Proponents of the deflation viewpoint rely in part on the assumption that although central banks can create credit people may decide not to borrow. Certainly this is true, private borrowing appears to have been dropping. However this misses the point that even if the private sector is reluctant to borrow money at the current low nominal interest rates governments can do the borrowing directly. Its clear that this is what’s happening – governments are stepping in to replace private sector borrowing and consumption – effectively becoming the “borrower of last resort”.
The questions then become 1) where will the money to fund this borrowing come from and 2) will this borrowing be inflationary? The main sources of government funding are private investors and central banks. It seems likely that in the US only the Federal reserve will be willing and able to step in and absorb the amounts of debt issuance that the US fiscal deficit will require – direct debt monetization and if it were to happen highly inflationary.
Stephen Johnston, partner at Equicapita, commented that “Inflation was always a key driver of our investment premise when we launched our energy fund. Oil returns have a high positive correlation to inflation which simply means that oil is a good inflation hedge. Keynesian deficit and money printing economic policies are now being pursued globally. If history is a guide, printing modest amounts of money creates modest amounts of inflation and printing large amounts of money create large amounts of inflation. The economist, Ludwig Von Mises once quipped “Government is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.”