Written by Andy Sutton

While I believe that the U.S. is heading towards a Weimar style hyperinflationary depression there are several developments that point to the possibility of another deflationary depression, similar to the 1930’s. Let me explain.

Inflation

For starters, let’s put to bed (hopefully) once and for all where price inflation comes from.

It is categorically impossible for general price levels to increase in the long run without a commensurate increase in the supply of money and credit. It is important here to make the distinction between short and long run. In the short run, an increase in general prices can be absorbed without a growth in the money supply because it could, in theory, be sustained by devouring savings but in practice, generally speaking, that isn’t how things work. People tend not to expand spending unless they feel comfortable that money and (particularly) credit are readily available.

Bubbles

The housing bubble of the early 21st century is a prime example. 30-year mortgage rates dropped steadily from 1981 through the present. Not surprisingly, low rates and readily available credit led to a massive price expansion by monetizing demand. The expansion in money to fuel lower mortgage rates and the expansion in home prices came from M3 in the U.S. which nearly tripled during that period.

Deflation

…Most folks understand that inflation has been responsible for the vast majority of our economic ‘growth’ over the past century. Inflation fueled the dotcom and real estate bubbles. In short, our economy is set up to run in an inflationary environment. Unfortunately, there is a predictable end to this scheme. At some point, the monetary environment devolves into hyperinflation, then a deflationary collapse. We certainly haven’t experienced hyperinflation yet in the U.S., and we know the Fed can win a battle with deflation because it can create as much money as is necessary to overwhelm deflationary forces…so we’re left to ask: what exactly is going on here?