Inflation and Prices

Why do we have inflation and deflation? Why do we need to have such a paradigm in modern financial markets? Inflation is a term associated with a growing economy and rising prices. Central banks mandate a 2% inflation target so that prices will rise, stimulating business. The problem with this gigantic Keynesian experiment is that the inflationists do not realize the extent in which they affect prices. Rising prices from expanding the fiat quantity of money move the increased amount of liquidity into monetary preferences at one point or another. Central banks do not have an accurate gauge of the liquidity in the market, as evidenced by their lack of knowledge of money vs. goods. If they understood the value of money in terms of goods, the money stock would not change in the manner in which it has. Central banks have manipulated people’s preferences by unsound monetary policies.

Deflationists look at falling prices as evidence of deteriorating economic conditions and falling prices. Interestingly enough, falling prices are an attribute of sound money. Governments fear deflation because as the debt burden becomes greater due to it, you need more of that currency to pay back the debt. They fear that falling prices will lead to destruction of an already fragile banking system. Absorbing the losses from an economic downturn will not be possible, as citizens will scramble for cash to meet debt obligations. In recent meetings, the Fed has made it clear that it wants to normalize its balance sheet. This can mean only one thing: the mortgage-backed securities are now worth something or they are preparing for the next financial crisis. The Bank of International Settlements has warned us that we could be on the precipice of a new crisis, even as the Bank of England determines who to lend to. While directing other banks to boost capital reserves, the Fed and the Bank of England still miss the point. Inflation is driven by high levels of money in the system that is being unwound. It is almost certain that the last mess has not been unwound as the banks attempt to prepare for the next crisis.

Inevitably, the Fed will inject the system with more money to keep the banks afloat and zombie businesses alive. Prices will rise and interest rates will rise with them, leaving central banks with no other choice but to inflate once more. Bankers may be able to hold off a crisis for a short period of time, but goods and services will eventually rise substantially because businesses have no more room for debt. It is no coincidence that a 1988 edition of the Economist magazine had fiat burning and a new currency coming in 2018. The opportunity in gold is an opportunity not seen since Roman times.

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Cheers,

Colin