I’ve been thinking about what the recent bail out of various financial and quasi-financial institutions could mean for hyper inflation as well.
The simplest I can make it to myself is the following:
In bailing out these institutions the fed/government is essentially monetizing that debt… they’re wiping the slate clean where losses would otherwise have been made and passed on to creditors. In doing this, they’re not pushing more money into the economy (immediately). All they’re doing is conserving the current level of reserves upon which other loans are made (and upon whose foundation a good deal of the existing money floating around in the economy depends).
As such, the bailing out of Freddie and Fanny does not immediately push more money into the economy and what would be required for the Fed to ensure continued inflation is continued monetary expansion… which requires the creation of new debt.
Certainly writing off existing debt makes the task of creating new debt much easier, since banks won’t be collapsing or trying to claw their way back to positive reserve positions (which would typically be done by calling in loans or at the very least not making any more). However the creation of new debt and thus continued monetary expansion and inflation requires the banks find new people to extend credit to for new projects.
The banks (who extend that credit, and that’s how they make money) see Freddie and Fanny, Bear Stearns and Northern rock being bailed out and see that it’s impossible to make losses… you can only make profits. So they should start to extend credit, preferably lots of it as highly leveraged as possible so that if the credit defaults they’ll be bailed out by the lender of last resort. In order to do that though, they need another bubble. The first one was the dot.com boom. The losses from that were covered by profits made in a housing bubble… which has clearly collapsed so it’s going to be tricky to extend vast swathes of credit in that market. So the banks are going to need some other form of asset to lend people money to borrow, based on nothing more than the fictional valuation of that asset and some ponzi styled price increase.
Where’s the next bubble then?
Clearly commodities are out - the government doesn’t want a commodities bubble.
Stocks? The government would like another stock bubble - but are the stock markets going to make huge profits? They can’t make them from financials any more (financials are relying on stocks to make profits remember - that would be two people standing on one another’s shoulders). So a bubble in stocks would have either from soaring PE ratios or from increased sales, which would require an increase in individual expenditure. That would require either individual incomes to increase or for the banks to extend more credit to individuals. So perhaps one source of the next bubble might be a personal debt bubble (as if the housing bubble wasn’t) but banks don’t typically lend to individuals without capital. In the case of housing, the capital comes in the form of what they’re purchasing - something that can’t be said of most other personal expenditure (cars, yatchs etc. don’t generally hold or increase their value). As such, it seems a fresh stock bubble could only come on the back of increased salaries. I’m not sure how that would occur since the only control that the Federal Government has over salaries and wages is in the form of taxes (they could drop taxes - that would be positive) or the salaries that they pay federal employees. I hardly think a federal employee salary bubble is likely though. In any event, even if they were able to get real incomes up by dropping taxes, we’d almost certainly see the wage price spirals of the 70s again.
They could perhaps create more derrivatives. For example, they could package up bonds in companies like GM and Delta Airlines into complex financial instruments which they vastly overestimate the value of or vastly underestimate the risk off, then sell off to massively leveraged buyers - creating huge counterparty risks that make GM effectively too big to fail. That’s basically the same trick they pulled in the housing market though and I’m not sure the Norwegian primary schools are going to fall for it again so quickly.
Seemingly the only way that the central authorities have of pumping more money into the market is increased government expenditure (or stable government expenditure with decreased taxes)… since the extension of credit to the government has never presented a problem. If government expenditure does not increase, then perhaps deflation is to follow… If government expenditure increases and/or taxes decrease, perhaps we’ll see continued inflation - but they would have to keep cutting taxes and keep increasing their expenditure to maintain those levels of inflation.
All of what I’ve said up until this point, of course, only focuses on one side of the equation - which is the money side of the equation. If the production of goods and services should fall drastically then you would have a situation where the same amount of dollars was chasing fewer goods and services - which could also trigger inflation. And that IMHO is a much more likely catalyst for inflation than monetary expansion… especially with the Fed going around centralizing control of the productive apparatus in the economy.
To be honest, I don’t think there’s any crystal ball here though. What happens will depend on lots of factors - foreign willingness to continue to by bonds, public policy etc. and all you can do is either hedge your bets or double up one way or the other. It’s a 50/50 gamble, so flip a coin!