Inflation vs Deflation – Only One Choice

Critics of government deficit spending correctly point out that perpetual debt accumulation is not sustainable. They’re right. But before they criticize an economic policy that aims to use inflation to whittle away the real value – and hence the actual burden – of accumulated debt, they’d be wise to consider the alternatives. Because there aren’t any.

Deficit spending has been touted as a potential driver of inflation, because only with devalued (inflated) currency can Americans hope to erode the real value of mounting levels of government debt. Continuing to print U.S. dollars, it is claimed, can only lead to too many dollars in the system, and hence a devalued dollar. We should be so lucky.

When American households join the Federal Government in spending more than they make, the only way to keep this up is to lower interest rates and increase the value of the underlying collateral. This second factor, the value of collateral, is particularly important for the American consumer, who has relied on home equity appreciation to enable ongoing borrowing which in-turn enabled ongoing spending beyond their means. The so-called financialization of the American economy over the past few decades has been specifically aimed at increasing the value of assets in order to stimulate more borrowing and spending.

The deflationary risk caused by debt accumulation becomes most acute if and when this asset-price bubble bursts. When the market value of the collateral suddenly becomes worth less than the amount of the loans outstanding, banks cannot extend new […] Read More