More Evidence That We’re In a Deflationary Environment

I’ve been convinced for some time that we’re in a deflationary environment – a climate of declining prices in spite of the massive amount of money that Fed Chair Ben Bernanke has pumped into the economy. I wrote recently about the cause and effect of a credit driven recession and a spike in the national savings rate – until consumers decide to begin spending money, there may likely be no inflation. And, it looks like consumers are not yet ready to begin spending.

This from Business Week June 29, 2009.

Federal Reserve Chairman Ben Bernanke is unleashing a tidal wave of money to fight the global recession. The nation’s monetary base – consisting of bills and coins in circulation plus banks’ deposits at the Fed – has climbed 114% over the past year. It’s only natural to wonder whether that will lead to high inflation. If anything, the wave of money it’s generating may not be big enough. How can that be? Because the inflationary effects of the new money are being fully offset, or more than offset, by the far-reaching and long-lasting impact of household debt repayments. While cleaning up debt is a good thing for the long-term health of the US economy, it’s hell on consumer spending, which accounts for about two-thirds of Gross Domestic Product. The economy is teetering on the edge of deflation – a general extended decline in prices – despite the Fed’s intervention. Excluding food and energy, consumer prices rose a modest 1.8% in the 12 months through May – and including food and energy, they fell 1.3%, the most since 1950. Plenty of legit economists don’t buy this low-inflation scenario. Sooner or later, they argue, all that money is bound to show up in prices. It’s not primarily inflation fear that’s pushing up interest rates, but rather massive federal deficit spending. Investors are demanding higher yields to take even more Treasury bonds. In fact, the bond market is forecasting inflation averaging only about 1.8% a year over the next decade, judging from the spread between ordinary and inflation-indexed Treasury bonds. (Emphasis mine)

That’s why I’ve maintained since this recession began that massive federal spending in the form of a so-called stimulus wouldn’t fix the economic problem. Deflation typically comes with credit -driven recessions (the last one being in the 1930’s). I have no reason to believe this time will be any different and the actions of the Fed, trying to solve a debt problem by creating more debt will only, in my view, make the landing that much harder.

Does that mean in spite of the Federal Reserve’s massive monetary injection we’ll see no inflation?

I don’t believe we will in the short term; however, in the long term, when consumers begin to spend money again, there’s a real risk of not only inflation, but perhaps even hyperinflation.

More on this in my next post.

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