An excellent question. though most would say ‘who cares’?  Let us examine the end result of each scenario:

INFLATION       The value of your money progressively decreases as central banks print enough money to prevent deflation (a contraction in the money and credit supply).  Anyone who has a debt will have no problems paying off the nominal value of the debt, as the nominal value of your wage increases over the nominal value of your debt.  Example: this year the price of bread is $1… next year the price of bread is $3.  I have covered this phenomena in some detail in previous posts, I encourage you to ask me questions if you still want some help understanding the concept of inflation.

DEFLATION      The value of your money progressively increases as central banks are unable to print enough money to prevent the contraction in the money and credit supply.  If you have a debt, it is almost impossible to pay off the debt as it’s real value increases (nominal value is unchanged) while the nominal value of your wage decreases.  Example: the price of bread decreases from $1 to 50 cents in one year.  The collapse of lending, increased number of loan defaults, all contribute to a contraction of the supply of money, which makes the individual value of money greater (think the polar opposite of inflation).

In short… INFLATION = good for people with debts.  DEFLATION = bad for people with debts.

Now “deflationists” will not contend with the assumption that INFLATION can occur, even hyperinflation like Zimbabwe, but they see it as highly unlikely as the level of money printing would be astronomically high.  Furthermore, any attempts to neutralize the effects of deflation with money print would hopelessly collapse as seen with the central bank of Japan in the Asian Financial Crisis.  Also, any money that is printed goes directly to creditors and doesn’t touch the local economy to raise the price of everything.  Post-Keynesian economists like Steven Keen, a man whom I deeply respect, also contend that there is evidence to suggests that the money print by the central bank precedes the increase in the money supply (M2 to be exact)…. which means that the central banks are printing money in response to bank insolvency.  Thus, the increase of $1-2 trillion in the Federal Reserve’s balance sheet was in response to the ‘bank runs’ which took place at the end of last year, rather than an effort to create new money to pump into the local economy.

Inflationists on the other hand say that the government is perfectly willing to go as far as to print our way to hyperinflation.  More importantly, that the government is currently pursuing a course that will inevitable lead to hyperinflation.  They contend that the government has a course of trading private debt with public debt, these are also known as bailouts and they continue to this day as the government is pursuing a relentless nationalization agenda.  This isn’t perceived to be so much of a problem as the price of the debt (i.e. the interest rate) is quite low, thanks to the majority of the debt financed by short terms T-bills (1-3 years bonds).  When these bonds are required to be paid off, the government rolls the debt over into new bonds… or simply put, it borrows money to pay off borrowed money.  This is somewhat manageable when the economy is in a boom phase, where there is predictable growth that can theoretically outpace the increase in debt.  The failure of neoclassical economics for both monetarists and Keynesians was that their models assumed the the economy would be in perpetual growth, which was found to be the case as gravity exists in the economics in the form of finite resources.  As the government increasingly swaps more private debt with public debt and simply rolls over the debt repayments, exponential functions take over and the debt servicing on the debt starts to become impossible.

Pretty soon, people who buy the debt (like China and Japan) start to realize that the US is not going to pay back that money with any real value and stop purchasing this debt (they already have btw).  This forces the US to start doing something called ‘quantitative easing’, which means that the central bank prints money and buys it’s own bonds.  As the money print continues, the government starts to pay creditors the freshly printed money.  These creditors want to dispose of this currency either through exchange into their own currency (as most of the creditors are foreigners) or they will spend it on raw materials or even US financial assets.  As more US money abounds, the value of this money begins to decrease, even outside the local US economy.  As the value of the dollar decreases, the US central bank will be in a trap: the only way to defend the value of the dollar is to raise interest rates, but this will increase the amount of debt the government as to go into to service the existing debt.  And, if the interest rates rise, all of a sudden the credit based economy grinds to a halt as no one can pay back their debts.  If the central bank chooses to ignore that the value of the money is decreasing and the prices of everything are increasing, entering into hyperinflation will occur more rapidly than anyone predicts as they will eventual ‘turn the corner’ on the exponential curve of the depreciation of the US dollar.

The Japanese example isn’t applicable, the inflationists say, as the nature and origin of Japan’s productive capacity and creditors are completely different to the US.  Also there is the tiny little fact that Japan is the largest creditor nation in the world, while the US is the largest debtor nation.  This is a striking point between the two schools… the PKs say that the scale of the debt black hole is too enormous for pure money printing to overcome.  The Austrians are saying that the money printing is being used to swap the private debt with the public debt, and if this process continues then the value of the currency will collapse.

So… which one is right?  The answer is, no one really knows.  Some people will say ‘I’m 100% sure this way or that way’, but in reality, we’re all just economic geeks watching the carnage unfold.  This is exciting to watch, but painful in reality to the people at the bottom of this gigantic pyramid scheme that we call money and banking.

Personally I’m not interested in the little esoteric arguments between the economic schools… and there are many.  I think there’s value in the analysis of the financial system from both schools and both possible scenarios make sense and are plausible.  We’ll just have to see what happens.  In any case, my advice is to horde faith in God and put your money in assets that will protect you from either scenario, which are precious metals (i.e. gold, silver, platinum).

God bless,

Dr Washo

PS   And if you’re a US citizen, support bills like H.R. 1207 ‘The Federal Reserve Transparency Act’ aka ‘Audit the Fed’

Finally, Kevin Rudd has indicated that the First Home Buyers grant is coming to an end,

"It's had a real effect, we're still measuring its full effect, but I think it's very important that as a community we understand that deadlines are imposed for a particular purpose," he said.

"It's had strong useful results so far, but I've got to say, that all good things must come to an end." -- Source

The property industry is already complaining, with Stockland's managing director Matthew Quinn coming out and saying "...we think that the market, the first homebuyer market, does have another six months to go before all of that underlying demand is soaked up and it will result in a rush of buyers towards the end of June" [ibid].

I'm not sure exactly what he means by "underlying demand" but I can only assume he means that an artificial lowering of the price (through low interest rates, first home buyers grants) will increase demand. Well obviously; the lower the price of any product, ceteris paribus, the greater the quantities that buyers will be willing to purchase. Add to that the constant trickery that interest groups have using on home buyers, such as: "you've just been wasting money on rent for the last 5 years, wouldn't it be nice to own your own place instead"; "it's just another, safer, form of investment!; and "interest rates are so low, plus this homebuyers grant will only be around for a while, if we keep enjoying life and decide to buy in five years, who knows how high they're going to be!" and you get more people buying homes -- younger and younger -- at the top of the credit bubble.

The government has misled, even if only indirectly, millions of people into levels of debt that they can't possibly service and even if they can, a lifetime of debt repayments. A house is not an investment. It's a consumer good that you have to upkeep. It's also a liability that you have to deal with if you lose your job. Fair enough, there may be non-economic reasons for home ownership, but if you're doing it because "house prices always go up", then it's time to consider renting instead. The government never offers you money to do intelligent things with it. As Ronald Reagan once said, the nine words you should be most afraid of in this world are "I'm from the government and I'm here to help".

Good riddance to the first home buyers grant; it was nothing more than a subsidy to the housing industry (and those related to it, building etc) at the expense of the taxpayer. It never helped the economy, it merely diverted resources from more productive means. In fact, as I mentioned earlier, I would go the other way and say it has (together with artificially low rates set by the RBA) probably resulted in many, many young Australians having a debt burden that's going to weigh them down for years to come, destroying families and lives in its wake.