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Wednesday, September 17, 2008

out of the frying pan, into the fire?

There are two possible extreme outcomes for this current financial crisis:

(1) deflation - assets (real-estate, stocks) fall in value, leading to a collapse in credit and confidence. Prices fall but no one can buy anything. This is what happened in the Great Depression.

(2) (hyper)-inflation - to keep the system afloat, the government takes over institutions (and their debts), and issues more credit. People keep their money but prices skyrocket. In the extreme, printing more and more money leads to hyper-inflation, like in Argentina, Weimar Germany, etc ...

The threat of (1) has apparently been serious enough that the government has essentially just nationalized large parts of the mortgage and insurance industries (with the Fannie Mae and AIG bailouts). These actions, however, increase the risk of scenario (2)...

1 comment:

Yeh Lao said...

Paul Krugman's op-ed on 9/7 NYT was talking exactly this so called "debt deflation" phenomenon.

Btw, John, glad to see you blogging again. Cheers.