Game over. Inflation wins

I hope to examine this in more detail later. But I wanted to get on record as soon as possible that the events of the last 48 hours have taken a decisive turn in the battle between inflation and deflation.

Commentators backing one or other economic trend are not really making judgments about economics, but about politics (and psychology). Either effect is a likely outcome of a set of political decisions. The deflationists believe that forces will conspire to make it difficult for politicians to inflate the money supply, without which our economic difficulties naturally lead us to deflationary conditions (like Japan for the past two decades). Inflationists believe that, faced with the pain of deflation, politicians will find a way to inflate their problems away.

The two major indicators that the inflationists have it right, at least in the medium term (the short-term is always too subjective to predict with much confidence) are:

1. The massive loan-guarantee package agreed by Eurozone countries and the IMF yesterday, along with the announcement by the ECB that it would be doing things (e.g. buying high-risk government bonds) that the Euro's founders swore it would never do, and that arguably it is not allowed to do under existing treaties. Many of those supposedly providing the guarantees are the same members of the Euro-club that hope to benefit from the guarantees. You cannot make insolvent entities solvent by having other insolvent entities guarantee their bad debts. So this arrangement places such a burden on the few Eurozone countries that are not insolvent and are therefore able (but not well-advised) to provide the massive guarantees, that in practice they will have to be helped by the ECB to provide the cash/stimulus needed if their own economies are not to be dragged down by the burden of propping up their more profligate neigbours. The ECB's announcement shows that they are aware of that.

2. The terms of the Conservative/LibDem coalition that are just emerging tonight. Far more tax cuts and spending promises seem to have made it through the negotiating process and into the new government's programme, than spending cuts. For instance, we can add to the Tories' ring-fencing of health and international development, the LibDems' commitment to increase spending on education. The only cuts that seem to have made it through this year are the Tories' claimed £6bn of "efficiency savings". The LibDems, who will have the Scottish Office, have probably been given a lock on spending cuts on the over-subsidised Scots. The Tories have apparently agreed to gradually implement the LibDems' worthy but expensive and misguided proposal to raise the income-tax personal allowance to £10,000.

These developments are bad news respectively for the Euro and the Pound, but as exchange rates are relative not absolute, and the size of the American deficit is big enough to have already placed the Dollar in a similar bracket, the outcome will be less a collapse in the value of one currency against another, and more a devaluation of most developed-world currencies. Widespread debasement of currencies is a certain harbinger of inflation sooner or later (probably sooner in the current circumstances of reflating demand for scarce resources). The politicians and civil servants have not surprisingly chosen the path of least resistance, which is to try to inflate their debts away and to fund large continued deficits with monetary expansion.