Watch Bond Market, Not Bank Lending or Velocity

A few weeks ago we wrote about the true cause of hyperinflation, which is a major break or failure in the bond market. It has nothing to do with demand, bank lending or the velocity of money as many have suggested. It is a confidence issue. It is not a rise in inflationary expectations but a loss of confidence in a country being able to repay its debts. As confidence is lost, interest rates rise. Monetization occurs when the cost of servicing the debt consumes too much of the overall budget, so that the government can’t provide basic services or loses its ability to function on a day-to-day basis.

The important point to note is that deflationary forces lead to hyperinflation. Once again, it is not demand, bank lending or increased velocity. Those things do not trigger severe inflation; they merely can be a symptom after the trigger. And by the way, increased velocity is basically another form of increased demand. Fundamentally, they are no different.

Is anyone paying attention to the first domino in the sovereign debt crisis? Take a look at this Bloomberg story - Iceland’s Economy Shrinks 8% as Prices rise by 11%.

Deflationary forces are causing severe inflation, as Iceland’s government is bankrupt. Moreover, bank lending in both the US and the UK has been sliding, yet we see price inflation increasing in the UK and starting to pickup in the US. Even amidst deflation in the private sector, Gold has risen to an all time high against both the Dollar and the Pound and also the Euro.

Read the rest here.