The reality of inflation, deflation, currency, and credit

The reality of inflation, deflation, currency, and credit


First published on August 6, 2010 (here: )


1st video (of 2):

I am clear that many people do not understand the basics of what inflation is nor how a deflationary credit crisis forms. In fact, I did not understand this for years myself, even when I identified it as happening (without understanding the mechanics).

Briefly, there are two very distinct kinds of inflation: inflation of the supply of a currency and inflation of the the supply of credit and debt. Many people do not distinguish between the two. The distinction is simple, but huge.

Increasing or inflating of the supply of currency permanently reduces the purchasing power of all of the rest of the currency. This is what people classically think of as inflation. More bills are printed and added to circulation (and without removing equal units of old bills from circulation). Currency inflation permanently increases prices in general, with all prices moving up quite evenly.

Currency inflation does not result in an eventual deflation (which is a reduction in the total circulation of currency PLUS credit). Currency

The Chinese Civil War led to severe inflation....
Image via Wikipedia

inflation just means there are more units of actual currency in circulation. The only way for the currency supply itself to deflate, hypothetically, is for the issuer of a currency to permanently remove cash bills from circulation and not replace them.

Credit inflation is an entirely distinct process. It does not involve printing more bills of cash. It involving only accounting.

If I sign a contract to rent a house for 12 months, I just entered a contract for future payment of debt. The landlord can write down in their accounting logs that I now legally owe a bunch of money to the landlord. No new cash has been printed. However, new accounting entries of debt have been created.

Next, I may sign more contracts to take home some furniture and electronics without paying for them yet. I am “renting to own.” The owners of the stuff that I am renting to own is issuing me credit, which means I promise to pay them over time. They make new accounting entries in their ledger. No new currency has been printed.

I may buy a car or a house with borrowed funds. Again, no new funds have been created. My parents could be loaning me the money, or my employer, or a financial institution (like a credit card issuer). The lender has provided cash that was already printed and owned by them. They write down that I owe them whatever they lent me plus interest. No new cash has been printed. Where the cash to pay for that interest will come from, no one knows.

I may even be sued and have a judgment recorded against me by a court. Maybe it is for a parking ticket. No new currency has been printed. However, new accountings of debt are recorded. The owner of the debt (the owner of the court judgment) can take that court judgment or “account receivable” and borrow money against it. It is credit. It is a legal asset. It is not cash. It does not involve the printing of new money. It is not currency inflation to obtain a court judgment in a lawsuit, nor to rent to own a TV on credit, nor to borrow to buy a house or car or anything else.

There is only one form of currency inflation: increasing the volume of actual currency. Credit inflation has many forms… and ALL of them eventually deflate completely. Legally due interest beyond the total amount of currency actually in circulation may not be paid. They may eventually be written off like other legal debts. Debts generated by credit are only charges, not currency- only accountings of debt. Those accountings in excess of the actual supply of currency may be written off or discharged as worthless, paid in part, or paid in full.

So, in an environment of “ridiculously” easy credit, people may forget the distinction legally between cash and credit. I can use either to buy groceries, right? We may presume that lenders will always offer us credit, and will offer us more and more over time. That is, however, absolutely false.

If lenders “withdraw” a credit line, the actual volume of currency in circulation does not change. If a creditor writes off a debt due to a bankruptcy proceeding or otherwise, the actual volume of currency in circulation does not change. However, when legally accounted credits (accounts receivable) are removed, the false de-valuation of the currency reverses. That is called deflation.

Prices of real estate might drop 90%. Why?

If real estate is typically bought with 10% cash and 90% credit, and then the market for credit collapses, all that is left is the “intrinsic CASH value of the property.” The 90% drop in price is just the removal of the credit portion of the market.

Same for stocks and gold whose prices are inflated due to “secondary” credit inflation. All credit inflation eventually disappears, sometimes very quickly. Credit inflation develops slowly, but collapse rather suddenly.

Examples: Japan in 1990s, US and Europe in 1930s, & any individual bankruptcy ever. When an individual goes bankrupt, that means their access to credit collapses, as well as their capacity to issue credit to others, right? Also, if the bankrupt person used to think “I have a credit line of $50,000 in credit cards, so this other $5,000 in my pocket really isn’t worth much,” guess what happens to the perceived value of the $5,000 in pocket when the $50,000 credit line is withdrawn?

Bankruptcy Filings...
Bankruptcy Filings… (Photo credit: MyEyeSees)

On a related note, I know of several other people who have said things like “the US government just promised to pay out an additional 783 trillion dollars next month. That is inflation.”

No, a government promise is just a government promise, especially if stated by a candidate during an election campaign. Inflation is an increase in the supply of cash in circulation PLUS the supply of credit. That RESULTS in rising prices. Government promises and statements of the Federal Reserve and advertisements of “no payments until next year on a brand new color TV” are all not currency inflation.

In other words, the authorization for the government to spend money is not the printing of money. It does not even mean that the government has that money to spend. A new authorization to spend suggests that tax revenues or other collection activity are predictable, but that has nothing to do with printing of new currency for circulation, unless there is a specific provision for issuing more treasury bonds (an authorization for the US Government to go deeper into debt, if it can only find someone to lend it money- but lately, lots of investors have been very willing, driving open market interest rates on lending to the US Treasury to ALL-TIME lows).

