Matt (a former co-worker) writes:

Many seemingly credible arguments are out there that say inflation is inevitable. There are also people who say deflation is coming. Please tell me if I am seeing this correctly, specifically as to why “experts” cannot even agree as to which direction these two diametrically opposite possibilities our economy will take.

The main things that are on the side of the scale of deflation are declining home prices and the credit contraction. The main thing on the side of inflation is all the money the Fed has been printing to support our noble and rational war in Iraq (yeah right) as well as stimulating our economy and bailing out these finance companies, among other things that the Fed dilutes our dollars for by printing more monopoly money.

Were are basically weighing two very heavy weights against each other on the scale. Given the uncertainties in these weights, some people think more mass is on the side of deflation, and others on inflation. In any case, we know that it is going to tip to one side or the other, since given two large, more or less random weights, it is highly unlikely that they will closely balance each other out.

This is how I see the situation (though I am personally more convinced of the inflationary argument). Is this roughly correct? Or am I totally misguided?

My reply:

Our Fed chairman Ben Bernanke in the article above jokes about dropping money from helicopters to prevent deflation. Hence the nickname “Helicopter Ben” the bigger picture as I see it is that when people start hoarding money after a credit bubble pops neither the banks nor government can force people to spend to boost the economy.

I imagine in the near future we’ll see rates cut to zero followed by a series of stimulus checks. I don’t think people realize how much money the government would have to create to counter the Trillions lost as housing declines approach 50% in places like California. It’s going to get ugly but this needed to happen after a Credit bubble of this size.

There are bigger issues at play here, namely the deflationary force of exponential technological growth and resulting automation on all sorts of jobs. People like to place all of the blame on globalization but it’s only part of the cause. This country is going to be a lot more humble in ten years but hopefully our economy will no longer be run entirely on debt and dreams of real estate tycoonery. People are going to actually have to do something productive again.

On my list of people I admire to the right if you click on the two black and white pictures you will learn about the economists who basically laid out the school of thought that predicted this mess we’re in.

The real issue here is “too big to fail”. We can choose moderate socialism and keep the system alive or we can choose to let Fannie, Freddie, et. al. fail at which point we’ll have full blown Socialism.

When you peel back all of the layers of the onion, you’re left with two competing philosophies. Wealth redistribution with all of it’s consequences vs. accountability. The irony of modern life is that accountability is now seen as a relic of our idealism. I don’t think that’s necessarily a bad thing. In a Democracy, wealth re-distribution may be the only way to ensure productivity growth.

Unnecessary taxation is a violation of law enforced by law according to Bastiat. In a Republic that’s one thing. In a Democracy it’s an entirely different can of worms.

As far as inflation vs. deflation, my thinking, summarized, is simply that the Austrian School of economics is the only school which gets notion of credit bubble collapse. Simplified, there is no free lunch, hence my deflation call.

Any self respecting believer in Moore’s law will be hard pressed to justify sustainable money printing based inflation. I’m not banking on oil pricing staying this high much longer.

Image by Sokwanele – Zimbabwe on Flickr.