Deflation or Hyperinflation?

By Tim McMahon, Editor

The monthly inflation rate dropped like a rock for the second month in a row. Journalists touted last month’s drop as “the largest monthly drop on a seasonally adjusted basis since 1947 when the Bureau of Labor Statistics first  started tracking seasonal adjustments”.

What are they going to say this month when it is almost twice as large?  Largest drop since last month?

This is real live deflation on a monthly basis (although not on an annual basis… yet).  Basically, deflation is falling prices (or more accurately a decrease in the money supply that results in falling prices) while disinflation is a slowing of the rate of increase in prices.

Are we in a deflation? Just ask yourself, are prices falling or are they rising slower?

See the article What is Deflation? and What is Disinflation? for more information.

The annual inflation rate fell from 5.6% just a few months ago to an annual inflation rate of 1.07% this month.  So on an annual basis we have disinflation but on a monthly basis prices have definitely  fallen giving us deflation (on a monthly basis). At this point, on a six month basis prices are down 3.88% so we have deflation on a six month basis as well.

According to the CPI, prices fell 1.92% this month and 1.o1% last month. So one more month like that will put us in deflationary waters on an annual basis with prices actually falling on a year over year basis. Because of the parallels to the “Great Depression” this scares the Central Bankers and they began spreading money around like it was going out of style in order to pump up the money supply and prevent a deflationary spiral.

Japan has been fighting deflation for almost two decades with interest rates near zero percent.  And today the FED cut its federal funds rate to a record low of zero to 0.25 percent in its fight against deflation.

The fight against deflation is a very tricky battle because during times of uncertainty the economy is balanced on a knife edge. Logically you would think that all you would need to do to fight deflation is increase the money supply enough.  But the current crisis isn’t the result of a contraction in the money supply but a contraction in the supply of credit.  This resulted from a complex combination of derivatives (that almost no one understands).

So fighting a credit contraction of massive proportions with a massive increase in the money supply will result in the money flowing into strange places and not necessarily into the credit market where the shortage is.  So you could end up with bubbles in some areas and shortages in others.  So pumping up the money supply too much could result in hyperinflation while not enough might result in deflation.

In the article Why the Bailout Will Result in Hyperinflation  Olivier Garret, CEO of The Casey Report makes the case that the massive extent of the bailout will not only counteract the deflationary forces but actually tip us in favor of hyperinflation.

Robert Prechter of Elliottwave said, “If inflation is a quiet thief, then deflation is an armed burglar. You wouldn’t invite either into your home, yet chances are that one of the two is stealing your money right now”.

The first step toward protecting your wealth is to understand which threat is most likely to arise today: deflation or inflation?

See Inflation vs. Deflation? by Robert Prechter to hear one possibility and read Why the Bailout Will Result in Hyperinflation to get a different perspective.

The November issue of The Casey Report includes an excellent debate of the arguments for each of the possible scenarios and how best to prepare for them. It also includes an excellent article entitled “The Greater Depression” by Doug Casey that gives one of the best descriptions of the cause and results of Inflation.

Doug gives a perfect example starting with the supposition that the city of Santa Monica, California, is an independent nation. “Life is mellow, and the weather is good”. From there the government decides that Santa Monica is not as prosperous as it ought to be. So it begins inflating the money supply.

From there he demonstrates the effects and the stages leading us up to where we are and what can be done about it. I highly recommend reading the November issue of The Casey Report.


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