If We Can Print Money, How Could We Have Deflation? – Part 4

Part 1 of this series on deflation discussed why it is unthinkable.  Part 2 discussed why a protracted deflation would be an utter disaster.  Part 3 discussed why governments can’t fully control deflation.  Here we discuss how we could have a deflationary bust, even though fiat currency can be created instantly and in unlimited amounts.

COVID Helicopter Money Proved the Inflationary Power of Fiscal Stimulus

Soon after COVID began in 2020, the Federal Reserve increased the money supply with unprecedented speed and size to combat the rapid slowdown in the economy; the increase coupled with Federal “stimmy” checks and reckless business handouts (PPP and EIDL loans, many of which were fraudulently obtained) quickly caused painful inflation.  Federal Reserve chairman Jerome Powell infamously said that the inflation was “transitory”, which turned out to be dead wrong.

U.S. inflation peaked near 10% (many believe it was much higher) and the Federal Reserve had to aggressively raise short-term interest rates to cool it off.  As of the date of this article, inflation is still high (“above target”), and the public has become acutely aware of its detrimental effects.  So, it seems debt can be rapidly created to combat any potential deflation, but the longer-term result is inflation and economic distortions.

Trees Do Not Grow to the Sky

The world’s tallest tree is a 381-foot Sequioa named Hyperion, 70 feet taller than the Statue of Liberty.  Just imagine how big and strong its trunk and roots are to support that much weight and sway.  Question: how tall can the world’s debt become before it topples over?  How financialized can the economy get before physical constraints pop the “everything bubble”?  Remember, trees do not grow to the sky.

Admittedly, here’s where my analysis gets speculative.  We’ve never had a worldwide fiat monetary system before (in known history).  We’ve never had a single country dominate the global economy (a unipolar world) and had the world fall back into multipolarity.  We can’t know what specific course of action the United States, China, Europe, Russia, and other major world powers will take.

On top of that, there are other variables like unforeseen (“black swan”) events.  Also, the emergent properties of complex systems like the world economy tend to produce unpredictable results (i.e., the more complex it gets, the less predictable it gets).  We can look to history as a guide (looking at hyperinflations and deflationary episodes), but in the end, we are just making educated guesses.  

When times are good, be happy;

    but when times are bad, consider this:

God has made the one

    as well as the other.

Therefore, no one can discover

    anything about their future. -Ecclesiastes 7:14

We should be grateful now, even though inflation has become a sore spot for most of us.  If things get worse, we need to trust in God’s plan for the world (and our own lives).  The economic environment doesn’t change virtues like gratitude, hard work, saving, diversification, putting God first, and trusting God with your future.  So even though inflation is the flavor of the decade, let me help you envision why you might want to put some of your financial eggs in the deflationary basket. 

How Could a Deflationary Disaster Play Out?

I have two main theses as to how a deflationary disaster could occur.  The first is where debt would become so large that governments could not stop the cascading effect of a sudden deflationary impulse (this is what happened after the 1929 crash).  The economy could rapidly shut down because the speed at which money moves through the economy (money velocity) could quickly approach zero.  This would increase the value of debt and cause forced deleveraging throughout the economy.

Much like trying to recover control of a car when sliding on ice, the deflationary speed could simply overwhelm any inflationary counter-steering response.  Even though the central planners turn the steering wheel, the car keeps sliding into the ditch.  That kind of rapid deflation could create a situation where world trade immediately goes back to a hard commodity-backed system, thereby ending the unbacked fiat currency experiment that started in 1971.

What I believe is more likely is that governments’ stimulatory reactions would kick in too late causing an extreme deflation-inflation whiplash (like 2008 on steroids).  The initial deflation would bankrupt the weaker, poorly positioned companies and individuals, and then the subsequent inflation would greatly enrich the survivors (who still have assets).  Such a scenario would make the cost of living nearly unbearable (heavy inflation ultimately leading to hyperinflation) and create hyper-extreme wealth inequality and social discord (yes, even more than there is now).

I liken this to a tsunami, where the receding tide empties a bay, but soon after a wall of water destroys everything in its wake (except those with hard asset lifeboats).  I believe this whiplash scenario is more likely than outright deflation, because governments do indeed have tremendous inflationary power at their fingertips and will attempt to appease the masses.  Unfortunately, helicopter money drops to the public is blunt instrument, which is likely to result in a hyperinflation.

My second, much less probable thesis is that governments would eventually choose (or even plan for) a deflationary cleanse.  Given politics and recent history, it is hard to imagine this scenario, but stranger things have happened.  Perhaps the US Government, influenced by the dollar-based banking cartel, will believe that a prolonged deflation is the only way to preserve the US Dollar’s role as the world’s reserve currency; or perhaps if hyperinflation became inevitable (e.g., when US national debt reaches 250% of its GDP), choosing a deflationary outcome would somehow be preferred by policy makers.  I can’t see how, but when a disaster becomes imminent, such a choice might somehow become politically palatable.

An Inflationary “Reset” to Save the Day?

Although this is an article about a potential deflationary bust, I would be remiss not to again mention that I believe hyperinflation is the more likely long-term outcome.  Governments can choose to proactively “reset” to a new currency or to suddenly devalue their existing currency (i.e., a hyperinflationary reset), as has been seen many times throughout history (Zimbabwe and Venezuela are probably the clearest recent examples).  Ultimately, some kind of reset, whether planned or not, is inevitable unless the fiat system can be balanced, which no government in history has ever been able to do.

Put another way, there are four endgame paths leading us back to a sound money system.  I’ll put them in order of which I believe is most likely: 1) a deflationary whiplash leading to hyperinflation, 2) straight to hyperinflation, 3) a deflation with an inflationary whiplash ultimately leading back to deflation (i.e., governments were too little, too late), or 4) a straight up deflationary default.  

Do you see how scenarios 1, 3, and 4 all involve serious deflation and why it is important to be ready for it?  In the final article in this series, we’ll explore how you can diversify for deflation.

For further study, here is a list of Scriptures on investing.  For a broader spiritual view on investing, inflation, deflation, and other topics, read Faith and Finances or do the Building Faith and Finances course.