Tuesday, July 8, 2014
Real Deflation Sets into World Economy
Real Deflation Sets into World Economy And it Appears to Be Uncontrollable Lex Loeb Contributor Network . Next time you listen to the dire predictions by Al Gore that global warming is irreversible go back and read what the experts were saying about the possibility that deflation would ever occur again with the advancement of the federal reserve bank over the years. The predictions by experts that the US and world economy can forever more print money to float our way out of a deflationary spiral is now being severely tested. I predict that the bureaucracy that wants to build it self up to defend the earth against man made global warming will fail even more miserably. The history of the federal reserve is that it did fail to prevent the last major world deflationary period after 1929. The present Fed reserve chief studied the economics of the great depression extensively and wrote a variety of papers on the subject. His knee jerk reactions to prevent the deflation started out pretty badly with the government moving from too big to fail for banks to a philosophy of letting some fail and saving others. That behavior was more like what happened in the banking collapse prior to the great depression. It is precisely what happened according to the Milton Friedman text in his book "Free to Choose." What happened back the depression banking failure, according to Friedman is that the government allowed a run to occur in a New York Area Jewish bank because it was not favored by government regulators and that got the domino's falling in the entire system. I thought Bernake was an expert and then I see what happened with Lehman brother and Washington Mutual and then again with Fannie and Freddie, Indy Mac and more. They were picking and choosing who they would save and would not save just repeating history. This time around it was not Jewish banks being discriminated against. I called for his retirement at that point because Bernake did not learn much studying the depression and the banking collapse that proceeded it. Now we are headed into the biggest deflationary hole in the Ground most of us have ever seen. The people alive today who lived though the last major deflationary period are now 70 years old or more. Americans got used to the idea that borrowing money is the way to buy everything. Credit cards Can buy gasoline and groceries and consumers can pay a lot later with high interest payments. In inflationary times it pays to use credit because the cost of credit is erased by inflationary pressures. There was no evidence in the past ten years that we had much in the way of inflation mostly because the US dollar became defacto currency in many parts of the world where local currency could not be trusted. The dollars were absorbed in eastern Europe in particular and Russia and did not come back after the fall of the Soviet Union. The dollar still is the major real currency in much of Latin America . The world was and still is a big sponge for US dollars and that prevented much greater inflation from taking hold. Government went crazy with easy credit as a result of the situation and created a giant bubble in the United States that was not due to inflation but wild speculation. This deflationary period has the world sponge still absorbing US dollars as fast as they can be printed and that makes it dangerous for the US government to go overboard printing dollars to float our way out of the deflation. Wholesale world devaluation now seems inevitable . Hyper inflation can turn this around almost instantly but it is even more dangerous because it will give Most American's severe financial whiplash most will not recover from. That is what happened before Nazi Germany became reality. Germany was the most advanced industrial economy on the planet and went into complete economic free fall. The reason for this was foreign countries held Germany to impossible obligations to pay war reparations for surrendering in world war one. The same thing can happen here in the USA with creditors demanding value for their money and the US effectively devaluing their overseas US dollar assets. There is reason to fear the bureaucracy at the federal reserve and the US Treasury because they definitely know how to deal with an inflationary economy but when it comes to a systemic deflation they have no experience. The experience the agencies had in the 1930s is not worth imitating. How then to deal with systemic world deflation? Probably the best way is to support the dollar with something of value because if that commodity or basket of commodities falls in value the value of the dollar falls too but it is worth that that much. Deflation appreciates the value of the dollar which is not a bad thing for holders of dollars as an incentive to put them to use. Deflation can be managed just as badly as inflation was managed for 65 years or maybe a better idea is not to get government involved in trying to manage it at all and let it find its place in the economic environment. What is wrong with workers taking a deflationary pay cut when the cost of living declines with deflation? Right now we have a government going crazy and panicking trying to figure out what to do to manage every aspect of the economy instead of treating the economy as an environment that is more like the weather. The government is out trying to tell the sky to stop raining instead of telling people the benefits of having the rain when you do have it. The problem with deflation is that existing loans to industrial corporations cannot be paid back if the sales prices of products produced declines in the same way people who paid too much for houses using credit find it hard to make their mortgage payments. Re-inflating the economy to save bad loans maybe a worse idea than telling banks to re-adjust problem loans to reflect the deflation by lowering the rate of interest at least temporarily and protecting the principal of the loans. If a bank receives 3 % interest per year on a 500,000 dollar loan for a house that had a 7 % mortgage interest rate before that, there is no reason the principle part of the amortization payments cannot stay the same and the bank can't just switch the loan to an adjustable instrument with the consent of the home owner. Call it an interest rate holiday. A home owner paying 500,000 dollar off in 30 years in monthly increments added to the amortization payment gets a major cut in cost just by cutting interest rate alone and protecting the principal value. Most banks already re-adjusted the interest rates they pay for deposits to next to nothing. Longer term contracts should be protected and there the federal reserve should consider paying the shortfall on certificate deposits that ultimately will mature when due. the banks can offer CD and longer term depositors sell out offers with more up front money now than waiting later. Most Cd's do not pay out interest for a number of years anyways when they mature. The government's attack on deflation is already proving to be futile and the fear is that they will make things even worse. The best thing for the federal reserve to do is to slow down the rate of bank failures as they think they have already done except for a new wave of deflation putting a lot more real estate debt at risk now. Deflation is feeding on itself world wide now and the statistics are out and proving it beyond a doubt. Before the economy can be re-inflated, if it should be, the dollar should get backing irrespective of what foreign governments do and maybe the Federal Reserve and Treasury should embrace deflation more than they do because they will need to print fewer dollars to satisfy world demand. Deflation need not be more of an enemy than Inflation. The real problem in the 1930s was not necessarily the deflation shock but the protectionist retribution activity that shut down both import and export markets. If a dollar is worth more than it should be possible to reduce labor costs with workers actually getting a raise because their buying power actually increases. In the age of the super computer all those calculations can be instantaneous. The other real question is if big government spending programs with high taxes are really going to get the economy out of a recessionary funk as it did not work well in FDR's management of the great depression where only a war really managed to break the economic funk. If I were invited to lecture the federal reserve bank I would give an embrace deflation lecture and I would suggest public service messages on television telling Americans what is happening and how to deal with it. They are waiting for easy credit to come back to re inflate everything and signs are now that it might not without a dangerous dance with hyper inflation. The kind of shock inflation the federal reserve may now be secretly considering as the big fix that is coming will devastate anyone who saved money for retirement and destroy all purchasing power. Embracing deflation does favor some members of society more than others but inflation of the sort to get the economy out of deflation requires that everyone borrow tons of money and spend it with wild abandon before the prices go up. Are you ready for a $20 starbucks coffee and a 2 million dollar suburban ranch house? what is wrong with a $1 starbucks coffee and a $150,000 suburban ranch house if you also take a pay cut? Inflation is more of an illusion because it makes people think they are rich. Deflation can make people who don't borrow lots of money richer. The government leans toward going crazy making borrowed money free. That got us in the bubble economy that came full cycle now. It may not be time for yet another Federal Reserve inflationary knee jerk reaction. .