Given the choice between accepting the risk of future inflation and dealing with the immediate and destructive consequences of deflation now, our fiscal and monetary authorities will always choose inflation. At least if 800 years of history and the last four years are any guide.
If I had to boil the whole thing down to one trite statement suitable for an election campaign, it might be it’s the assets, stupid.
Here’s why.
The vast bulk of the assets in our financial system are actually forms of debt. One person’s debt is another person’s asset. I owe you and you hold the debt note. The banking system in particular holds most of the world’s debts as assets on its books. Your mortgage liability is their asset.
Similarly, money market funds that invest your cash in corporate and sovereign debt, insurance companies, endowments, and pension funds all do this, too.
Just considering the debt side of this story, what would happen if the world’s debts suddenly became worth less, or even 'worthless'? Every entity in the list above would suffer losses and possibly bankruptcy. Without asset inflation, it would all come crashing down:
- Municipal pensions would be ruined and unable to meet their obligations
- State pensions: ditto
- Corporate pensions: ditto, again
- Money market funds would 'break the buck'
- Endowments would get eviscerated
- Insurance companies would go bankrupt
- Annuities would fail
And those are just some of the immediate financial impacts of a deflationary spiral. The political and social impacts would be just as great, with careers ruined and unpredictable national directions taken.
So keeping the debt and equity markets well and truly propped up is right at the top of the list of ‘things to do’ for every central bank on the planet.
The problem with the story, as I am sure you are aware, is that the whole system of money and debt simply has to keep expanding exponentially for all of this to work out.
by cmartenson 
