Inflacionatus: How on earth can you continue to hold on to your deflationary views Deflaticus? The monetary base has exploded, inflation is rising and while the dollar has not fallen over the last 12 months, it has not risen much either, as one would expect during a deflation.
Deflaticus: The monetary base may have exploded, but the velocity of money has plummeted as a more cautious deflationary psychology has taken hold. That’s why the banks are sitting on all that money rather than lending it out. Banks can’t find enough qualified borrowers to lend money to and people are more reluctant to take on debt, because they are more cautious about their ability to repay it. As to the dollar not rising more than it has done, we have experienced unprecedented money printing and financial repression, with the Federal Reserve attempting to keep interest rates at historically low levels. Despite all this the dollar has actually risen slightly. Doesn’t this indicate how powerful the deflationary forces are?
Inflacionatus: Actually, in my opinion, it indicates the opposite. Despite the strength of the deflationary forces, particularly the collapse of housing prices, inflationary forces, as reflected in the CPI, are still making themselves felt. Doesn’t this indicate how powerful the inflationary forces are?
Deflaticus: Touché. But what I really want to say is that I don’t believe the Fed is all powerful. The evidence shows that the Fed tends to be a follower rather than a leader. For example, I don’t believe interest rates are being kept low because of the power of the Federal Reserve. I think interest rates are low because borrowers are willing to accept record low rates as a result of the new deflationary mindset of caution, conservatism, careful creditors and debt retirement. Have you tried to refinance your mortgage lately? Now the banks are doing the kind of careful due diligence that they should have been doing years ago.
Inflacionatus: I have to disagree with you on one point. There is no single individual alive today, more powerful than Ben Bernanke, the chairman of the Federal Reserve. Bernanke has admitted that the printing press is the reason we don’t have to worry about deflation. At the click of an electronic key the Fed can create unlimited new money and there is no shortage of individuals and institutions willing to spend those newly created dollars.
Deflaticus: That’s a very naïve view. While it might be true if we lived in Zimbabwe, we actually live in a mature credit-based economy where investors can demand higher rates of interest if they perceive any signs of inflation. With everyone feeling a little more cautious and conservative, at the margin, less is spent, loaned and borrowed, so deflation seems inevitable. There are also political and social forces that you are not taking into account. For example, it’s becoming increasingly difficult for the Fed to keep printing money because of all the political headwinds it faces.
Inflacionatus: Are you seriously suggesting, that when push comes to shove, governments will not print money to prevent a deflationary collapse in asset prices? Governments will lie and bluster to get people to act differently, but if they think the only way to support asset prices is to print money, that’s what they will do, just like they have always done.
Deflaticus: Look, the sovereigns can no longer afford to keep printing money and even if they could it’s becoming politically unacceptable to do so. What chance do you think there is of another $750 billion stimulus bill in the United States in today’s political environment? Don’t you think the Tea Party and other Republicans would have something to say about that? In Europe, Germany is one of the few countries that can afford to keep printing. However, Angela Merkel, the Chancelor, would be thrown out of office if she caved in to those demanding that Germany increase its money printing to subsidize the lifestyle of the Club Med countries. She is not going to allow that to happen. Greece ended up defaulting on most of its debt. That’s what we are going to see happen in a great many more countries.
Inflacionatus: O.K. so I suppose we will just have to agree to disagree on this all important issue.