Hyperinflation on the way?

We already know that the Fed is contributing to inflation by lowering interest rates again in an effort to artificially expand credit in the market. And we know about the recently signed tax "rebate" deal. Beware of government when both parties agree to something. It usually involves spending money with no purpose.

But these superficial measures, while they will likely have a detrimental effect on the economy and inflation, are not the elephant in the room. The question is whether or not more countries will stop using the U.S. dollar and T-Bills as a safe haven for money. Now that the Euro has been established for a decade, there are indication that more countries are moving to Euro as a safe haven. But here is the prisoner's dilemma. Those countries with enormous U.S. currency reserves cannot sell them without setting off a panic that will wipe out there value before they are even sold.

The best that any of these countries can do is gradually shift their reserves to the Euro, the Pound of something else. But with Japan and China and other mercantilist nations, they apparently have no choice but to continue buying T-Bills as a store of value with the extra dollars their central banks retain in order to keep their currency value artificially low to encourage export and discourage imports. The question is what happens when the U.S. ceases to be their largest market? So long as we are their biggest trading partner, mercantilist policy dictates that they keep their currency pegged to the dollar. What happens though when Europe's buying power exceeds the U.S. as it likely will in the near future?

Will they start pegging their currency to the Euro, or is there enough momentum in enough markets to keep them from switching from the dollar any time soon. Keep in mind that the dollar is now the de facto currency in many nations and even the official currency in nations like Ecuador.

So in short, I don't know the answer. The factors are there to make hyperinflation happen, but it appears that there is still too much vested interest in the rest of the world to keep the dollar propped up. It may only take a minor event to convince the rest of the world to abandon the dollar. When that happens, our market is going to be flooded with dollars and that will be when hyperinflation occurs. In the short term, however, we can almost certainly expect inflation to get much worse.

Mercantilism Revisited

This is a follow-up to the questions I asked about mercantilist policies and the predictions of the Austrian School.

The rise in prediction of prices by the Austrian School appears to be correct, but because of the way most mercantilist policies operate, the inflation occurs in the value of assets (land and capital) rather than in regular commodities. This results from an artificial expansion of capital. Because the expansion of capital is usually geared toward industry rather than consumer spending, however, the inflation occurs more noticeably in specific areas rather than the economy as a whole.

The policies of loose credit eventually lead to speculation and overvaluing of assets which in turn eventually start to creep into inflation in the rest of the economy. This overvaluing of assets eventually leads to an unsustainable bubble when credit is closed off to prevent widespread inflation from occurring in the rest of the economy. This is what happened in post-Bubble Japan. This may also be what happened in post-Civil War U.S. (the Great Sag/Great Deflation - normally attributed to increased efficiency in production). This will likely happen in China as well where consumer prices are not increasing, but land and asset speculation may be out of control.

All of this cannot occur without a central bank, of course, to control the supply of money. We have seen this is the U.S. with the housing sector. Consumer prices remained steady while the price of housing increased dramatically. Then we started to feel inflationary pressure, so the central bank (the Fed) tightened credit. This led to deflation in the housing market. The question is whether nor not we will do like Japan and have the central bank pretend bad loans don't exist or if we will let those who speculated take their lumps.

If we do like Japan, as the Bush administration seems inclined, we will have a stagnant economy and deflation for the next ten years.