerns associated with the effects of inflation. (see The End Of Inflation?)

RISKS FOR INVESTORS 

It doesn’t matter much what you own at this point. If there is $ sign which indicates its value, that value will be significantly less (by 50% or more) in the event of a credit collapse and the onset of deflation. The biggest losses will come early; and they will be difficult to reverse.

In the past, quick response by the Fed has allowed for varying degrees of restoration and recovery. The long-term addiction described earlier has made it less likely that any Fed response to the next financial and economic catastrophe will offset the tidal wave of credit collapse and bankruptcies that ensue.

The popping of investors’ inflation-supported balloons (stocks, bonds, commodities, real estate, cryptocurrencies, etc) will be devastating.

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

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