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10/17/2009 06:12 PM
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U.S. Economy Will Suffer Simultaneous Inflation and Deflation
by: Joseph Brom October 16, 2009
Joseph Brom

For the next several years, Americans' net worth will decrease and their food and energy costs will increase as the economy suffers the effects of both inflation and deflation. Keynesianism and Monetarism can not explain this paradox because the money supply canít simultaneously increase and decrease. However, John Exterís Inverted Pyramid resolves this economic contradiction.

In 1960, John Exter, then Citibank Vice President, developed what is known as the Inverted Pyramid. The Inverted Pyramid is an upside down pyramid made up of assets backed by debt. The foundation of the Inverted Pyramid is the ultimate form of money, gold, because it is an asset with no liability attached to it. The US Dollar or Federal Reserve Note, which is a debt-backed currency because it is a liability, sits above gold. Higher still is more debt, US Treasury bills, which back the US dollar. As you move up the pyramid, the debt-backed assets get more and more illiquid such as corporate bonds, stocks, real estate etc.

Since the US dollar is a debt-backed currency, increasing debt increases the money supply. Exter argues that as debt and leverage increase in an economy, the money supply inflates and creditors move up the pyramid into increasingly illiquid assets, which cause price increases in those debt-backed assets. The problem, he argues, is that when the economy is saturated with debt, the money supply can no longer be inflated. As the debt becomes difficult to service, bankruptcies and defaults increase, the money supply deflates, and creditors to move down the pyramid into more and more liquid assets; out of real estate and stocks and into US Treasuries, US dollars and ultimately into gold. This flight to quality is deflationary, which results in price decreases in the debt-backed assets. Thus Exter, like many today, predicts the inflationary policies of the past would result in a debt-deflation collapse. However, as Richard Cantillon, a 17th century French economist, showed, inflation does not affect all prices equally or simultaneously; the same holds true for deflation.

The case can be made that the debt-deflation will result in a hyper-inflationary collapse. Since there are two kinds of currency, the US dollar and gold, there are two different pricing systems; one in US dollars and another as a ratio of an ounce of gold. For example, a barrel of oil can be priced in US dollars or as a ratio of an ounce of gold. To calculate the gold/oil ratio, divide the gold price ($1050) by the oil price ($77) to get a gold/oil ratio of 1/14 an ounce.
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[link to seekingalpha.com]
edited to 50%

Last Edited by SPUD on 10/21/2011 11:45 AM