Wikinvest Wire

Memories of deflation and hyperinflation

Thursday, March 20, 2008

Caroline Baum at Bloomberg notes the important differences between the Federal Reserve and central bankers in Europe - the operative words are deflation and hyperinflation.

Put a gun to a central banker's head, and he'll repeat the mantra that inflation is always and everywhere a monetary phenomenon. Money -- too much of it -- causes inflation; too little, the reverse.

Yet when Fed officials talk about inflation, it's as if it were an exogenous event.

That's not the case in Europe. The memory of 1920s hyperinflation is forever etched into the psyche of German central bankers. The recollection of wheelbarrows full of worthless deutsche marks has haunted generations of Bundesbankers and European Central Bankers after them.

That may explain the ECB's reluctance to lower interest rates at a time when economic growth is slowing: Inflation in the euro area is accelerating at a 3.3 percent rate, a 15-year high.

For U.S. central bankers, the great deflation of the 1930s is imprinted in their collective conscience, something to be avoided at all costs.

In early 2003, just as U.S. economic growth was accelerating after a prolonged recovery from the 2001 recession, both then-Fed Chairman Alan Greenspan and then-Fed Governor Bernanke talked about the risks of deflation. The federal funds rate was still at 1 percent in the first half of 2004, even as the economy was booming.

Bernanke returned to the subject of the Great Depression repeatedly during his stint as Fed governor from 2002 to 2005, detailing where the Fed went wrong and what the Fed could have done to ameliorate the problems of the banks (provide liquidity or lower interest rates).

In his book of essays, Bernanke calls the Great Depression the "Holy Grail of macroeconomics."He writes that "the experience of the 1930s continues to influence macroeconomists' beliefs, policy recommendations, and research agendas."
Having never experienced anything akin to hyper-inflation in the U.S., save for periods around both the Revolutionary War and Civil War, this is all the more reason to think that hyperinflation is much more possible than many experts currently believe.

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Anonymous said...

I don't understand this stuff very well at all, but I gather that increased liquidity is driving M3 first? Where is the money going from there? If it stays trapped in frightened financial institutions will it still be inflationary?

Is "trapped" dumb?

Tim said...

I don't understand this stuff very well at all

You're not alone. Unfortunately, the words "money supply", "inflation", and "deflation" are such loaded words that it is very difficult to have a meaningful discussion about them without spending a fair amount of time defining terms.

staghounds said...

I'd consider a 90% decline in a currency's value over one man's working life a pretty severe inflation.

Anonymous said...

You nailed it Tim. I do expect too that the threat in US is high inflation whereas the thread for EU is deflation. When central banks target and aim at something, it is sure to create the other.

Mathlete said...

M3 evaporates into the ether if banks don't lend. That's the deflation scenario. People will watch M3 drop like a rock and their assets, including commodities, will get taken out. Then they will chant: Bernanke Lied, Inflation Died.

Anonymous said...

how do you get hyperinflation without corresponding wage growth? Put another way, how is a lady in the U.S. going to get all that money to burn in a stove?

Tim said...

Who says we won't get wage growth?

Tim said...

There's $600 of after-tax wage growth coming in May for every American worker.

Anonymous said...

$600 made a difference early this decade, but now we are confronted with the fact $20-50K/year equity 'taps' are not taking place. Many ARMS are resetting and payments are rising more than $600/month.

How much 'money' found its way into consumers pockets during the housing bubble? That 'income' is gone and something needs to replace it or mean-reversion comes into play re: prices, imo.

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