Can Inflation and Deflation Coexist?, Part II

Could we actually be headed toward a massive deflation — perhaps a deflationary depression? To me, the bottom line is that the political buffoons in D.C. have things so screwed up that no one can predict with certainty exactly how our economic debacle is going to play out.

The only thing we can be certain of is that virtually everything the government does will make things worse. Regardless of whether it’s “jobs programs,” “rescue packages,” or any of a myriad of other anti-free-market measures government loves to impose, its spending must be paid for in one of three ways: printing, borrowing, or taxing — and all three are bad for the economy.

Leo the Centimillionaire is right when he points out that we are in a deflationary period right now. But my guess is that once the Obama “change we can believe in” crowd starts implementing its massive New Deal II programs, a rapid increase in inflation cannot be far behind.

Lately, however, I’ve begun to ponder an unthinkable scenario: inflation and deflation at the same time! In such a scenario, housing and oil prices, for example, might continue to drop, while the cost of food and other essentials might continue to rise. It would be a chaotic and confusing way of life for all of us … to say the least. Perhaps this is what the wild swings in the stock market have been signaling. The market seems to be telling us that it can’t make up its mind between inflation and deflation.

In any event, Leo is also right when he says that no one can be certain how long it will be before a panicked U.S. government floods the world with its fiat currency in an effort to “fight deflation.” But keep in mind that Leo’s point of view has its roots in what he perceives to be the financial realities of our economy.

Some economists, in what seems like a desperate attempt to justify government interference in the marketplace, argue that false prosperity is better than risking a depression. (The polite phrase is “severe recession.”) They could not be more wrong. A depression is an adjustment period in the supply and demand cycle that forces people and businesses to become more efficient.

It’s a “reprimand” for being naughty — for treating themselves to the fantasy that prosperity can be created without work. The more irresponsible their actions, the worse the reprimand — in the form of a recession or depression. Just as it is in the long term best interest of children to be taught a lesson by getting an occasional spanking for misbehaving, so it is with adults who have been financially irresponsible.

Not everything that is in our long-term best interest feels good, but, long term, a deflationary depression is a healthy process — a financial catharsis. Prices fall to where merchandise can be sold, overvalued investments drop to realistic plateaus, and, when everything reaches its natural level once more, the market is again healthy.

The question is, what politician has the courage to spank 300 million people? Certainly not one that I’ve seen running for office recently (with the possible exception of Ron Paul).

Unlike Leo, however, my guess as to how things will play out is rooted more in human nature than in economics. In other words, mine is a sociological perspective. The reason I believe that the printing presses will ultimately win out is that (1) people will never accept a permanent lower standard of living and (2) politicians are both gutless and shameless (and, in their defense, often do not even understand the consequences of their actions).

As all class warfare preachers know, taxing the rich and borrowing both have their limitations. But printing money requires only that the government be able to purchase paper and ink — and pay its electric bill.

And the nice thing about inflation of the money supply is that it’s an invisible tax. As prices rise, people cannot keep pace, and their standard of living drops. Then, to add insult to injury, the government points its soiled finger at “corporate greed,” “the rich,” and special-interest groups.

But, make no mistake about it, government is the only entity that has the power to print color and words on a piece of paper and proclaim it to be “legal tender.” And that is the primary cause of rising prices.

So, yes, I still believe that in the end — and I do mean the end — government will try to print its way out of the economic maelstrom it has created. In the meantime, you’re going to see a lot of industries in big trouble … and in Part III of this article, I’ll give you some examples of which industries those might be.