43. “Why Credit Deflation Is More Likely than Mass Inflation: An Austrian Overview of the Inflation Versus Deflation Debate”
by Vijay Boyapati
Abstract: This article provides an Austrian overview of the inflation versus deflation debate which has captured the attention of the economics profession in the years following the US housing bust. Much of the Austrian analysis of this debate has focused on the massive expansion of the Federal Reserve’s balance sheet and attendant creation of new reserves. Several Austrian economists have predicted that the creation of new reserves will cause a massive increase in inflation. The money multiplier theory, on which these predictions are based, is criticized and an overview of the Austrian business cycle theory is provided to explain why banks are reluctant to issue new credit. Finally, an analysis of the politics of deflation is provided and a class theory is presented to explain why a policy of controlled credit deflation is more likely than a policy that would result in mass inflation or hyperinflation.
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Have you considered the scenario where the political class nationalizes its currency and transfers monetary power to their treasury? The U.S. Constitution certainly makes it easier for this to happen, especially if public opinion continues to be so negative regarding the banking class.
More people in the U.S. feel negatively about the government than they do the banks.
I like your argument for why there won’t be hyper-inflation, but what about non-hyper-inflation? I would like to know why you feel that slow deflation is more likely than, for example, 1970s-style inflation.
Excellent essay. I appreciate the way you counter the typical inflationist arguments by simply observing what actually takes place in reality when banks make loans. Very effective.
Wonderful to see this analysis in an solidly Austrian context. I have always been at a loss to understand how Austrians, with the correct economic theory, still cannot make a decent analysis with respect to the inflationary deflationary outcome. Now we have an in depth analysis that hopefully will open the eyes of some Austrian thinkers.
I find you analysis of the banking and political classes spot on. This is why the Euro might blow up before the Dollar as Europe currently has a politician (Trichet) govenor. It will be very interesting to see who succeeds Trichet.
The author has constructed his thesis and presented his arguments very well. But he doesn’t consider several other scenarios that may play out during the course of this critical period. For example, one such situation could be – what if the direction of inflation helped both the political and the banking classes? Inflation always happens during periods of wars. There’s at least one in Afghanistan that is actively being engaged by the US. I’m not saying there will be a war, but if there is (considering today’s geopolitical tensions) – then where’s the money to spend?
Also because dollar is the world reserve currency, debasing the currrency means that the dollar assets held by other countries that engage in trade are getting devalued as well. So it is not just a domestic inflation, I think this has enormous impact world wide as well. There are just way too many variables that determine the future’s course and it would be very hard to predict it, even harder to predict their sequence. Above all, the answer to this debate is potentially the most important of our time.
I liked very much this paper. In particular, it underlines very well how bankers and politicians tend to exploit the monopoly of the creation of money. While the former behave mostly like “rent-seekers”, the latters are more prone to hyperinflation: pure political power is surely more shortsighted and usually has also the monopoly of the use of strenght.
In fact, historically, banks start to stop creadit creation when losses on their assest side emerge and then they ask government for bailing out in some way – suspending the redempion of notes during the gold standard could be saw like a rough QE.
The only thing that it hasn’t been considered is that, being the usd the main reserve currency, the fed also “exports” inflation: actually there is an incentive to foster credit expansion in emerging markets with evident consequences for commodities. In that case, the constraints above mentioned for bankers are – maybe – weaker. So, also a “stagflation” scenario, occuring after years of lag, could be assessed.
I found this paper to be quite fascinating. However, I was shocked that it never addressed the issue of sovereign debt monetization. To my knowledge, this is a huge factor, if not the primary factor, influencing Austrian predictions of hyperinflation in the U.S.
It is impossible for the U.S. government to pay off its existing and future liabilities. And, since the only options open to a government facing insolvency are open default or hidden default through monetization, this fact cannot be omitted in a discussion of the likelihood of hyperinflation today. This issue is all the more important given the Fed’s current policy of purchasing 600 billion in treasuries.
You can have inflation or hyperinflation without a credit-induced bubble, after all. Ironically, this seems to be precisely the point that Boyapati himself makes about Weimar and other hyperinflations that occurred at the hands, not of credit-producing bankers, but of politicians trying to liquidate debts they could not feasibly service or retire.
I wonder what difference it makes to predict the future level of inflation – either “price” or “monetary” kind. I don’t think it is possible to predict the average price level at all. Sure we can have rapid deflation in some areas and rampant inflation in others. In fact, the average price level can be considered as the output of a system which involves so many variables that are interconnected in a very non-linear fashion. We could easily classify it as a chaotic system, and the numerical output of such systems are pretty much random variables.
The only thing one can be sure of is that there is a power elite in control of money and they can print it at will and give it to anybody they want. We have to work hard to get it but they can type in numbers, and that’s it. So, if there is anybody out there who thinks holding fiat money is a good idea because there is a deflationary future ahead, he should better wake up and quickly tie his assets to something real.
With total debt at $ 65 Tr. and an economy of $13 Tr. the fed has now monetized $ 2 Tr. arriving at a total of $ 3 Tr. in assets.
That is just 5 % and leaves 95 % of debt still choking the US. A choke like that is not inflationary.
Excluded are Derivatives of $600 Tr.
Unfunded liabilities are $ 300 Tr. This necessitates the repeal of the welfare state.
No amount of creative accounting can change that.
Even if Ben’s helicopter were big enough the result would be catastrophic. We need to bring spending in line with revenues and people must feel the need to work for a living.
Company bailouts need to be stopped.
Observator’s comment on Boyapati’s article mentions some issues that I hope can be clarified. 1. $600T of derivatives presumably have some money effect, but it may not be face value, and the effect may depend upon the category of derivative. Are any readers aware of studies on this money effect? 2. Money effect changes may straightforwardly determine the inflation / deflation question. Are any readers aware of recent studies that measure the total amount of money (including all non-monetary-base factors, such as credit) injected into the US economy since 1.1.2007 and the total amount of money () withdrawn from the economy during that time by credit reduction, shrinkage of the derivatives pool, and other factors? References would be appreciated. It would be very interesting to know how much further the Fed would have to go just to break even.
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