Hyperinflation, deflation, neither, both?

There has been much in the media of late about deflation or inflation. Each side has their advocates and with broad economic health indicators weakening over the last several months working non economists may wonder who is right?

The problem may well be one of definition. Since technical definitions have been watered down over time by commentators who overuse them,  there is some doubt about what they all mean.

So herewith a fast review. Inflation is defined by monetarists as too much money chasing too few goods prompting producers to raise prices to recover their costs. Deflation conversly is too little money chasing too many goods, driving producers to cut pricing to move goods. Think Wal-Mart’s price roll back marketing campaign. Hyperinflation is a rapid loss of confidence in the currency driving citizens to dump it as fast as they get it.

There are other terms bandied about such as Stagflation which is inflation coupled with a weak economy. Think back to the late 70′s for a case in point. Disinflation is a contortion that fits many meanings but may be viewed as deflation light, or a gentle unwinding of inflation.

Currently, a hot topic in the news is deflation is causing a double dip recession. Deflation in this context is used as a symptom of a weak economy, that the Fed or the government at large needs to do something about, rather than the disease. Forgetting for now the philosophical question of what role government can and should play in the economy, lets look at the reality.

What can the Federal Reserve do to fight this declining economy? The tool of choice is Quantitative Easing which means the Fed is using its magic checkbook (creating money) to buy treasury paper, treasury guaranteed mortgages, or other sovereign debt instruments. When the Fed does this they put huge sums of money into the hands of money center banks and broker dealers. These proceeds are counted in the monetary base, hence money.

Inflation comes when this money is put into the system and used (multiplied) by banks or spent by consumers or corporations. The speed with which this money is spent (changes hands) is called Velocity of  Money. The faster the money changes hands the higher the risk of inflation. Too much money chasing too few goods. If the money does not change hands, if it stays with the banks/broker dealers (in many cases the same folks these days) there is no velocity of money, and no inflation.

That is the case today. Money is not changing hands. Banks are content to take a small return from the Fed on their reserves (free income) rather than lend. Big business is in many cases flush with cash that they are not spending. Hence discussions in the financial press about dividends, stock buybacks, etc. Consumers are not spending because a) they can’t, b) they don’t want to.

So our economy which is driven by consumer spending is stuck in neutral. Inflation is not a problem because no money is chasing ‘goods’. Deflation is a problem because producers can’t sell their goods, so they cut prices hoping to draw sales so they can make more goods and maybe hire workers.

So the Keynesian stimulus tool with the trillions of dollars in debt creation and dollars flooding the banking system does no good. There is no ‘stimulus’. Putting more money in the system via more quantitive easing does not change the dynamic, rather illustrates the definition of insanity. If you are the Fed and your only tool is a hammer, all problems look like a nail.

What about hyperinflation? That is not yet a problem as investors around the world still have some confidence in the dollar. This is due in some immeasurable way to the lack of an alternative. Eurodollars? Can you say Greece? Gold? There is not enough of the stuff to be a medium of exchange at current price levels, AND it does not pay interest.

Until the world wakes up one morning and decides the dollar is going to zero, hyperinflation is not a threat. In the meantime, keep an eye on the price of dollars in the currency of your choice.