Tetrapod's  Instablog

We all know what happens when a country resorts to printing money to monetize their debt:  their currency ultimately collapses, resulting in hyper inflation.  Right?

It will invariably happen if done by a country in isolation, but that is far from the current environment.  The 2008 crash, where worldwide markets and economies synchronously collapsed shows us that in our world of real time communications, and floating currencies, the whole world needs to be considered, or very wrong conclusions will be drawn.

When countries' economies are as inter related as they are today, no country can inflate (devalue) their currency without provoking a race to the bottom.  No one wants to be left with the strongest currency in a time of low utilization and high unemployment.  It's nonsense to imagine that Asia has decoupled to the extent that their economy will flourish if the developed world economies flounder.

Therefore, what would happen if the US (and likely UK and Europe) cannot withdraw their stimulus without crashing their economy, and they must continue stimulation and quantitative easing to avoid a debt depression?  Looking in isolation, you would say that their currencies will devalue, and their interest rates would skyrocket.  But what if all of the major economies find themselves in this situation?  The debtors need to inflate, but the creditors must also maintain their competitive edge, so must inflate in tandem.  What would that look like?  No major currency can be seen to collapse if they are all collapsing at about the same rate.  How can we see it happen?  Only by looking at liquid assets such as Gold, Copper or Oil which are not being inflated.  It won't likely show up as wage / price inflation due to weak demand and high unemployment.  That is, not until resource prices raise the cost of production above current price levels.  Then it will show up in prices, but still not in wages.

So we will see it as an increase in commodity prices, and ultimately producer and consumer prices without an increase in wages.  In other words, a declining standard of living.  This will kill corporate revenues and margins,, further depressing the economies of the world, requiring more stimulus and reinforcing the cycle.  This looks suspiciously like a deflationary spiral, but with asset and price inflation.  So what's deflating?  Wages, residential, and commercial real estate.  Farm land and hard assets will inflate.

What about GDP, interest rates and sovereign debt?
That's a little harder to see, but I suspect that nominal GDP growth will remain positive, while "Real" GDP growth (based on CPI) near zero.  GDP growth in gold terms will be strongly negative.  Interest rates will go up along with mild CPI inflation, so bonds will fall, but not collapse.  No major country will default on their debt.  If any gets close to the edge, others will step in with support, as they will be considered too big to fail.  If bonds can't be sold, they will be bought by the central banks.



Disclosure: None