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Rare moment of economic insight from ZeroHedge

August 23rd, 2010 · No Comments

Although it had to be a guest post…Usually, quite a bit of Voodoo economics can be found on this otherwise excellent site.

But the stimulus, apart from being slow and inefficient, has simply not been enough to offset the fall in consumer spending. For its part, the Federal Reserve has been busy propping up all assets—including Treasuries—by way of “quantitative easing”. The Fed is terrified of the U.S. economy falling into a deflationary death-spiral: Lack of liquidity, leading to lower prices, leading to unemployment, leading to lower consumption, leading to still lower prices, the entire economy grinding down to a halt. [ZeroHedge]

Indeed! We should all be terrified of that, to be honest. And, as we’ve argued elsewhere, these policies have produced the difference between the 1930s and today, at least for now.

However, does this article go on discussing ways to combat this clear and present danger?


After all, this is ZeroHedge. Instead, it discusses a rather more hypothetical and distant bogey, hyperinflation. This is supposed to happen when people start selling (instead of buying) Treasuries, prompting the Fed to redouble its efforts, setting off something of a vicious cycle.

This is the ‘bubble in the bond market’ argument that Krugman already disposed of.

While we won’t exclude the possibility of hyperinflation entirely, it is remote and for it to happen, credit demand has to go up significantly, which seems very unlikely any time soon.

Most will be familiar with Friedman’s maxim that inflation is always and everywhere a monetary phenomenon, but for QE to produce hyperinflation, the money created has to somehow enter the economy. It isn’t happening now, there is little reason to expect it in the future when the economy will be even more depressed (a necessary condition for the Fed to embark on more QE). Exhibit1 in this case is the $1 in excess reserves the commercial banks are sitting on.

Even if the bond market and the dollar crash, it’s hard to imagine how that would trigger hyperinflation. Higher bond yields will simply depress the economy more while imports are too small a proportion of the overall economy (and hence price level) for it to cause much higher (let alone hyper) inflation (and many imports are priced in dollars).

Since much of Europe (let alone Japan) is in worse shape, it’s also hard to imagine against which currency the dollar must fall so drastically as to trigger hyperinflation.

Tags: Credit Crisis