Will We See Inflation, Deflation, or Hyperinflation In The Future?

Some people have argued that the United States is going to face a long period of deflation, such as occurred in Japan in the 1990s. Others argue that we will see high rates of inflation like we did in the 1970s. Still others argue that we will see hyperinflation (i.e. an increase in the prices of goods of over 50% per month) such as what happened in the Weimer Republic in the 1930s. So who is right? I think the most likely scenario is that within the next few years we will see inflation rates in the high single digits to low double digits, about 6% to 14% per year.

The rate of inflation is determined largely by three things: the overall supply of money, the velocity of money (i.e. the rate at which the money circulates in the economy), and the supply of goods. All other things being equal, the greater the money supply the greater inflation; all other things being equal, the greater the velocity of money the greater inflation; all other things being equal, the fewer goods the greater inflation. For more information about this read here.

One reason I think we will see high inflation within the next 2-3 years is that the Federal Reserve has been greatly increasing the money supply. According to their latest report M1 money supply has increased 16.2% over the last 12 months and M2 money supply has increased 9.0% over the same period. Unfortunately the Federal Reserve no longer publishes the broadest measure of the money supply, M3. One can only estimate this number. The estimates I have seen have M3 increasing at about a 7% rate.

People who think we will see a debt-deflationary spiral argue essentially that the velocity of money will continue to slow down and that the money supply will contract due to a decrease in banks issuing credit and giving out loans. The velocity of money is really the X-factor that is hard to predict. People who see deflation in our future argue that people are saving more, banks are not lending, and the credit is contracting. This will continue in the future and will cause the velocity of money to slow further. Because of these factors, I think inflation will remain low over the next 3-6 months. However, I think we are already seeing signs of inflation picking up.

Both the CPI (consumer price index) and PPI (producer price index) have gone from negative to positive in recent months. See graph below:


The people who think hyperinflation is coming argue that the huge budget deficits that the federal government is running will force the Federal Reserve to monetize some of the debt because the government will eventually not be able to sell bonds at reasonable interest rates. This monetization will continue leading to inflation. This inflation will cause foreigners to sell their dollars eventually leading to a complete collapse of the US dollar. This is the doomsday scenario and something to keep in mind.

I think, however, there is only a low probably of this happening within the next few years because US debt levels have not yet reached critical levels. During WWII government debt was at 125% of GDP today it is at about 80% but is raising very quickly (see below). We could get to that point one day though.


Once again I think over the next 3-6 months we will see very low inflation. However, within the next 2-3 years I think we will see moderate to high inflation primarily because the Fed is greatly expanding the money supply and leaving interest rates at basically 0%. I am open to the data as it comes in and will change my position accordingly. That is why it is good to know the hyperinflationary and deflationary scenarios in case evidence comes in supporting those scenarios. If it does you can be ready and not surprised.