Summary: The emerging nations are overheating, many of them suffering from a too-loose monetary policy transmitted from the US by their currency pegs to the US dollar. Many of the developed nations are in the grips of deflationary forces. This gap between the two worlds results from the now dysfunctional post-WWII global geopolitical regime. The almost inevitable opposite policy responses (tightening and loosening) of emerging and developed nations will destroy it. Here we take a brief look at US deflation; a later post will look at China.
As Bernanke probably well knows, the ideal time for a last-ditch effort to prevent deflation (i.e., QE2) was this Fall. The last opportunity to do so may have been in October. Leaks from the Fed suggested that they intended to go then, but plans probably scuttled due to fears of political blowback. The announced program for QE2 looks like too little, too late. With this tardy and timid response we continue to follow Japan into the long deflation (more details here).
During the next year or so deflationary forces might push the US into debt deflation, or even push CPI below zero into full-fledged deflation. The former would be painful for a high-debt economy like ours; the latter is potentially disastrous (as it was during the 1930′s). Here are some of these forces:
- Slow or no growth in the US (approaching stall speed), with few signs of economic recovery;
- as the population grows, the rising number of unemployed depress wages;
- the federal stimulus programs slowly wind down with near-zero odds of new Federal spending (other than extension of Bush’s tax cuts and wars), spending cuts are possible in fiscal 2011-12;
- almost certain cuts in spending, wages, and jobs at the state/local level, esp in 2011 as Federal grants end;
- slowing exports to Asia (they’re fighting inflation) and EU (due to their self-imposed austerity);
- falling prices of some important assets (e.g., residential and commercial real estate);
- low odds of more monetary easing beyond the announced program ending in June, due to opposition from Congress and the Open Market Committee (especially after the seats of the 3 regional Bank Presidents rotate in January);
- rising energy and food prices — sector prices rising faster than wages are deflationary (as they were in 2008; see this explanation). For instance, the current La Nina might increase winter heating bills and reduce global crop yields.
Of course, a full-fledged recovery or a second recession in 2011 would radically change these factors.
Hampering our ability to fight deflation is the hysteria about inflation, firmly rooted in faux economics. Warnings about invisible bond vigilantes, invisible crowding-out of private borrowing by government borrowing, and invisible structural unemployment (as in if we stopped extended unemployment insurance, most of the unemployed would take those invisible empty jobs). It’s the equivalent of people screaming “fire” as the ship sinks. Much like similar episodes in early 2008 and especially 1937.
Unlike those instances, today this results in large part from political motives. As do the accusations that Obama’s anti-business — despite the bailouts, a bank-friendly regulatory legislation, and few new regulations (almost nil compared to Nixon’s). The worse, the better! Hampering or halting every effort by Obama to fight the slowdown — and riding the resulting punk economy to electoral success.
Cold but effective tactics. But we have no grounds for complaint. If we choose to be sheep, we must accept that there will be shepherds — and wolves.
For more information
Posts about deflation:
- Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
- A situation report about the global economy, as the flames break thru the firewalls, 26 January 2009
- Inflation or Deflation? Nobody knows what path will we take., 21 July 2009
- Economic theory as a guiding light for government action in this crisis, 10 March 2009
- Fetters of the mind blind us so that we cannot see a solution to this crisis, 1 April 2009
- A lesson from the Weimar Republic about balancing the budget, 10 February 2010
- All about deflation, the quiet killer of modern economies, 19 July 2010
- Important things to know about QE2 (forewarned is forearmed), 21 October 2010
Posts about China:
- Power shifts from West to East: the end of the post-WWII regime in the news, 20 December 2007
- China becomes a super-power (geopolitical analysis need not be war-mongering), 9 July 2008
- Words to fear in the 21st century: Lǎo hǔ, lǎo hǔ, Lǎo hǔ, 14 July 2008
- A different perspective on the US and China, seen by an American living in Russia, 23 March 2009
- China – the mysterious other pole of the world economy, 22 July 2009
- Another big step for China on its road to becoming a great power, 27 July 2009
- Will China collapse?, 5 August 2009
- A revolution is not a dinner party. Thoughts about the future of China, 19 August 2009
- Update about China: a new center of the world, 13 December 2009
- Fertilizer overuse destroying Chinese soil, 18 February 2010
- Rare earths – a hidden but strategic battleground between the US and China, 5 May 2010
- Today’s example of the inscrutable mystery of China’s economic statistics, 13 May 2010
- How China builds its commercial empire, 12 July 2010
- The West has power, but often little self-insight, 19 September 2010
- A look at the future (it’s already here, but it’s not in the USA), 29 September 2010
- Why China will again rise to the top. About their most important advantage over America.
Originally published at Fabius Maximus and reproduced here with permission.