Asset Inflation Is Over, For Now

Think of the credit bubble like an ever growing plane. After the 1970s inflation, credit was reduced relative to GDP. Credit wasn't a bubble, and it was like an SR-71 Blackbird. It was flying high, like interest rates. By the late 1990s it was a Boeing 747. The operational ceiling for rates was cut in half. After the 2008 crisis, it turned into a Spruce Goose. The ever declining interest rate and shrinking GDP growth rate is like the ever-larger plane. Now we are approaching the point where Japan and Europe reached, where the plane is so large it cannot get off the ground. You cannot inflate away a credit bubble with more credit! And the Fed can only create more credit. USG creates more credit when it borrows. The important lesson from the plane analogy isn't that the altitude (interest rates) keep dropping, but that you need ever more credit growth to keep the plane from nose-diving. A credit bubble expanding at 8 percent goes into a nose dive if growth slows to 5 percent if debt/GDP is more than 300 percent, because a 3 percent drop in growth is equivalent to 10 percent of nominal GDP.

The 1970s inflation was caused by the inflation in prior years, which led to devaluing the dollar against gold. As was the dollar devaluation by FDR in 1934. There were too many US dollars floating around and not enough gold. Instead of devaluing the dollar, Nixon closed the gold window. The value of the dollar fell. He could have done like FDR and said it takes $100 to buy 1 ounce of gold. That might have prevented the inflationary decade by frontloading the devaluation. It also would make the job easy today: devalue against gold to balance the amount of fiat against reserves.

What do we devalue against now? How do you devalue a currency with no reference value, when the currency in question IS the reference value and other countries are devaluing? Europe can decide to take the euro to USD 80 cents, China can devalue the yuan to USDCNY 10, USDJPY can go to 200, but how does the dollar devalue? It can only happen against some asset, like gold. The U.S. could end all of this tomorrow if they said 1 ounce of gold is worth $10,000 dollars. Wealth would transfer to gold holders and the U.S. Treasury is the largest in the world. Not a bad idea, right? Another option is the debt jubilee where everyone is sent checks for say, $50,000 and that money must be used to first pay down debt. Debt is eliminated, and savers get $50,000 to spend. That might be the most politically palatable option because everyone gets some benefit from the inflation and it rewards savers, and we want to have a just government that favors healthy, eucivic behavior.

Runaway inflation is only going to happen if there is a social event, such as if everyone "agrees" or "knows" that oil should be $200 per barrel and runs it up there. And the Fed also has to sit by and let it happen, the government has to let it happen or be so incompetent that it can't stop it. If at any moment they get worried or get cold feet, like they are doing now, the nose of the plane starts tipping down.