Tuesday, November 25, 2008

Is the Dollar Headed into the Toilet?

I've never said the inflationists are wrong about inflation. I do think the inflationists are wrong if they say the dollar is absolutely going to inflate; and likewise I'd say the deflationists are wrong if they are certain about their perspective. With inflationists, you do tend to see more unsubstantiated and absolute belief in their position than you do with deflationists. I've only said whether the dollar inflates or deflates is a policy decision, and that it is my belief those in power would rather see deflation. But I may be wrong or not have the whole picture.

The vertical expansion of base money supply is worrisome at this point; base money supply has nearly doubled since September after being flat for years. Not dividing cash investments into other stores of wealth such as gold would be ill-advised at this point unless the vertical trend flattens very soon.

That said, given that money supply in any fractional reserve system is the sum of printed currency and credit, and that fractional reserves set by the Fed are at 10% and have probably been whittled down over the last few years, then at least 90% of the total money supply would be credit. Now say there is a 20% contraction of credit, and printed money doubles: then overall money supply has still dropped by 8% since the 18% loss to general money supply through credit contraction is compensated by only a 10% increase in printed money. Similarly, if credit drops by 50%, then even tripling printed money would not be enough to compensate a system which has been "credited out."

As has been argued by me and others before, as money supply tightens, prices need to fall to compensate, and hence deflation, where a given dollar can buy more and more.

So where the value of the dollar goes from here is a guessing game, and only the federal regulators know the answer.

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