I have repeatedly written about the risk of deflation, arguing that this is what we are headed for.
http://econmom.blogspot.com/2009/11/inflation-vs-deflation-not-so-simple.html
Now, voting members of the FED seem to agree, or at least are proclaiming it in public.
http://www.nytimes.com/2010/07/30/business/economy/30fed.html?src=busln
Subscribe to:
Post Comments (Atom)
Posts
6 comments:
For sure we have deflationary pressures. Levers are being pulled to counteract this by increasing money supply, more government spending, etc. Certainly this results in devaluing our currency and when our government borrows an extra trillion dollars, devaluation has got to be in someone's plan because its not like they plan on paying it back!
So the question is: who doesn't want currency devaluation and are they powerful enough or is their response undersirable enough to keep us from pulling the levers to control deflation?
Another question: what is the long term response of those levers getting pulled? Perhaps the deflationary pressures are short term and increasing the money supply has a short and long term effect on the economy. As long as levers can be pulled to counteract the long term inflationary pressures of increaing the money supply, we are OK. But can the money supply be contracted as easily as it is expanded and does the economy have a similar and proportionate response in either direction?
I don't think so. My gut says that the borrowing and printing will have long term inflation effect that cannot easily be compensated and that when things start turning and aggregate demand starts increasing, the economy will have a second order response with an overshoot in inflation. So starting our economy with a deflationary bias is part of the plan.
Hi John! I really appreciate the well reasoned comments and questions. Here are my thoughts:
1) China doesn't want devaluation, as it will decrease the value of their massive Treasury holdings and increase our competitiveness abroad. Can they stop it? No...they need us. Big time. We still hold the Ace. Consumer demand from the U.S. has been the primary driver of their boom.
2) Even though devaluation and ultimately inflation seem likely at first glance, the deflationary pressure driven by the bursting of the housing bubble and subsequent collapse in aggregate demand are much stronger forces. The hole is big, and it is going to take alot to fill it. Money supply can be pulled back quickly if there is a sharp uptick in aggregate demand, but there won't be. Time and debt reduction are the only cures.
3) Inflation could win out in one scenario - a U.S. default. In that case we could have a hyperinflation in the style of Weimar Germany. I think this is unlikely, as there is still plenty of wealth to tax in the U.S.
All in all, I still think we are headed into a long deflation.
So we are pulling the lever to counteract deflation by printing money, but the debt hole is so big that the economy is not responding because the money is going toward debt and not increasing demand (by being spent)?
And that hole is so big that printing enough money to see a response would collapse the dollar - or is it that we don't have a way to fairly and effectively distribute that much money?
Ok, this is becoming apparent. And you think for a long time (5-10years)? Wow! I have been expecting 5-10 years of no growth, but I haven't pictured long term deflation... what does that look like?
It looks like a cross between Japan in the 1990's and the U.S. in the 1930's, but worse. In Japan's case, aggregate demand simply did not respond to monetary easing because they kept saving even though interest rates were so low. In our case it won't respond because debt levels are so high and consumers will use the cheap money to pay down debt or simply build savings they lost during the last market decline. Also, "printing $" is not the same thing as easing monetary policy. For inflation in a 70's or 80's style* to take hold, we need too much $ chasing too few goods. Instead, we have too little money and WAY too many goods. There is a huge over supply of 'things' out there. For inflation to really take hold you need velocity (or the money to move through the system quickly) in this case it won't.
*Those recessions were driven by business cycles and inventory reductions, not massive deleveraging. They were very different in nature than this one.
This discussion inspired me to close my long positions yesterday. Thanks!
ok - but don't sue me if I am wrong!
Post a Comment