Deflation Threat - A Simple Concept

Government spending and money printing has been identified as key causes for an alleged inflationary environment. As the government prints more dollars, the dollar loses its value, or so it is commonly believed.

To illustrate: The government is using a fire hose to fill up a barrel. Under normal conditions, it's just a matter of time until the barrel overflows (causing inflation). The twist today is that the barrel has a hole; in fact it might not even have a bottom. Regardless of how powerful the hose, the barrel isn't getting full. There is no inflation today.

What is the Hole?

Since the April 26 top, the U.S. markets have lost about $5 trillion of market capitalization. That's $5 trillion of wealth evaporated in 20 trading days.

On the other side of the ledger, the U.S. government has spent between $1 - 2 trillion on various bailouts.. Europe just unleashed a $1 trillion plan. Nevertheless, the stock market has erased more wealth in 20 trading days than the U.S. and Europe spent combined in over two years.

The 2008 global equity, real estate and commodity meltdown erased an estimated $50 trillion worth of wealth. Most of this wealth (and credit) is denominated in U.S. dollars.

As wealth and credit implode, there are fewer dollars in circulation. The law of supply and demand simply states that shrinking dollar supply results in higher prices for the remaining supply. Is the dollar supply shrinking? Is the demand for dollars increasing?

Yes, it is. The destruction of dollar denominated money supply is evidenced by the money supply (M2) contracting on a year-over-year basis for the first time in 15 years. Bloomberg reported that the rate of inflation has fallen to a 40-year low.

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• In disagreement. -天下无马- ♂ (62 bytes) () 06/04/2010 postreply 07:45:39