Inflation, Deflation or New Nation? → Washingtons Blog
Inflation, Deflation or New Nation? - Washingtons Blog

Monday, October 27, 2008

Inflation, Deflation or New Nation?

Smart people like PhD economist Krassimir Petrov argue that we will have stagflation - inflation plus stagnant growth.

Other smart people like PhD economist Nouriel Roubini argue that we will have deflation (and see this).

But the debate about whether we will have inflation or deflation may be overshadowed by the question of whether the whole playing field is going to shift.

Specifically, inflation and deflation are both things which occur relative to a certain currency. For Americans, this means asking whether dollars will buy more or less.*

But the G-20 meeting in mid-November could totally change things. The biggest creditor nations might demand that a new world reserve currency replace the dollar (they've hinted at this). Or they could demand that the U.S. dollar go back to the pre-Nixon gold peg agreed to under Bretton Woods (they've hinted at this, too).

If a new nation takes over the role - which the U.S. has held for 64 years - as issuer of the world reserve currency, this will fundamentally change the landscape on which the inflation versus deflation debate occurs. The dollar would fundamentally be changed and - with it - the risks of inflation or deflation.

Confidently forecasting inflation or deflationary before the G-20 meeting is like trying to use the team roster to forecast who will win the second half of a football game when a major earthquake has just tilted and uplifted part of the gridiron and ripped deep canyons in another part.

* The Austrian school of economics points out that inflation and deflation are really about the size of the money supply, and not prices. If a new currency replaces the dollar as reserve currency, that would still shift the debate onto entirely new territory.

Of course, the U.S. is, or may soon become, insolvent. This would also dramatically shift the debate.

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