Mythiot

Inflation, Deflation and the U.S.-China Relationship

Christo, the decline in the USD from early 2002 to mid-2008 can largely be attributed to a faster increase in the supply of USD worldwide relative to other currencies. Now that assets are deflating, the opposite is happening. That is, the supply of USD is contracting faster relative to other currencies and the result is that the USD is getting stronger. This will continue as long as this deflationary process runs. The monetary policies of central banks will not be inflationary because the velocity of money is zero at this point. Usually in a fractional reserve system, when central banks increase the monetary base, that increase is multiplied many times through bank lending. But banks are no longer lending. The contraction in the global money supply will be an order of magnitude greater than any expansion resulting from the monetary policies of central banks. The decline in the price of oil alone will have a much greater impact on the supply of USD than the Fed. We might start to see the inflationary aspects of monetary policy after a couple of years of deflation, but IMHO now is absolutely NOT the time to short the US dollar.