2nd video:

Remember, by the way, that the US Government has no power to issue Federal Reserve Notes. Federal Reserve Notes are private currency contracts issued by the private Federal Reserve based on the Federal Reserve’s claim over the assets of the US government, such as future tax revenues. The US Treasury sells bonds on the open market and promises legally to repay them plus interest by taking wealth from it’s underwriters (such as taxpayers) with or without the consent of taxpayers.

Holders of Federal Reserve Notes are counting on the organized coercion of the US Government (and the Federal Reserve) to maintain the exchange value of the FRNs. Holding a FRN (US Dollar) is holding a share or secondary claim on the Fed’s primary claim against the assets and operations of the US Government, including national parks and missiles and the “accounts receivable” of relevant courts and perhaps of the IRS and of course yes also any gold stored in Fort Knox. Ultimately, the underwriters of the purchasing power of the FRNs are the US citizenry (and their current and future assets).

Again, in summary, there are only two kinds of inflation. There is credit inflation, which always deflates (collapses), and always faster than the preceding credit bubble inflates. There is also currency inflation, which never deflates.

After Germany lost the “great” war in the 1910s, it was charged or assessed huge reparations. In order to dramatically reduce the value of the reparations, Germany printed tons of new currency bulls, hyperinflating the currency. This was financially very detrimental to the German citizenry who held that currency, but only secondarily, for the primary target was the British Empire (to whom the reparations were due). That was not a credit inflation, so it did not deflate. That was a currency inflation of printing new bills.

In contrast, the credit bubble (credit inflation) of the last few decades, which is prominent still in the US and UK and EU, is now deflating. It will be quite the opposite of hyperinflation. Holders of currency will be greatly benefited, and to a lesser extent creditors will benefit (at least creditors of debtors who can pay them back in the full amount of the deflating currency). Marginal debtors will be bankrupted, and many debtors who are not marginal yet will soon be marginal and perhaps then bankrupt. Most creditors also carry debt (like banks) and may also go bankrupt.

A deflation is the fastest possible transfer of wealth, with the obvious exception of invasion or what is otherwise known as theft. Deflation is a sudden redistribution and concentration of affluence like no other.

Stocks markets fell 89% in the US from 1929 to 1932. The current credit bubble is much larger than the one preceding that decline. Accordingly, I expect stocks and real estate to all drop in price by more than 90%. many companies will go out of business or be nationalized by governments. I expect commodities (because they are global markets) to drop in price slightly less in total price change in terms of US Dollars, Euros, etc, but to drop even faster than US stocks or US real estate, just not as far ultimately because of foreign demand for commodities. Also, many lower levels of government in the US, UK, and EU will go bankrupt and may cease to function completely, such as Greece or California, led to glory by that famous and brilliant student of long-term economic cycles demanded by what are obviously the smartest voters in the world, Governor Arnold “I’ll be back” Schwarzenegger. 😉

Note, the Great Deflation already started in 2007 and 2008. It is simply about to dramatically accelerate.

Nations to watch that may prosper from this historic redistribution include: Korea, Taiwan, India, Indonesia, Malaysia, Pakistan, and Mexico. In contrast, I expect the European Union to dissolve within a few years.

The long-term stability of the US may be eventually questionable, but that is probably several years away. First, expect huge advances in taxation as well as classic communist and socialist policies of confiscation (like from “suspected terrorists” in particular and “anti-government rebels” in general). Standard business practices of the 1990s will likely result in civil and criminal lawsuits. The people will be thirsty for scapegoats… oops I mean villains, and if Governor Schwarzenegger recognizes that in time to avoid being targeted as the villain, I’m sure he can find some alleged evil-doers toward whom to point a finger, even if the actual court proceedings are political theatre designed to distract from the primary parties involved in controversial activities. Remember, the US President can legally pardon ANYONE of most anything- yes, legally. However, first there must be a conviction and prior to that a prosecution. If you believe that “attorney general” is not a politically-charged office, I invite you to study the history of the USSR first and then the US.

Also, note that while the presidency of George W. Bush ended with record low approval ratings, his distinctive conspiracy theories involving Al Queda are still generally accepted worldwide. People trusted him at the time he made the accusations. “Mission accomplished!”

Official, popular versions of history do not ever exactly conform with how the past actually happened. History does not exist until someone creates it. Some things are left out, some things are added, and if, in 1000 years, people believe a conspiracy theory about Al Queda, then that will be considered history, not speculation or propaganda or diversion or trivia or myth. It will be “the actual reason why we entered the civil war” (or whatever).

Note, for reference, that if Stalin or Mao or Hitler promised 783 trillion dollars of spending next month, that did not equate to currency hyperinflation. They just seized the accounts and real estate of the jews or the “bourgeois.”

If you believe that hyperinflation is inevitable in 2010 and/or in the relevance of blaming politicians for their politics, thank you very much. Your docile participation in the credit bubble of Great Deflation is making a lot of people very rich very quickly- well, maybe not a lot of people, but at least a few of us. 😉

One Krone-note from 1919 (overprinted on 1 Kro...

One Krone-note from 1919 (overprinted on 1 Krone of 1916) from Austria (text in german and hungarian language) (Photo credit: Wikipedia)

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One Response to “The reality of inflation, deflation, currency, and credit”

  1. The Running Son Says:

    Whew… I think I’m a bit smarter for reading this 😉

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