In my previous post I discussed why Inflation might be a stronger possibility than deflation Sophie’s Choice. The broad arguments I talked about were
- The over-whelming Government incentive to inflate away debt (bazooka theory)
- The Dollar devaluing causing imports to become expensive (Exogenous supply shock)
However I have probably missed a very important data point in this argument – The lack of a precedent in history.
“No fiat currency has suffered a sustained increase in purchasing power (deflation). “
The most common examples used to refute this are
- The Great Depression of 1929
- The Decade long Japanese deflation
The Great depression fall in prices is an inaccurate comparison because the currency in 1929 was Gold backed (Not Fiat). History is witness to many gold-linked currencies inflating and deflating in cycles. The Dollar that deflated in 1929 is not the same Dollar that is in circulation today. One was Gold and the other is TP. Where is the beef?
The Japanese case was different because there was no price deflation (mild at best) in fact what caused wealth erosion was a severe case of asset deflation. The Bubble in real-estate exploded and deflated over a decade. Japan did not Price Deflate!
There is a commonplace confusion between price deflation and asset deflation. Price deflation makes your money more valuable whereas asset deflation causes a drop in your wealth.
Incidentally, Price inflation can co-exist with asset deflation –this will create a dual effect in eroding wealth. Price inflation will make buying everyday goods more expensive and asset deflation will make erode your assets (house/ financial assets/derivatives)
I would also add that in the case of Japan, the BoJ started QE only after a full 7 years after the peak. Uncle Ben is determined to act instantaneously and has repeatedly said that he believes creating inflation is trivial for any sovereign with its own fiat currency as long as there was the will to act. So I guess QE 17 cannot be ruled out 😀