Big Question #1: Deflation or Hyperinflation?

Deflation versus hyperinflation is probably the most important question for those who expect an upcoming bust, be it quick or gradual. Clearly, in the case of hyperinflation, we will not have a crash but rather a bust, since the nominal value of stocks would skyrocket while at the same time the economy tanking -- which means you better own gold. Deflation requires the opposite strategy, which is the hording of cash coupled with shorting the stock market.

What causes hyperinflation?
Hyperinflation is a process that can only occur with fiat money (including debt-backed). When I say "hyperinflation", I am not talking about rapid inflation such as 5% per month. In my opinion, that is still normal inflation because hyperinflation is a completely different dynamic from inflation.

Rapid inflation is simply a rapid increase in the supply of money -- with fiat money, the government prints more very quickly, and with debt-money, they monetize the debt while banks issue loans, etc. Hyperinflation, however, is exactly the same dynamic as a "run on the bank": trust is lost in the issuer. Hyperinflation can be triggered by rapid inflation or a destruction of the GDP of the issuing nation -- either of these equates to a "tax on cash" that can become so great that nobody wants the money any more, and there's a panic to sell your cash for commodities or foreign currencies. This process occurs exponentially fast, and occurs precisely because there's no commodity backing for the currency -- there's no real value to the currency.

To summarize, hyperinflation is a panic out of a troubled currency. This is very different from normal inflation.

What causes deflation?
Deflation (in the rapid sense, i.e. supply related) only occurs with debt-money, and not with traditional fiat-money. It is a common misconception that the U.S. has traditional fiat money -- it does not. People who claim that the U.S. government is just "printing money" are pretty close to the truth, but not 100%.

The government doesn't print money directly, but rather borrows money at interest from a central bank that prints the money. Private banks can also borrow in this manner. This borrowing/printing causes inflation. However, when the debt is paid back to the central bank, it ceases to exist as money, which reduces money supply causing deflation.

The inflationary process is exponential because bank's use their borrowed debt-money as reserve for the money they lend out. This means that a bank that borrows from the central bank and then issues a loan to a citizen is only the beginning of the inflationary cycle. This same debt-money can be re-deposited and re-loaned over and over. There are certain reserve requirements, but in the end the total amount of money that the banking system can create is limited only by the amount that the public can borrow.

Notice that I say "money created", but really I mean "I.O.U dollars" created -- that is, debt rather than deb-money is created. During an inflationary period, in the world of commerce, these I.O.U. dollars are generally treated the same as dollars themselves.

Right now estimates are 50:1 -- 1 unit of debt-money (federal reserve note) for every $50 worth of I.O.U's for debt-money. That's a lot of inflation! However, the deflationary spiral can quickly unravel this process through a cycle of debt liquidation:

1. Defaults on loans cause a reduction in money supply (debt used "as" money is eliminated), and therefore deflation
2. Decreasing optimism due to defaults causes less money to be loaned out, slowing or stopping inflation
3. Trust is lost in ability of debtors to pay, interest rates skyrocket and value of existing debt (in dollar terms) decreases, causing deflation
4. Decreasing purchasing (due to decrease in credit) decreases money velocity, causing deflation
5. People who are still able pay back their loans do so because of interest rate increases, and their debt cease to exist as money (deflation)
6. Deflation causes money value to rise, making it harder to pay back loans
7. Goto 1

Will inflation continue?
It should be clear that inflation (under central banking) requires people to take on more and more debt. Now, however, it is obvious that credit is tightening, and that there's no-one left to borrow to continue inflation: the worst borrowers (sub-prime) have already been lent to (and many have already defaulted), and everyone in the U.S. is piled with debt to the ceiling.

Deflation Short Term, Hyperinflation Long Term
Every paper currency in history eventually hyperinflates, so we already know what to expect long-long term. However, for the short term, the 50:1 ratio of debt to debt-money means that a deflationary cycle could increase the value of dollars by many, many times. This is a problem for the government since governments benefit from and, indeed, almost require inflation, because it reduces the real value of their outstanding debt (also, they make billions in revenue from the inflation tax).

But isn't the Dollar Over-Valued?
It has been mentioned that the dollar is overvalued, which is probably true. However, even if foreigners reduce their demand for dollars by half or more, the deflationary spiral would probably increase the value of dollars much faster than any changes in demand could affect it. In fact, if deflation starts, people will be scambling for dollars to repay loans, so it's likely that the demand for dollars will actually increase.