I've been saying for some time that the primary force on the sagging economy is, and has been, deflation--the contraction of credit and money in circulation. It's effect is to force a general lowering of prices, and today we hear that prices fell 0.7% last month, the first time we have seen such numbers since Ike was in office. Deflation is a two edged sword. As one side slashes prices to try and stimulate new sales, it gives your dollar more buying power and benefits savers. Indirectly, it even acts as a wage increase. But the other side is that all dollars you owe in debt are equally heavy, and making a monthly payment on a debt therefore takes proportionally more and more of your spending power. Stated simply: in times of deflation cash is king, and debt is your worst enemy. And the reason why the beneficial effects of deflation will not help us now is that we are mired in debt.
There is simply too much debt in the system, at every level, from personal finances, to family budgets, to cities, states, and finally the government itself. We have all been living a lifestyle that relied on huge credit flows to sustain purchasing and, to my mind, credit is simply a debt that eventually has to be paid back if you ever use it.
If you look honestly at the economy now, you will see that very few sectors show any promise of growth, and most are relying on the government for whatever vitality they now have. The financial industry received massive government support in the last 6 months, and sales of homes, cars, or any other big ticket item rely increasingly on government guarantees or Fed programs to underwrite the loan. Cities and states are now begging for government bailout funds, and looking for ways to raise taxes. The bond market, a primary way in which Uncle Sam raises cash, is being propped up by a $300 billion bond purchase program by the Fed! The Chinese and Japanese are seeing the light and cutting back on the underwriting of U.S. debt, and this is a bad omen.
The question is this--how long can the government continue to guarantee an economy that continues to decline under the enormous pressure of deflation and debt? And how can a recovery begin until that debt is purged and assets begin to appreciate in value again? What we are seeing in that little price decline of 0.7% is an event that has not happened in several generations--deflation. It's here, it's real, and it can continue for years. Credit is gone, customers thin out, businesses lay off workers and cut prices all through the system to try and boost sales, but the debt eating away at consumer buying power prevents them from lining up at the blue light special, and so the cycle repeats.
Yet like any force in nature, there is an equal and opposite reaction out there that will eventually halt and reverse deflation, an even more fearsome force--rampant inflation. The Fed has, in fact, been trying to re-inflate the economy and restore credit flows for months, albeit unsuccessfully. It's efforts to restore credit have failed largely because the banks are cutting back lending in this environment, no matter how many bailout bucks they are given. They are carrying massive and growing debt and the bailout money simply vanishes into that black hole.
Total bank lending declined $50.3 billion in November of 2008, dropped another $18.2 billion in December, then plummeted $60 billion in January of 2009. After holding the line in February, it continued to fall, with banks lending $43.2 billion less in March, and another $40.6 billion less in April. So all the Fed effort to restimulate lending and credit has come to naught. The government commited $700 billion in TARP funds to the banks and another $182 billion was channeled to them through AIG, the Fed set up loan backstop guarantee programs totalling $6.2 trillion, The new stimulus bill promised $1.1 trillion, another $745 billion was commited in housing initiatives--the result? Since October of 2008, Banks have cut lending by $210 billion. Clearly you can drag a horse to water, but you can't make him drink. In this case the government can't make banks lend, nor can it force debt burdened consumers to borrow. So with the private sector in this debt/deflation standoff, the government is underwriting just about everything these days.
Where does the government get all these trillions when it is now running on a massive deficit itself? Uncle Sam cannot get the money he needs through taxes, and bond sales are no longer working their magic. What then? Bernanke's answer is the printing press--monetizing the enormous debt as needed to keep the system running by simply printing more dollars. The Fed balance sheet has balooned in recent months. His great gamble is that he can somehow then manage the orderly flow of all these new dollars into the economy. If he pulls it off he will be named "Man of the Century," but if he loses control we get the oncoming train of runaway inflation at the end of the deflation tunnel we are in now, and then even the spendthrift savers in the economy go down. We may have to live through both forces, deflation and then inflation, before things find a new balance--years from now, not a few months or fiscal quarters.
There is simply too much debt in the system, at every level, from personal finances, to family budgets, to cities, states, and finally the government itself. We have all been living a lifestyle that relied on huge credit flows to sustain purchasing and, to my mind, credit is simply a debt that eventually has to be paid back if you ever use it.
If you look honestly at the economy now, you will see that very few sectors show any promise of growth, and most are relying on the government for whatever vitality they now have. The financial industry received massive government support in the last 6 months, and sales of homes, cars, or any other big ticket item rely increasingly on government guarantees or Fed programs to underwrite the loan. Cities and states are now begging for government bailout funds, and looking for ways to raise taxes. The bond market, a primary way in which Uncle Sam raises cash, is being propped up by a $300 billion bond purchase program by the Fed! The Chinese and Japanese are seeing the light and cutting back on the underwriting of U.S. debt, and this is a bad omen.
The question is this--how long can the government continue to guarantee an economy that continues to decline under the enormous pressure of deflation and debt? And how can a recovery begin until that debt is purged and assets begin to appreciate in value again? What we are seeing in that little price decline of 0.7% is an event that has not happened in several generations--deflation. It's here, it's real, and it can continue for years. Credit is gone, customers thin out, businesses lay off workers and cut prices all through the system to try and boost sales, but the debt eating away at consumer buying power prevents them from lining up at the blue light special, and so the cycle repeats.
Yet like any force in nature, there is an equal and opposite reaction out there that will eventually halt and reverse deflation, an even more fearsome force--rampant inflation. The Fed has, in fact, been trying to re-inflate the economy and restore credit flows for months, albeit unsuccessfully. It's efforts to restore credit have failed largely because the banks are cutting back lending in this environment, no matter how many bailout bucks they are given. They are carrying massive and growing debt and the bailout money simply vanishes into that black hole.
Total bank lending declined $50.3 billion in November of 2008, dropped another $18.2 billion in December, then plummeted $60 billion in January of 2009. After holding the line in February, it continued to fall, with banks lending $43.2 billion less in March, and another $40.6 billion less in April. So all the Fed effort to restimulate lending and credit has come to naught. The government commited $700 billion in TARP funds to the banks and another $182 billion was channeled to them through AIG, the Fed set up loan backstop guarantee programs totalling $6.2 trillion, The new stimulus bill promised $1.1 trillion, another $745 billion was commited in housing initiatives--the result? Since October of 2008, Banks have cut lending by $210 billion. Clearly you can drag a horse to water, but you can't make him drink. In this case the government can't make banks lend, nor can it force debt burdened consumers to borrow. So with the private sector in this debt/deflation standoff, the government is underwriting just about everything these days.
Where does the government get all these trillions when it is now running on a massive deficit itself? Uncle Sam cannot get the money he needs through taxes, and bond sales are no longer working their magic. What then? Bernanke's answer is the printing press--monetizing the enormous debt as needed to keep the system running by simply printing more dollars. The Fed balance sheet has balooned in recent months. His great gamble is that he can somehow then manage the orderly flow of all these new dollars into the economy. If he pulls it off he will be named "Man of the Century," but if he loses control we get the oncoming train of runaway inflation at the end of the deflation tunnel we are in now, and then even the spendthrift savers in the economy go down. We may have to live through both forces, deflation and then inflation, before things find a new balance--years from now, not a few months or fiscal quarters.
