One of the great debates of the current depression is what is the end state, a hyperinflationary or deflationary collapse? While there are valid arguments on both sides, it is certainly not clear to me which argument is more valid. The argument for hyperinflation points to the exponential growth in the money supply.
The counter argument is, “ok, although it is true that the growth in money has been explosive, why haven’t we seen a corresponding explosion in consumer prices?” Of course this notion confuses definitions of inflation. Furthermore, who is to say that there won’t be an explosion of consumer prices in the near future?
The deflation argument is usually based on pointing out that the necessary deleveraging process entails paying of debt or default, both resulting in the destruction of credit money. The counter argument here is that the Fed can print up money at virtually no cost, and if the public and businesses refuse to borrow, the Fed can directly purchase assets (ala the Bank of Japan) to pump money into the economy.
As usual, Murray Rothbard clarifies the issue. This time he did so in “Making Economic Sense“, a collection of essays on contemporary events written during the 1980s and 1990s. In the essay, “Lessons of The Recession (Chapter 70)”, he states:
“Lesson #5: Don’t worry about the Fed “pushing on a string.”
Hard money adherents are a tiny fraction in the economics profession;
but there are a large number of them in the investment
newsletter business. For decades, these writers have been split
into two warring camps: the “inflationists” versus the “deflationists.”
These terms are used not in the sense of advocating
policy, but in predicting future events.
“Inflationists,” of whom the present writer is one, have been
maintaining that the Fed, having been freed of all restraints of
the gold standard and committed to not allowing the supposed
horrors of deflation, will pump enough money into the banking
system to prevent money and price deflation from ever taking
“Deflationists,” on the other hand, claim that because of
excessive credit and debt, the Fed has reached the point where
it cannot control the money supply, where Fed additions to
bank reserves cannot lead to banks expanding credit and the
money supply. In common financial parlance, the Fed would be
“pushing on a string.” Therefore, say the deflationists, we are in
for an imminent, massive, and inevitable deflation of debt,
money, and prices.
One would think that three decades of making such predictions
that have never come true would faze the deflationists
somewhat, but no, at the first sign of trouble, especially of a
recession, the deflationists are invariably back, predicting imminent
deflationary doom. For the last part of 1990, the money
supply was flat, and the deflationists were sure that their day had
come at last. Credit had been so excessive, they claimed, that
businesses could no longer be induced to borrow, no matter
how low the interest rate is pushed.
What deflationists always overlook is that, even in the
unlikely event that banks could not stimulate further loans, they
can always use their reserves to purchase securities, and thereby
push money out into the economy. The key is whether or not
the banks pile up excess reserves, failing to expand credit up to
the limit allowed by legal reserves. The crucial point is that
never have the banks done so, in 1990 or at any other time,
apart from the single exception of the 1930s. (The difference
was that not only were we in a severe depression in the 1930s,
but that interest rates had been driven down to near zero, so
that the banks were virtually losing nothing by not expanding
credit up to their maximum limit.) The conclusion must be that
the Fed pushes with a stick, not a string.”
Isn’t it interesting how the recurrent inflationary recessions lead to the same questions over and over again.