Deflation First, Then Inflation

Around March of 2014, there were several headlines about disinflation and deflation in the European Union.  Today, peripheral European countries are still undergoing deflation, and others may soon as well.  See this article that briefly discusses briefly the situation in Portugal.

The danger in the Eurozone is that interest rates are already so low that new borrowers cannot be enticed by the low rate alone.  This defies the normal sequence as things, as banks are usually trigger more or less borrowing primarily based on adjustments in the interest rates.  Tyler Durden summarized the situation well in March.

As the velocity of money borrowing decreases, something different will happen this time.  As we pay down our debts, the money that we use “disappears” from the monetary system.  This is because upon repayment, this credit cancels out a phantom debt.  As Mike Maloney puts it, debt is not money.  It is subject to readjustment.

World events mean deflation first, then inflation…(click to watch Maloney’s video clip).

It will be important to watch the effects of deflation on wage increases over the next two years.  Will wages decrease, and if so, homogeneously across all industrial sectors?  Even more important, once deflation occurs, it will be important to hedge against over-reactive central banks.  They will want to return us to an inflationary period, where national debts are alleviated by a depreciating currency.  Unfortunately, if this causes a loss of confidence in the currency, hyperinflation could pursue which effectively destroys all practical use that fiat currency.

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