Let's see you get out of this one, Bernanke.
Okay, that headline’s not really true. Well, it’s true but it’s misleading. A reader suggested we “punch up” our headlines, so we thought, hey, what’s scarier that deflation? Outside of John Meyer being the voice of a generation, nothing.
Read literally, the headline is true. Deflation will, given the chance, wreck the world economy. But it’s misleading; it conveys the sense that deflation is already destroying the economy. That is not true.
But it doesn’t mean deflation isn’t lurking around, and that investors, consumers, corporate executives and government officials shouldn’t be prepared to wrestle with it.
When both the CPI and PPI reports last week showed signs of deflation, the immediate reaction was to write them off as temporary. The general thinking is the Fed’s so busy trying to inflate and reflate the economy that any deflation couldn’t possibly last.
But the data reveal a “new” story, Greg Weldon writes (as relayed by UBS’ Art Cashin.) There’s been an intensification of the consumer credit contraction, he says. “The more recent tightening in overall credit conditions appears to be a bigger-picture dynamic, as per a deepening down cycle of deflation.”
One of these has got to turn on the inflation.
The Fed has basically doubled its balance sheet in a year, but that hasn’t induced the creation of fresh credit or spurred economic growth. Bank reserves have exploded, and the government’s pressing the banks to lend, but as has been reported, they aren’t lending as much.
And while the banks are getting heat for supposedly not lending enough money, the reason they aren’t lending has at least as much to do with consumer demand for borrowing as it does the banks trying to hoard cash.
What creates inflation is demand for money, and the velocity of it changing hands, not how much credit the Fed creates. (For reasons too convoluted to go into here, the Fed doesn’t actually create money; for details, just follow Bob McTeer.) And with more and more Americans losing their jobs, or having their salaries frozen, or their salaries or hours cut, there just isn’t a lot of demand for money.
Inflating the monetary base is very different from inflation, as noted in a paper written by Van Hoisington and Lacy Hunt of Hoisington Investment Management.
It is totally incorrect to assume that the massive expansion in reserves created by the Fed is inflationary. Economic activity cannot move forward unless credit expansion follows reserves expansion. This is not happening. Too much and poorly financed debt has rendered monetary policy ineffective.
And on they go:
The highly ingenious monetary policy devices developed by the Bernanke Fed may prevent the calamitous events associated with the debt deflation of the Great Depression, but they do not restore the economy to health quickly or easily. The problem for the Fed is that it does not control velocity or the money created outside the banking system.
Investors, they conclude, should not bet on inflation as a portfolio strategy.
