Skip O'Neill – Liberty for All

Ron Paul for A New Direction

Inflation or Deflation, What’s Next?

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When the Fed creates money, also known as monetization or quantitative easing, they exchange newly created dollars for assets, typically US bonds. It is the necessity of having to exchange the new money for assets that is key. There are already trillions of dollars of bonds in existence. The current owners of all those bonds may sell them en masse if they believe the Federal Reserve is determined to inflate at any cost. This would create a situation which could quickly lead to total and utter destruction of the currency through an uncontrollable hyperinflation as everything dollar denominated gets sold. It is this unacceptable situation which would lead to the demise of not only the dollar, but also the Fed itself that the deflationists contend will handcuff their money creation.

The Federal Reserve realizes this predicament so it creates a situation where it can monetize bonds without the negative repercussions. To do this it needs a deflation scare. After the dot com bubble burst and again after the housing bubble burst, the spinmeisters set out to work. The Fed can create new money during times where people are fearful of deflation as it is precisely this fear that prevents the snowballing hyperinflationary scenario described above.

There is another alternative to a deflation scare that will also allow massive quantitative easing, at least the first or second time around. That is a crashing stock market. Bonds typically rally sharply during stock crashes so the risk of a bond rout are slim.  It is a fine line indeed that the Federal Reserve must walk. Create too much money in the absence of a deflation scare or crashing stock market and risk hyperinflation. Do nothing and we actually have deflation as the bad debts are written off. This scenario is unacceptable to the Fed because all their banker friends who took unwise risks will be taken down as well.

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Written by opinionoregon

March 6, 2012 at 3:28 pm

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