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November 04, 2008

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Curt

Yes, we are in a deflationary period, but the risk is growing that the world is tired of borrowing America money. If the global economic conditions continue to worsen, many nations may abandon the dollar - which would cause the dollar value to sink, resulting in massive inflation.

The current deflationary period will continue until the assets (cars, houses) are liquidated, perhaps another year. But, after that, the highly inflationary monetary policies of our government are likely to overwhelm the market with inflation.

Therefore, in time inflation will overtake deflation. The combination will be desasterous. The deflationary period will cause a lot of job losses and losses of assets, then the inflationary period will spike interest rates so that even if you did have any money left it will cost you more to get a loan and have less value.

Milos Sugovic

Curt, thanks for the post. I think you bring up a few important distinctions here, that is, short-term versus long-term effects of the recession on inflation, and the pressures that come from within and from abroad. In the short-run deflation seems unavoidable as aggregate demand dropped, credit dried up, unemployment is high, inventory is piling up domestically and abroad, and the list goes on and on. What’ll happen in the long-run is less clear as dollar flight is likely. But it’s debatable if inflationary pressure coming from monetary policy, a depreciation of the dollar, and government spending will counteract the pressure coming from the hurting goods, labor, and capital markets. What’s most alarming is that a short-term deflation may be the US’s entry into a liquidity trap a la Japan, which I’ve discussed on http://peppercomblog.typepad.com/my_weblog/2008/05/will-the-us-flo.html and I notice you have too. And as you mention in your post http://www.pennyjobs.com/pp/public/Articles.aspx?aid=225, if the US stays in an L-shaped recession, we could see a Japan-like effect. If that happens, the short-term deflation might not be so short after all.

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