The link to the full story seems to have been missing. It’s over here:

http://mises.org/fullstory.aspx?control=1578

There is another viewpoint from which the likelihood of raging stagflation appears unlikely in the years ahead.

Frank Shostak has written about the likelihood that the real pool of funding–products and services devoted to production–is in the United States is stagnant, or in a downward spiral. If so, the Federal Reserve System’s attempts to promote rising prices in the years ahead won’t get much traction.

The real pool of funding is sustained and expanded through savings and productive investment. However, this pool of producer goods and services can go into decline if enough people stop saving, while wasteing scarce and precious capital through widespread malinvestment,and profligate, reckless consumption. Meanwhile, the more government pours scarce wealth down the black hole of government spending, regulatory enforcement, and central bank inflating, the worse the situation becomes.

When the pool of funding declines, activities that had been profitable become less so, or produce losses. The reason is that the new scarcity of producer goods and services manifests in altered price relationships, so that greater costs must be incurred in producing revenue units. As profits get hard to come by, and losses become more prevalent, the structure of production is shortened, thereby making debt more difficult to discharge. As this new reality sinks in, banks and borrowers become more cautious about creating new debt, and more reluctant to borrow to finance new projects. Wage rates sag, since wages are paid out of capital, which is actually growing scarcer, despite the “heroic” efforts of the Fed to create new money.

During the nineteen seventies, the Fed’s attempts to orchestrate inflation worked all too well, because the capital base in the US was probably expanding in spite of malinvestments, high rates of taxation that most people found ways around, and the growing burdens imposed by the regulatory state. Price inflation rates raged, because it was profitable for borrowers to acquire assets through debt. Wage rates soared along with inflation, because it was profitable for businesses to pay the rising wage scale.

However, it seems clear today that fundamentals have changed. The Fed is as enthusiastic as ever in its irrational pursuit of the impossible, namely alchemy; however, there is pretty compelling reason to conclude the real pool of funding in the USA is headed south. Since the last severe recession in 1982, corporate and personal borrowing rates have soared, saving has gone down nearly to zero, the scale and sheer madness of malinvestments–internet sand castles, retail space growing five times faster than the population–dwarfs anything I’ve read about in American history. Consumption is boiling. The housing boom is a good example of irrational, wasteful consumption, in which nearly anyone with a pulse can borrow money to build or buy another gleaming new or remodeled home. The scale and scope of leveraged speculation–housing is an example of this–is unprecedented, and has created an enormous universe of financial derivatives that defies anyone’s analysis or understanding. Meanwhile, the Federal government is doing it’s level best to destroy wealth through ramped up spending, regulation, and war-making. It doesn’t seem so far fetched that we may be in the process of eating our seed corn.

If so, then the Fed’s efforts to grow the supply of money over the next several years may fall short of what is needed to keep asset prices elevated. Slumping asset prices create failed loans, which compounds the reluctance of banks to extend new risky credits. Under such circumstances, the demand to hold precious money rises, and the process is reinforced.

What I’m trying to describe is a setting in which a deflationary meltdown may occurr–bigger than the Fed, bigger than the Federal government, and shocking, perhaps, to devout believers in the inevitablity of rapidly rising inflation in the years just ahead. If deflation takes hold, then at some subsequent point the Treasury may resort to printing currency to pay government salaries and suppliers, bringing us South American-syle hyper-inflation. However, central bankers do not have godlike powers over the creation of money, or the direction of larger financial events.

Mark,

Central bankers certainly do not have “godlike powers…over the direction of larger financial events.” But they do have tremendous control over the supply of money, and when the health of the banking system is in question, they will provide all the “liquidity” necessary in an attempt to prevent widespread damage to the system. Maintaining a solvent banking system and preventing widespread bank failures is, from the Fed’s own perspective, one of its most, if not most, important policy goals.

Jonathan,

The points I was attempting to make are that the Fed does have great ability to create fiat paper money, and preventing a widespread banking collapse is quite possibly its most important policy goal. The question of whether or not the Fed can prevent a future severe deflation (or a runaway inflation for that matter) leaves the realm of economic science and enters the area of forecasting, which, like all entrepreneurial activity, is really an art and not a science.