Monday, April 17, 2006

Since When Can You Stop a Bubble from Deflating?

Every time I hear someone of prestige state that they need to "fight deflation" or that they have "deflation fears," I get the same reaction: You can't stop an open-ended balloon from deflating. You can slow it down by pumping credit hot air into the monetary system at a certain velocity, maybe even reflate it for a while, but you can't really cure the problem, because the supposed "problem" is in fact a cure.


[Thanks for unitoops.com for the photo.]

"What nonsense is that?" you say. I say that, all else equal, deflation is a cure for inflation.

Why don't economists get this simple principle?

The latest example of an effort to "fight deflation" is Japan. "We cannot allow a setback in the current recovery track," Prime Minister Junichiro Koizumi said. "There are signs of deflation ending, but I am wary of whether deflation has been beaten. It must be judged cautiously." (Japan's Prime Minister is quoted from sirchartsalot.com.)

He makes it sound like deflation is a virus. Deflation is not a virus; it is the antidote to a virus, which virus is the inflating of the Japanese yen that caused them to bubble in the first place.

Ever since 1913, the US and other nations have allowed those responsible for maintenance of the currency to inflate it, even encouraging them to do so with unending credit reserve pumping. So what now do they expect? It's either deflation, or de facto devaluation. Either the inflated monetary unit must deflate back to normal, carrying that country's economy with it on the ride down, or the unit must lose its asset- and exchange-value credibility. There is no third way. Gold is making this crystal clear at this very moment, and gold is usually the fat lady singing.

It is time central governments bit the bullet, paid the piper, did their mea culpas, and found a way to deflate us safely back to fiscal and monetary sanity. Japan had the chance to do so over the last eight or so years, but instead they blew it (pun intended.)

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