If there was one person who could best explain the threat of deflation in 2014 despite massive amounts of money creation, it would be the late John Exter. He was a giant intellect who had all the mainstream credentials. He was Harvard educated, a Federal Reserve economist, a member of the Council of Foreign Relations and most uniquely among mainstream insiders, John was a gold bug. He was a personal friend of the great Austrian economist, Ludwig von Mises and I'm told by retired stockbroker Barry Downs who married John's daughter, that he and von Mises debated the inflation/deflation argument all the time, with von Mises, of course, taking the inflation side of the argument.
I doubt Exter would buy the government's current massively understated levels of inflation. But he would not at all be surprised that we have not yet entered a hyperinflationary period of time because he understood that the more debt money that is created, the bigger the drag on macroeconomic demand. He did not buy the argument that other Austrian economists feared, namely that deficit spending by government would automatically lead to hyper inflation. Instead he argued that the more debt money that is created, the more severe would be the ultimate deflation because in a fractional reserve fiat system debt is the raw material from which money is created.
To illustrate his view of the dynamics of deflation, Exter drew up an inverse pyramid shown above. Up to a point, as money is created the system does in fact inflate. People become overly optimistic and they buy and invest in illiquid, speculative and oftentimes unnecessary luxury items. As the system expands, these illiquid, speculative and luxury items become massively overvalued, but the debt from which they were financed does not disappear. Ultimately, as the system expands and becomes ever more insolvent, a tipping point is reached in which the system turns into reverse as it did in the 1930's and more recently in 2008-09. When that happens the speculative overvalued, unnecessary items at the top of the pyramid are sold with people first rushing down the pyramid into Treasury Bills and Federal Reserve notes (currency).
In my view, after many years since 1971 of more and more liability money being created at a faster and faster pace, the 2008-09 Lehman Brothers event launched the start of the deflationary dynamics of Exter's inverse pyramid. The massive and unconventional money creation by the Fed and other central banks staved off the problem for the time being. In the process, we do see a leveling off of total debt as you can see by the red in the chart on your right. However, keep in mind private sector debt (aside from student loans) has declined while unproductive, non-cash generating government debt is growing very rapidly.
The Chart above right illustrates why we are in trouble. Note the rapid, exponential growth of debt (red line) compared to the growth of income (GDP - blue line). Debt has been growing almost exponentially while income is growing in a linear fashion if at all. John Williams, an economist who believes we are inevitably heading toward hyper inflation, believes if GDP (blue line) were adjusted for an honest cost of living as opposed to the current CPI, it would actually be heading dramatically lower. But the need to generate Keynesian "animal spirits" requires manipulation of the numbers to dupe the public so they keep spending to keep the system expanding.
Going back to John Exter's inverted pyramid, once a set of dominoes is set in motion, one default begets another and another as the margin clerk requires payment of debt. As items are sold to repay debt, credit contracts and prices collapse as items are sold in mass to raise cash. Banks go into default as loans cannot be repaid because the value received for the sale of assets collapses below the value of the loans used to fund them. In this process business profits collapse. Workers are fired and default on their loans and a massive negative feedback loop is created.
With all of these dynamics, people and businesses understandably hold on to the money they have in order to meet their most urgent life sustaining needs. In other words, monetary velocity (how rapidly money turns over) decreases. One of the reasons I believe John Williams is right in suggesting that we never came out of the 2008-09 recession is because current monetary velocity is continuing to plummet as shown by the chart from the Federal Reserve Bank of St. Louis on your left. I believe this picture is consistent with statistics that show America's middle class is very rapidly disappearing. We are even reading now that Americans are building up debt simply to buy food and gasoline for their cars. To the extent that trend grows and continues, the American economy is a train wreck waiting to happen.