Mish & Bob Murphy, On Deflation, Money Supply & Credit
I basically agree with Murphy's main point, namely that what matters for price inflation is not the quantity of credit, but the quantity of money.
The reason why a higher money supply raises prices is because money represents a claim to real goods and services, and more claims to goods and services will given a certain amount of actual goods and services reduce the purchasing power of money. By contrast, a pure credit transaction which does not increase money supply will not raise prices, as the increased ability of the borrower to buy goods and services is cancelled out by the reduced ability of the lender to buy goods and services.
It was for this reason that Mish missed out on the big commodity price rally earlier this year, when money supply was booming while bank credit was stagnating (and even contracting somewhat).
Also, Mish is wrong to assert that central banks can't create inflation using sufficiently radical measures (Think about what legalizing counterfeiting would do, or if that is too anarchistic to you, how about the Fed sending a million dollar in cash to every American).
However, the recent deceleration of money supply growth suggests that in the short term, we may (It is not certain-but not implausible either) see another period of deflation.
In the current monetary system, where most money exists as deposits within a fractional reserve based system, money supply simply cannot (except for one scenario analyzed below) in the long run expand much faster than credit. Money supply growth can outpace credit growth for some time as long as banks substitute longer term financing for financing through money like deposits, but sooner or later (theoretically the end would be when 100% of financing comes through money like deposits, but in practice the process will end sooner)this substitution will not be able to go on.
So, while credit is not directly relevant as Mish claims, it is indirectly relevant, and for this reason it should be watched. And because of its role as a leading indicator of money supply, the recent contraction in bank credit certainly increases the odds that the recent money supply stagnation might continue for a while and even turn into outright contraction, which in turn means that the probability of renewed price deflation has increased.
As mentioned before, money supply can grow without any credit growth even in the long run if the Fed would implement some scheme (like my above suggested legalizing counterfeiting or sending a million dollar in cash to every American) to radically boost currency in circulation. However, such radical schemes are likely off the table, at least for the rest of the year, meaning that they do not pose a risk for the deflationist scenario during the rest of the year.