Presidential Aide: “A package for you, Commander in Chief.”
Treasury Secretary Paulson: (Grabbing the package from the Commander’s hands) “I'll take that!”
President Bush: “Colonel, I mean Secretary, What is it?”
Paulson: “It's a DVD of the Great Recession, Episode 1: The Deflation Scare of 2008-09.”
Bush: “How can that be? The story isn't even over yet?”
Paulson: “It's called ‘marketing,’ sir.”
Bush: “Play it! Fast forward please, I don't have time for details...There's foreclosed houses for sale, stock prices going down, gas prices down...wait, that's me! Here at the Oval Office, at this moment!”
(Pause. Next, both the real and the virtual Bush arms wave in unison.)
Bush: “When was that scene?”
Paulson: “That was then.”
Bush: “When was then?”
Paulson: “Just then.”
Bush: “So when is now?”
Paulson: “Now, sir.”
Bush: “NOW?”
Paulson: “No, just then.”
Bush: (Pleading) “When will this show be over?”
Paulson: “Soon, sir.”
Too many proponents and detractors of deflation make an erroneous assumption. Often it goes without saying that deflation either must or cannot last for years like the Great Depression of the 1930's. Deflation is happening all around us. The summer sticker shock seems a distant memory. Currently, across the globe debt defaults cascade like dominoes. Robert Prechter style deflation rages, not 13 years ago when he boldly proposed it in a book, not for the next 13 years, but right NOW. Prices are dropping more quickly than thought possible since price discovery occurs at ludicrous speed over the internet. Everything is going down: houses, stocks, corporate and municipal bonds, commodities, precious metals, foreign currencies, shipping rates, cars, gasoline, electricity. Even US Treasury bonds aren't going up; the chart of the 10 year yield since last December looks more like a California earthquake chart rather than a trend.
Even though Prechter's timing was way off, he did get one thing right. The US dollar is about the only thing going up. Institutions hoard dollars to pay off current liabilities or to guard against future liabilities. Consumers can't or won't spend, and put cash in the bank. Banks aren't lending. The demand for dollars, at least for now, outstrips supply.
Who knows how long the present deflation will last? We could see fire sales for many months, but I doubt many years. Real money supply figures step up strongly as electronic dollars are being created from Federal Reserve computers. Most if it now goes down the black hole of bank reserves. Eventually, money from nothing could make its way into the real economy and bring back up those prices we see every day.
Note to practitioners of academic arguments: All the yammering about inflation happening now because of increases in one or more measures of money supply drive me nuts almost as much as those who leave out gasoline and food when analyzing inflation. Those fixated on the money supply live in some virtual world, maybe Druidia. I'm not splitting hairs over semantics; I'm making the case for reality. The real world in which I and 300 million other Americans live consists of sticks and bricks, roads and commodes. I don't eat the money supply. I don't fill up my car with M1. The rest of it is just ethereal intellectualism detached from real life.
The Druidians, I mean, money supply fanatics have it exactly backward when it comes to using the English language to explain inflation, but they do have a point about one subject. Some money supply measures have been skyrocketing during the financial crisis that began in late September. Not only is there doubt that the Federal Reserve will ever drain back out that liquidity, but there is a greater danger. Helicopter Bernanke might adopt Zimbabwe monetary policy, and create money on his computers to buy Treasury Securities that the rest of the world won't buy. When that happens, Americans will be flushing less, because they will be eating less, because the cost of food will go up 1, 2, 3, 4, or 5 times.
A lag will occur between now and when the Great Recession, Episode 2: The Revenge of Inflation comes out. Although impossible to forecast exactly how long, the lag likely will last between 1 and 10 years. The cost of living (i.e. inflation) in the US will impoverish the unprepared. Wishful thinking and the Schwartz aren't going to help anybody. Twenty dollars per gallon gas anyone? Not NOW. But soon.
Copyright © 2008 Chuck DiFalco
