inflation, deflation, currency, and credit

The reality of inflation, deflation, currency, and credit

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...

Image via Wikipedia

7 Responses to “inflation, deflation, currency, and credit”

  1. Bernadine Says:

    ok… so what to do esp. when there is so little left to invest or buy gold.

    • jrfibonacci Says:

      For many people, reducing their expenses is a practical priority. They may wish to find like-minded people to form housing co-operatives for economy (and an experience of community).

      Others have credit available and/or valuables to sell, so they have more alternatives, such as for prudent investing or even re-locating. Most people know that they do not know how to prudently in vest in current markets, so they are open to consult someone who has a clear record of competence.

      People who are “natural” promoters (or willing to experiment with that) can generate large residuals with minimal effort. As always, amongst the best things to do is to introduce other people to services (or products) that provide distinctive value to them. Trying to sell telegraphs to people who have reliable access to the internet might not go well. Similarly, there are lots of people trying to sell bad investments and bad investment services, which leaves a huge vacuum of opportunity for competent service providers.

      There are always services and innovations that are attracting attention, from spears to iron to guns to steamships to light bulbs to railroads to steel to telegraphs to air conditioners to tanks to aluminum to airplanes to televisions to lasers to bombs to computers to missiles. What will be next? Maybe algae-based bio-fuels (“synthetic” crude oil).

      If countries like the US have systematically protected and even favored the oil industry, actively resisting innovation competitive to the oil industry, those places are not he places where such innovations are likely to blossom, are they? Until a competitor to oil is established, the mid-east (Arabia) may be the next region to rise to economic prominence, just as North American rose to economic prominence by exporting oil to the rest of the world, up until around 1970, when the singular Oil-Producing-Exporting-Country became a net importer of oil, an “OPIC” and a new family of “OPECs” began to rise in economic influence and political affluence.

      There are always places that are gaining in disproportionate access to affluence, like Europe and then North America did in recent centuries (note the summary data of USA at it’s recent peak in global affluence: around only 5% of global population, but around 50% of global affluence). Other places will be the future recipients of the affluence leaving the former imperial treasuries: the leaders among the developing and emerging economies of the world. I personally do not think that the mid-east will do especially well if their main customers in North America and Europe do not do well. I have specific forecasts about many specific areas of the world. For many people, a shift in attitude- such as to humility and gratitude and personal responsibility- may be relevant.

  2. chris Says:

    What were the resources you utilized in order to properly understand inflation/ deflation? I’m interested in who you read in order to come to the realization…it closely resembles the work of Nicole Foss.

    So in your mind, a pile of one’s own physical currency is far more valuable than the equivalent of silver coins or bullion..given of course one’s sustenance and shelter are taken care of?

    • jrfibonacci Says:

      One author who clearly distinguishes credit inflation (and inevitable credit deflations) from currency inflation is Robert Prechter. However, any intelligent legal professional or accounting professional “should” understand the trending patterns of the creating of contractual obligations (“credit”) and the resolving or negotiating of such contractual debts/claims/accounts receivable. In particular, one might be surprised that more “Austrian Economists” do not seem to emphasize the issue of panics of “bearishness.” As for favoring piles of bullion or piles of paper, I make no general comment. Certain currencies I predict will continue to deflate, yes, but your question of value is actually about transaction value as in market value. Gold and silver are not inherently monetary. They are just metals like copper or brass or iron. Paper and ink are not inherently monetary. Some negotiable instruments are better than others. Sometimes, some paper increases in value relative to various metals. All fluctuations are temporary.

      I monitor and forecast trends, like trends in human behavior, like borrowing or buying or stealing or farming or taxing. Price changes follow behavioral changes.

  3. chris Says:

    Thanks, it’s important to know where philosophies have their incubation.

    Of course there are no absolutes, only theories..but “trends in human behaviour” such as the ‘stampeding herd’ (in investment speak) is where any present reality lays.

    What I find very interesting in this regard is the concept of the “All Consuming Self” which had it’s birth after WW1 and which underlies virtually all human (irrational?) behaviour today. I became aware of this concept via the Adam Curtis documentary “The Century of the Self” available on Google Video

    It seems like a bit of a coincidence that the corporate creation of the ‘All consuming self’ coincided pretty much with the creation of the Federal Reserve system…it seems, Debt based money and consumerism, fit hand in glove.

    “Gold and silver are not inherently monetary”

    What if all nations Gold and Silver and other resources were monetized (overnight and with a mathematically sound approach) in conjunction with complete destruction of the debt based monetary system in it’s entirety? (all debts and credits are wiped out)

    Not withstanding the 6-12 months of transitory chaos…would credit deflation become a thing of the past?

    I say this because there is a lot of evil intention in the world, primarily revolving around debt based control of the masses. So it should follow, that there are equal and opposite forces working to end this tyranny of the “Capital machine’ ( coined by Damon Vabel in ‘Debunking Money’) and the movement to a system based around resources and production and not money, from money.

    They may say I’m a dreamer….

    You should get your music up on Bandcamp (free) so it’s easy to peruse in the one spot. Mines up there at

    • jrfibonacci Says:

      To a farmer, a tornado or earthquake may be evil. To you, if you are scared of something that you understand only partially at best, it could be evil to you.

      Currencies are backed by governments that claim authority over the properties of their jurisdiction and citizenry, like by taxes and military drafts of the citizens and so on. For governments to add a promised exchange for some metal does not change the basic issue of the promise of organized coercion as the basis for any paper currency. If the government says “we renege our promise to redeem these coupons fo gold,” as happened in the US in 1933 and1971, then unless some person or group has the military capacity to hold that issuer of currency to it’s original promise, then the original promise is functionally worthless.

      No one is stopping you from using silver or salt or barrels of oil as your primary method of exchange. People worldwide favor currency for some reason you apparently do not accept. Do you use currency? Why?

      Again, the source of credit inflation and credit deflaton is private contracts of future performance, like buying a car from your neighbor with a down payment and a promise of future payment. You are missing the point.

  4. chris Says:

    Whoops..just realized I mentioned a ‘Utopian Final Solution’

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