Thursday, September 24, 2009

US Dollar Inflation vs Deflation, Currencies and Financial System Must be Reformed

This is a quick note. Jesse's American Cafe had a must read article on the inflation x deflation debate.

"In a credit crisis there is often a 'credit crunch' which is what was seen in the financial system when short term credit transactions seized up out of fear. This is not the same as a true monetary deflation which is a real contraction in the money supply, at the least. So far we have not seen this. And we may never."

I have posted several times on the concerns with the U.S. Dollar. Because the debt in the U.S. will never be repaid, something will happen to the U.S. Dollar, either it's big inflation, or suddden devaluation, or yes, a new currency will be created. All the major nations and currencies in the world are interconnected, so it is a very complicated problem. Gold is part of it, but not the entire answer.

Jesse says "... the eventual fate of all fiat currency is failure and reissuance of a 'new' currency, due to the sustained erosion of a seemingly incessant, if gradual, inflation." "And it should be perfectly clear that to choose a monetary deflation as a fiat policy decision for a country that is a net debtor would be bizarre to say the least."

But he goes on to state that in a deflationaty environment not all things lose their nominal values. Some things that are needed still increase in price, such as some foods or those controlled by oligopolies. The things that are not so essential suffer deflation. Some prices will rise so that their's owner's profits remain high - to compensate for the losses on other revenue streams.

On of the keys of thr article:

"The growth rate of dollars is slowing at the same time that the 'demand' for dollars, the velocity of money and the creation of new commercial credit, is slowing. GDP is negative, and the growth rate of money supply is still positive, and rather healthy. This is not a monetary deflation, but rather the signs of an emerging stagflation fueled by slow real economic activity and monetization, or hot money, from the Fed. The monetary authority is trying to lead the economic recovery through unusual monetary growth. All they are doing is creating more malinvestment, risk addiction, and asset bubbles."

He concludes that the banks "must be restrained, and the financial system reformed". Funny, Brazilian President Lula said pretty much the same things yesterday at the U.N.

Please read the article in its entirety if you can.

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