What we can see is cyclical inflation – with import prices due to a falling dollar and money printing being transmission mechanisms. An inflationary environment will invite a response by the Fed – making the deflationary trend more powerful in my view. We are not off to Zimbabwe.

See my piece on Scylla and Charybdis for more on this:

http://www.creditwritedowns.com/2009/06/central-banks-will-face-a-scylla-and-charybdis-flation-challenge-for-years.html

Edward, You are arguing form over substance…..technically the US cannot go bust, although (at least theoretically), if we have a major dollar crisis with a big backup in rates (medium to long part of the yield curve), and therefore a deflationary spiral (this is not my view), the US government would go “bust”. In other words, the mkt will force the us to stop providing massive QE (printing money), by killing the dollar and preventing the government to honou its obligation?.

First, if people continue to buy / fund US debt by purchase of treasuries then there is a good chance that this extra money will not reach the consumers (no employment growth). This will flow to banks and money channels. This will lead to high US asset prices (not sure if they can go higher) through higher valuations.

The cost of government debt will manifest through higher cost of public goods. But I am not sure if this administration will let cost go up. It means more borrowing. => more headache

After inflating US asset prices to certain extent further funds may flow out of US into other markets. Globally, we could see more bubbles initiated in first half of next year. Part of this money will also go in financing other sovereign government bonds. It means US government borrowing may end up financing global debt.

But if commodities and particularly oil hits the consumption basket with higher prices then we have inflation. This will reduce sales of discretionary => further pain.

If world currencies hold up their relationship with dollar then it is possible price rise may be contained through global demand constriction. At this point some countries may loosen the peg. I think this will trigger a currency pressure through naked positions or high stake currency bets.

Net-net
I think we might see cycles of inflation and deflation compressed in short periods of times. Consumer prices may not be as impacted as it takes time to transmit through the system.

then again it seems all weird and confusing.

You might want to rethink this. Yugoslavia had industrial capacity and employment levels are at depression levels but still managed to have an inflation rate of four quintillion percent. I know because the C$200 or so that I sent to my uncle out of my summer job were enough to have him pay off the loan he took to add a second story on his home. Had he waited a few days he would have had most of that C$200 in his pocket and still been able to pay off the loan.

And if you research Weimar Germany, Zimbabwe or the South American experience you would find that inflation tends to go hand in hand with economic weakness because that is when governments become desperate and intervene in the economy by printing money and monetizing debts.

The inflation in the system will manifest itself first in asset prices – with industrial and food commodities or oil being the transmission mechanism into consumer prices. Secular consumer price inflation will not return until the slack in the system is purged.

Try looking at your healthcare, education, food, energy or insurance costs and you find inflation. Look at the cost to mail a letter or buy a cup of coffee at Tim Horton’s. Look at detergent, tooth paste, toilet paper, shampoo, soap, dental floss, razors, etc. You find that items of the same quality cost more, not less and that the price reductions come from the substitution of inferior products and packaging changes that disguise per unit costs.

Ah, the good ol’ playbook!

But as von Mises pointed out, a deflationary spiral caused by collapsing credit (i.e. debt) as we are in now sops up and dwarfs any attempts at money printing. If one looks at the bank reserves they are at astronomical levels en masse and little of the governmental attempts to inflate are having any affect.

A weaker dollar is also in the U.S. interest as it reduces real (vs. nominal) foreign debt and reduces trade imbalances favoring exports over imports. The U.S. may pay lip service to a stronger dollar in order to keep foreign creditors calmer, but I believe it is in fact pushing a weak dollar policy as a partial solution to jump starting economic growth.

Faber may be right about inflation down the road if the economy begins to expand again. Right now he is way, way ahead of himself IMO.