A pessimist's prediction: Hyperinflation

By Bill Fleckenstein

Last week's 26-year high in the price of sugar must have stuck in the craw of the deflationist camp, those who fear a bout of falling prices. And that's as good a segue as any to the inflation-vs.-deflation debate.

I've spilled plenty of ink on this important topic (for example, read "What's next: Inflation or deflation?"), and this week I'd like to turn to a friend of mine, Marc Faber, for his assessment.

Marc's most recent Gloom, Boom & Doom Report contains an excellent discussion of inflation vs. deflation, and he makes the connection between the policies we're pursuing -- massive stimulus to create inflation, due to the fear of deflation -- and the funding crisis that I have warned about that will arrive as the U.S. has trouble financing its increasing debt. (Read "Why creating jobs is so hard.")

I decided to quote liberally from Marc's report. But I encourage folks to read it in its entirety. (Here's the Gloom, Boom & Doom Web site; a subscription is required.)

For newer readers who continue to ask me to elaborate on this subject, hopefully Marc's commentary will bring them up to speed:

Deflation can be avoided through debt and money printing. This isn't to say that I support such policies, or that I find deflation to be "bad" and inflation to be "good." (Price stability is the most desirable condition.) But the point is that if a government is really determined to inflate its problems away, it can be done. Those people who believe in deflation have, however, some strong arguments. Their principal contention is that the economy is so weak (output gap) that the private sector's contraction cannot be offset by government spending and money printing.

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In fact, the massive money printing and the rest of the stimulus are why gross domestic product has held up as well as it has. More from Marc:

The deflationist argues that, because we have a weak economy, we shall have deflation; an argument with which I would tend to agree in the very short term.

I believe that in fact we have passed the point of maximum downside pressure. But more from Marc:

A true deflationist will also argue that because of deflation, economic conditions will worsen and, therefore, long-term U.S. government bond yields will decline. . . . But what happens to fiscal deficits and monetary policies under a scenario of a further decline in economic activity and a further collapse in asset prices? The answer is very simple. Deficits will increase further and more money will be printed. And the longer weakness in the economy prevails under the deflationary scenario, the more fiscal deficits will pile up and the more easy monetary policies will be pursued.

So, whereas near-term deflation is a distinct possibility, in the longer term inflation is more likely because of several factors. When the economy recovers (and the recovery is likely to be fragile), the Fed will be very reluctant to increase short-term rates. Another reason for the Fed's reluctance in this respect will be the size of the government debt, given that higher interest rates would increase the interest burden. Therefore, I can't imagine any scenario under which the Fed wouldn't keep interest rates at an artificially low level, as it also did post-2001. That such a monetary policy, combined with the growing fiscal deficits discussed above, is more likely to lead to inflation rather than deflation should be clear.

Continued: The funding crisis

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