Friday, November 6, 2009

If A causes problem B, then B cannot be rectified unless A is first removed

A Path To Runaway US Inflation, from Mises Daily,by Ganesh Rathnam

I'll borrow an analogy from Peter Schiff. Imagine if you will a victim at the unfortunate end of a Brock Lesnar knuckle sandwich. The blow has knocked him out cold and the medics try to revive him. The best suggestion they can come up with is to have Lesnar pound the man's head even harder with his fists. When the man has seizures from the repeated pounding, a medic (coincidently named Bernanke) screams gleefully "Hurray, he's moving."

Sadly, such is the response to our present crisis by the policy makers in Washington, DC. To solve a problem caused by malinvestments resulting from easy credit at 1 percent interest rates, the Fed is supplying even more easy money at 0.25 percent. None of the malinvestments have been allowed to be liquidated.

Housing prices have been propped up, banks and auto companies have been bailed out, regulations have been increased, debt covenants have been violated, unemployment insurance has been extended. In addition, there's the cap-and-trade bill, the healthcare bill, and a "czar" around every corner.

All of these increase the already-humongous burden on wealth creators. In short, the problems that caused the Great Recession have been compounded. Real output must then necessarily decline. How can anyone logically assert that we are in the beginning of a recovery?

Declining output is not the answer to keep a system with a debt-to-GDP ratio nearing 400 percent (800 percent if you include Social Security and Medicare obligations) solvent. From this vantage point, one can conclude that the real recession is ahead of us, not behind us.

One then must decide whether it will be a deflationary recession or an inflationary recession. Intelligent people can disagree on this, but my take is inflationary. . .

total output will decline eventually because there are no investments being made to maintain capital and improve productive capacity. There may be blips here and there, but they are more likely to be the result of capital consumption than of any sustainable increase in output. Meanwhile, for reasons detailed below, the money supply will constantly increase. We then have the textbook case of more money chasing fewer goods, leading to rampant price escalation. . .

If you happen to catch a NASCAR race on TV, you might hear a driver screaming over his radio, "Tight, tight, tight … LOOOSE!" This cry is followed invariably by a crash.

What the driver is referring to is his race car's inability to turn the corner. A "tight" condition means the car doesn't want to turn and is heading straight for the wall. A "loose" condition means the car turns too readily and wants to spin out. When a car is difficult to turn, the driver ends up putting so much wheel into it that when the car eventually does turn, it overshoots, spinning out of control; and the driver rear-ends the car into the wall.

This is exactly the scenario I envision for the impending price inflation. Bernanke and company are screaming that there is deflation everywhere they look. To combat this deflation, the Fed will keeping printing money and adding reserves by buying all kinds of assets. This will continue until general prices violently overshoot on the other side, causing runaway price inflation. . .

The Fed will bail out all the affected parties by creating money. Bailouts cause malinvestments that lower real output, beginning the cycle again. This cannot continue forever: it will eventually result in a runaway-inflationary depression.

1 comment:

  1. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.