Please explain your three possible futures.
In a deflationary crash, a portion of the money within an economy disappears. This means that money becomes scarce. This means that what money there is becomes very valuable. Because the money looks valuable, everything else looks cheap. That is, prices tend to go down, and people that have savings tend to do well. Unfortunately, because “real” money is rare, it becomes hard for people to pay off debt. Another way to look at it is that debt is measured in money, and the money just became more valuable, but people commit to paying back a certain amount of money. The debt _should_ be cheaper, but it isn’t because the amount to pay is written in a contract and can’t be changed.
In an inflationary crash, more and more money is added to an economy, but the money loses its value because there is so much of it. If money becomes worth less, then prices go up to compensate. So, everything becomes very very expensive. In this scenario, those with savings end up owning worthless money. Those who are deeply in debt can pay of their debt easily, because the debt is measured in “old”, good money, and they are now paying with “new”, bad money.
In either of the two scenarios above, the economy will be in a very bad place. People will become unemployed, some people will lose a lot, and others will lose a little. Either way, the value of the taxes paid by the American people will go down. If the US Government tries to borrow too much money while this is happening, the foreigners buying treasuries may effectively shut down borrowing by asking for too high an interest payment. At that moment, the US Government wont have enough money for day to day expenses, and will either have to dramatically cut costs (ie. fire half the federal employees out there and pare back unnecessary spending), or refuse to pay the rent on its treasuries, thereby destroying the US Dollar as a currency.
So what will happen if the US Government does nothing?
We’ll have a deflationary crash. Everyone who was involved in making fairy money will be bankrupt, and their employees unemployed. Anyone who spent carelessly during the last five years and accumulated too much debt, will have to declare bankruptcy, which will bankrupt anyone who lent them money. Companies will be paying their employees salaries in very valuable money, so they will make unproductive employees redundant. Companies will temporarily be unable to borrow money, so companies that depend on debt to survive will be crushed. Essentially, only productive companies and people will do well. Unproductive companies will cease to exist, and unproductive employees will have to learn to be productive or change to jobs where they actually produce something of value. Many productive people will be caught in the crossfire and lose their jobs as their companies fold. Because banks are at the heart of this problem, many of them will go bankrupt, and their customers (productive and unproductive) will lose their money. This will be alleviated somewhat by FDIC insurance, but that will take time, and people with more than the FDIC limit in dead banks will be hurt badly.
Wow. That’s bad. Is there anything good about a deflationary crash?
Yes. Very much so. The crash will wipe out unproductive companies, causing dramatic unemployment. This is actually a good thing in the long term, as those employees have essentially been freed to be productive as part of successful companies. Businesses will be willing to do business again, because they know that anyone left standing after the initial crash probably doesn’t have any bad debt or fairy money. Individuals with too much debt will be able to declare bankruptcy and will not spend the next thirty years of their lives slaving to pay a mortgage they can barely afford. They will lose a house they never really owned, but gain freedom from crushing debt. The entire economy will become much more efficient as the unproductive elements are flushed out.
This means a deflationary crash will be extremely painful, but fairly short (a few years at best).
Okay. So what about an inflationary crash?
In an inflationary crash, the US Government comes up with some way to replace the counterfeit money with real money, by swapping real money for fairy money. That is, they’ll buy bad debt and give you good money for it.
At the very least, this just means that all the problems we have today, we will still have tomorrow. In reality, it will be worse, because there will be more “real” money out there, the value of the “real” money will have dropped. Before we had counterfeit money and good “real” money. Now, we’ll just have bad “real” money. The taint of the fairy money will have been mixed into “real” money.
Unproductive companies that counterfeited money will do fairly well, as they now have real money, even if its bad money. They will stagger along and try to find other ways to counterfeit money. Prices for goods will go up, but wages will not go up to compensate. Those who have debt will still find it difficult to pay off, because more of their money will go to buying other necessities. But, they won’t go bankrupt. Unproductive companies that are fairly unsound internally will continue to operate as they can still (barely) maintain interest payments on their debt. More people will be employed than in a deflationary crash, as half-alive companies stagger on.
Companies will still not want to lend to each other and will be very wary in doing business, because it will still not be clear who is productive, and who isn’t. Taxes will increase as the US Government covers the cost of the money they borrowed to replace the fairy money. Economic growth will stall as the economy continues in a kind of “living dead” state.
Because companies are still afraid to lend, and because prices are increasing, mortgage rates will increase dramatically, meaning that most people will not be able to buy a house. Those that have mortgages with an interest rate tied to economic figures will be forced to go bankrupt anyway. As they go bankrupt, the US Government will have to come up with more money to replace money that looked good, but actually turned out to be fairy gold. This will be an ongoing process and will last years. During those years, companies will be afraid to do business with other businesses because they know all the fairy gold has yet to be uncovered.
A slow inflationary crash will last decades. A quick inflationary crash will force the US Government to default on its debt, and kill the US Dollar, making dollars worthless.
Er. Is there anything good about an inflationary crash?
Well, the pain will be less extreme, as there will be less unemployment. However, the pain will last a decade or two longer. Fewer banks will close and bank accounts will look like they have money in them, even though the “real” value of that money will drop so that it buys less. Politicians will claim that they have made things better because there is less unemployment, and the ATMs didn’t stop working.
What about the US Government defaulting. What are the other factors influencing that?
It’s easy for the US Government not to default. It just has to not borrow money, and pay off existing interest. Unfortunately, in order to keep the lights on, the government borrows around 2 billion dollars a day by selling Treasuries.
Any attempt to convert fairy gold into real money will scare international investors to the point where it may become impossible for the government to sell treasuries. The government will be walking a tightrope. Perhaps they will get to the other side successfully.
Any attempt by the government to convert counterfeit money into real money (the technical term would be “monetize debt”), will also scare international investors.
So, any attempt to lend money to failing companies, or to insure their debt (In other words, “If your money turns out to be fairy money, we’ll swap it for good money”), moves the US closer to default, as it either inflates the currency, or it increases the taxes required from citizens, or both.
Another gambit the government may try is to start huge public work projects to employ people and get money to the people. This is better than converting counterfeit money, but still increase the chance of default if the government doesn’t cut other non-productive programs to compensate. This would still not improve confidence in living-dead companies, and lenders would still be wary. On the whole, it’s not obvious that this approach is worth the trouble.
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