Will Deflation Be Followed By Hyperinflation Dealing the Economy Another Blow?

In my last post, I argued that we’re in a deflationary environment; prices are declining in spite of the fact that “Helicopter Ben Bernanke” is flooding the economy with freshly printed money.

The reason?

Consumers are in savings mode and aren’t spending.

But, isn’t the risk of inflation real given the amount of money the Fed is injecting into the economy? The definition of inflation is too much money chasing too few goods and services. In Economics 101 terms, there’s a lot more demand than supply and prices are driven higher.

From where I sit, most of the world’s politicians are either blissfully ignorant of this risk, or irrationally arrogant enough to think they have enough power to control the markets and consumer prices long term. If I were to venture a guess, I’d choose the latter.

Recently though, one of the world’s leaders weighed in; taking a position that’s seemingly contrarian to the rest of the world’s leaders. This from “The Wall Street Journal” June 3, 2009:

German Chancellor Angela Merkel, in a rare public rebuke of central banks, suggested the European Central Bank and its counterparts in the US and Britain have gone too far in fighting the financial crisis and may be laying the groundwork for another financial blowup. Chancellor Merkel expressed “great skepticism” over the clout of central banks and suggested their aggressive moves in Europe, the US and the UK might backfire. The public criticism is unusual – and not only because German politicians rarely talk harshly about central banks in public. Axel Weber, the head of Germany’s central bank, warned that too-loose monetary policy could fuel future inflation. Mr. Weber was among the body’s most vocal skeptics on asset purchases before the bond-buying program. Mr. Weber warned that overly generous monetary policy had helped build asset-price bubbles in the past. Although the administration of President Barack Obama has carefully avoided criticizing the Fed, Republicans and Democrats in Congress have questioned the wisdom of the Fed’s power and its governance as they contemplate far-reaching changes to the nation’s financial regulatory structure. Some private economists – and a few inside the Fed – say the Fed’s aggressiveness is increasing the risks of an outbreak of inflation and creating the unwelcome perception that it will bail out big financial institutions when they take big risks that turn out badly. (Emphasis mine)

Ms. Merkel, hats off to you!

You are exactly correct. In my opinion, the actions of the world’s central banks and governments WILL make the problem worse and will lead to inflation but only after consumers deal with their accumulated debt and find themselves in a place where they again feel comfortable spending money. When we get to that point, all bets are off. And, unless the Fed can pull the excess ‘liquidity’ out of the economy, inflation will likely commence.

The right answer to this economic mess was to take our medicine, let companies that ‘were too big to fail’ and who made bad decisions – fail. But, that didn’t happen and now the problem may get worse. Mark my words.

Some analysts expect a rally in the equity markets over the next 4-10 weeks. Given the current stock valuations and the direction of the economy, I’d say those folks who are raising cash on expected rallies and using an absolute returns* style of money management are pretty darn wise.

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