Wikinvest Wire

A deflationary spiral?? Not likely in the U.S.

Monday, January 12, 2009

An article by Rich Toscano and John Simon of Pacific Capital Associates makes a very good case for why an extended period of CPI-deflation is highly unlikely in the U.S.

The motivation of policymakers is summarized nicely in this paragraph:

There is a powerful combination at work. Mainstream economic pundits, academics, and policymakers are united in their opinion that deflation must be prevented. They are providing a theoretical justification for highly inflationary policy, and right or wrong, this justification is widely accepted as truth. Meanwhile, from a politician's standpoint, inflation is a far more viable and easy path than deflation. This combination of real-world incentive and theoretical justification induces our monetary and fiscal leaders to overwhelmingly favor an inflationary outcome.
And with a pure fiat money system, where the whole idea of printing up hundreds of billions (if not trillions) of new dollars is quickly becoming the consensus "lesser of two evils" in how to best avoid another Great Depression, it all really boils down to whether or not they'll be successful.

They will.

Who knows what the world will look like when they're done, but they will be successful.

The entire piece is well worth a look, particularly the discussion of nine counterpoints, one or more of which have "deflationists" so excited at the moment:
- Pushing on a String
- Japan
- Lost Financial Asset Wealth
- Credit Deflation
- Debt Defaults
- Recessions
- Foreigners Won't Let Us Inflate
- The Fed Doesn't Want Inflation or a Dollar Crisis
- The Fed Will Reverse Course
The conclusion is as follows:
We in the United States have been dumping our dollars into the world for years and we continue to do so. We owe a staggering amount of foreign debt denominated in dollars and we are gearing up to borrow even more. Our legislators and the stewards of our currency are rabidly hostile to deflation -- they are hostile, in other words, to the idea of the dollar gaining purchasing power. They have shown via word and deed that they will do whatever it takes to prevent deflation from taking hold. When deflation is viewed as even a remote possibility, there are effectively no limits to the amount of money the government can create nor to what they can do with that newly minted money.

Under these circumstances, we just don't believe that the dollar is going to gain purchasing power in any sustainable way. The current deflationary storm could continue for a while yet, but the longer it goes on, the more violent and severe its reversal is likely to be.

Deflation is a choice within the current monetary regime. It is a choice that our government has shown it will not make. There are serious long-term risks inherent in our dysfunctional monetary system, to be sure -- but deflation isn't one of them.
The next look at the Labor Department's Consumer Price Index is due on Friday and the year-over-year reading as of November - the commonly accepted, definitive measure of "inflation" in the U.S. - printed at a lowly 1.1 percent.

It is possible that, with energy prices that have continued to plunge through the mid-December reporting period combined with a few other falling prices elsewhere, we'll get our first negative inflation number since 1955.

Just wait to you hear how acceptable the idea of "printing money" becomes then.

The word "deflation" (and, by inference, the threat of another Great Depression) may become President-elect Obama's most powerful tool in convincing Congress and hundreds of millions of Americans that "debasing the currency" has become our national duty.


Nick said...

On the one hand, the recession is likely to be very real, lasting, and painful. On the other hand, it's quite possibly the greatest and best excuse for massive government spending, socialization, and wealth redistribution in our lifetime. There's no better time to push one's agenda, especially if it would be highly debated in normal times, than in times of "crisis", where you can claim that the country must take drastic measures to "help" the situation (eg: Bush's post-9/11 policies).

There's really nothing worse for the country than politicians run a muck, enacting grand sweeping new reforms and mandates under the guise of "emergency powers" and "temporary measures" in response to a "crisis". About the only thing you can be sure of is that the world will be a worse place if/when everything gets back to "normal".

Anthony Alfidi said...

With banks afraid to lend, the fiscal stimulus will have to be the mechanism for the transmission of new currency into the economy. Spending on infrastructure will launch the wage component of the wage-price spiral needed for inflation.

Anonymous said...

The most interesting point I've heard as to why the US will not end up like Japan is because Japan had a large savings rate. A large savings rate means the public will clamor against inflation to avoid injuring their savings. But a small savings rate here in the US means, for us to escape our huge indebtedness, that the political pressure will always be to inflate to avoid the pain of debt.

There just aren't enough savers in the U.S., so inflation, here we come.

Anonymous said...

It's quite sobering to read a demand for inflation written last time around.

Anonymous said...

The standard of living throughout the world is already declining. Not once in the entire history of man has any dictator, empire or country been able to prevent the standard of living from declining by simply printing money. It's been tried many times throughout history but never successfully.

The problem is not, I repeat, the problem is not that we need to prevent deflation. The problem is that we need to prevent the standard of living from declining so that we might escape the pain and want of depression and misery.

It doesn't matter what the value of the currency is. What matters is whether or not the people have the needed wealth to buy and consume what they need and want. If you think present healthcare, for example, is unaffordable now in the U. S., just start printing a whole lot of currency and see what is going to happen to healthcare cost.

Poverty can never be elimated simply by printing money.

People started years ago speculating in houses and stocks rather than safely saving their money in government-insured CD's. Why? Because they felt compelled to try and get another two or three percent return on what they would have otherwise gotten by saving their money. They took speculative risks in an effort to prevent their standard of living from declining and/or to hopefully accumulate enough in order to someday retire. Virtually everybody started playing this risky game until the game quit working.

The downturn which is happening right now started long before the first suprime mortgage went sour. It started when people began taking the speculative risks they felt were necessary in order to maintain their standard of living. And it proved to be a failed effort because, guess what, the standard of living for that big, big middle class is still declining. And printing money is not going to solve that problem.

The problem is how does the middle class afford the present healthcare system, how does it afford to send its kids to college, how does it afford ever to reitre, etc. etc. etc.

The problem is not deflation. The problem is middle-class affordability.


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