With all the government spending and the concerns over government expansion with the likes of the new health care bill, shouldn’t there be a great deal of inflation? The US Treasury has a debt ceiling of $14.3 trillion. In the last six months, the debt increased by $864 billion. Even more ominously, since the new debt ceiling was enacted on February 12, debt is up by an astonishing $422 billion! Where is all this “money” going?
The Sentinel is a strong proponent of a deflationary scenario for our economy. We base the conclusion on the Saeculum model and an analytical evaluation of our unwinding credit cycle. Our current deflationary scenario is a function of the previous credit cycle. The previous credit cycle created an unprecedented amount of inflation. The public recognized the effects of inflation as higher prices. Higher prices are not inflation per se, but rather a consequence of credit expansion. Higher prices appeared in a variety of sectors (stocks, bonds, real estate, commodities). Without this previous credit binge, deflation cannot occur. Inflation precedes deflation.
The primary difference between previous bouts of inflation (China in 800 AD, Continental Congress, Civil War government) and the most recent inflation is the issuance of credit in electronic form (not paper). Credit issuance in this cycle achieved unmitigated levels. Credit in the previous bouts was a function of physical paper issuance. The government or some other entity issued more paper certificates than the wealth (usually precious metal coins) they represented. There is a scene in the movie Lawrence of Arabia where Anthony Quinn’s character upon finding a stash of Turkish paper money, scatters it wildly in an open area with complete disdain. Quinn’s character only desired true wealth – gold or silver coins. He did not trust paper produced by a government. He instinctively knew that the issuer of the paper had the ability to devalue it by producing more of it.
In previous bouts of inflation, government issued certificates for temporary financing needs such as war. The government-issued certificates circulated as money alongside precious metal coinage though the public recognized they had only implied value (not real wealth). Eventually, the certificates had progressively less value since the “price” of things they purchased, increased. In the case of the Continental dollar, nobody wanted the paper and eventually it ceased to circulate.
Today government’s debt increase is due less to fighting war and more towards taking care of its citizens (social programs). This is particularly dangerous since war financing usually has a start and finish. Social programs tend to expand as evidenced by the recent passage of President Obama’s health care legislation. In these cases, there is a start but no end.
The reason we don’t see more inflation is due to the strong deflationary forces already in effect. For example, the greatest example of deflation in our economy is in commercial and residential real estate. Despite overwhelming government and Federal Reserve Bank support for this sector (mostly in the residential sector), real estate remains mired in a downward trajectory.
Deflation is both a monetary and psychological phenomenon. It simply gets to the stage where borrowers do not want to borrow and lenders do not want to lend. In a credit-based economy, this spells deflation. The vast reduction in consumer spending has simply been replaced by government spending – witness the deficits. Without this government spending the ravages of deflation would be far more evident.
Unfortunately, while government fights deflation, it creates longer-term structural debt problems for its citizens. This has serious social and financial implications. Be prepared.
Jim publishes The Sentinel Economic and Financial Newsletter.