Understanding the Threat of Deflation – No

Wait a minute! We are in the midst of a deflationary threat, a downward spiral like that of the 1930’s and the one which hit Japan
in the 90’s. The velocity of money is shrinking toward zero, because banks are unwilling to lend and people are unwilling to spend, all due to fear and uncertainty. Even when given billions of dollars, banks have chosen to hold most of it in reserve against an unknown future where things could get even worse. Money is not circulating. The victim barely has a pulse and some people are afraid he’s going to jump up and hurt himself.

Look, we need to revive the moribund economy, get it breathing and functioning again. The worst thing we could do is what Hoover
and his Treasury Secretary Andrew Mellon did back in the 30’s, which was to tighten credit and balance the budget, resulting in higher interest rates, deflation, and the Great Depression. Right now we are on track to equal or exceed the human misery of the thirty’s. Despite all the romantic stories, it was an ugly and desperate time. We must do everything we can to avoid the mistakes that exacerbated that suffering.

Already we are seeing unemployment. approaching 10 percent, and showing no signs of stopping. Everytime a company reports a loss, they placate the hounds of Wall Street by laying off thousands of workers. Those workers have to cut spending, leading to more losses and more layoffs. This downward spiral can only be interrupted by financial intervention, both monetarily and fiscally by the Fed and Congress, respectively. When the private sector fails, the public sector must assume responsibilty to alleviate the problem.

There seems to be a widespread belief that the Fed or Congress, or both, merely “prints money” to solve the problem. This may be true in Zimbabwe
or other third world countries where inflation has spiraled out of control in the midst of wanton poverty, but developed countries must balance the books by selling debt. Every dollar our government spends over the revenue it takes in must be financed by the issuance of treasury bills and bonds. This is not funny money. In fact, our debt is in such demand that short term treasury notes were yielding 0% at the height of the crisis. This means that people were willing to lend Uncle Sam money at zero interest just to be sure it was there when they needed it – the 21st Century version of money in the mattress.

Furthermore, the yield on 10 year bonds is below 3%, showing a healthy demand for longer term debt. Compare that with 15% yields during the inflationary spiral of the 70’s and 80’s. This was known as stagflation – inflation in the face of stagnant growth. There was a loss of faith in the dollar, but today the dollar is increasingly strong . In fact, it has once again become the currency of choice. Gold is soaring, but this is the fear factor at work. Survivalists are taking physical delivery of the metal as the ultimate barter tool for end times. I wonder what value a shiny mineral will have in the primitive barbarian world they are imagining. The American Indians shunned the White Man’s yellow metal, calling it “death that in darkness comes smiling.”

Today’s concern is not inflation, but its more deadly twin, deflation. Once that spiral takes hold, we all go down the drain. Controlling inflation is tomorrow’s problem. As the economists view it, inflation can be readily controlled by reining in the horses – increasing interest rates, decreasing money supply, tightening the budget – before they run away. Right now, the horses don’t want to run. The stimulus – like a whip to their backsides, and loosened reins in the form of lowered interest rates has been supplemented by dangling the carrot of money in front of them. If they don’t run now, Heaven help us all.