New Inflation Will Be Followed by New Deflation

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First, there was the New Woman. Then, there was the New Economy. Now there is the New Inflation.

Asset inflation is as different from the regular kind as an illicit affair is from an ordinary one. It is much more agreeable when it comes in… and much more painful when it goes away.

And it is not all created by central banks or Treasury Departments.

By now, we understand central bank inflation only too well. It worms its way down to the consumer economy through the banking system. Eventually, but not immediately, prices rise. And when prices rise too steeply, voters begin to howl… businesses get jumpy… investors start to flinch… and the whole economy goes sour like old milk.

But this ‘New Inflation‘ is different. It is the ‘Wave of Liquidity‘ that is floating up prices of capital assets… and rich peoples’ toys… all over the planet. Yes, the rich have done very well out of all this new liquid. It has boosted up their wealth. Their stocks, their bonds, their property… even the works of art that adorn their walls have floated up.

Where does all this money come from? Ah… that’s what is new about it. And it is why the financial industry is making so much money.


It works like this. You have a house worth $100,000. You take out a mortgage for $50,000. Then the mortgage is mixed together with other mortgages, stirred, shaken and sold to a financial house, X. There, it is used as collateral for a loan of $500,000…which is invested in a leveraged buy-out of a Company Y…which then issues bonds worth $5 million, which are taken up by hedge fund Z, that borrowed the money to buy them from the Japanese at a low interest rate, exchanged it for dollars, and now invests in these junk bonds at twice the yield.

At every step, the financial intermediaries make their commissions, their spreads, and their fees. At every step, the amount of notional ‘money’ in the world multiplies. Your income has not changed… your house is still the same… business Y makes no more profits. The real economy remains just as it was. This feverish financial activity… this ‘financialization of the economy’ adds nothing… not one jot or tittle… to the real wealth that is in the world. There are no more factories… no more diamonds… no more steak sandwiches. All this money-shuffling produces nothing but more profits for the money-shufflers and more wealth for the rich people around the table.

As long as the credit bubble expands… it also expands the values of the assets held by the rich. Their stocks, bonds… junk bonds… and all other assets, go up in price. Which means, that they are the beneficiaries of the New Inflation. When their junk bonds or houses or stocks go up in value… they have more purchasing power. They can trade financial assets for other assets. They can use them to buy a time-share in a corporate jet… or a vacation house at St. Barts. Or, they can simply buy more ‘stuff.’

We can be sure that they are not going to drive up the price of toilet paper or margarine, however. Consumer prices are, broadly speaking, unaffected. The rich don’t use more toilet paper just because they have more money. Nor do they eat more hamburgers. But insofar as they have more purchasing power, thanks to this New Inflation, they grow richer, compared to the rest of the world.

This might not make much difference, eventually, of course. Every dollar created out of thin air eventually goes back from whence it came. All this pseudo-wealth – created by the New Inflation – will eventually disappear. Credit booms are typically followed by credit busts. Junk bonds typically have their moments of glory, followed by their hours of desperation and defeat. Things that go up so spectacularly can be expected to go down in a sensational way too.

But here is where the real problem arises. While financial assets rose in price, so did the debt burden on the proletariat. The New Inflation meant new wealth to the rich; to the lumpen… the booboisie… it meant debt-financing. What the middle and lower classes got out of it was an opportunity to ruin themselves; which they took up readily.

New Inflation is sure to be followed by New Deflation. We wonder what that will feel like.

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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1 Comment on "New Inflation Will Be Followed by New Deflation"

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Dave G
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I enjoy your website. Anyone who does not see what is going on with the Fed printing press need only recall WWII war bonds to understand that something is not right here. War bonds were bought by the public to finance the war. Yes, it was actually paid for with real money. Today there are no war bonds. Why is that? Where is the war money coming from? Think about it. The amount of printing press money needed to finance the war and its inflationary effect is pretty scary. Add to that the consumer and financial credit bomb and it… Read more »
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