Why the Fed is Steering the Economy Into Deflation

July 15, 2010

"Contempt for Workers is the Religion of Elites"
Why the Fed is Steering the Economy Into Deflation
By MIKE WHITNEY

The Fed is steering the economy into deflation. It's a political calculation that will keep unemployment high, increase excess capacity, and deepen the recession. The Comsumer Price Index continues to fall, bank lending is down 4 per cent year-over-year, housing prices are slipping, business investment is off, and consumer credit continues to shrink. On Wednesday, the Commerce Dept reported that retail sales fell 0.5 percent, more than analysts expected. This is the second drop in retail purchases in the last two months, signaling weakness in consumer demand. The slowdown hit nearly every sector including auto sales, furniture, computers, building materials, clothing and sporting goods. There was also bad news on housing on Wednesday. The Mortgage Brokers' Association reported that loans purchase applications fell to a 13-year low last week, and refinancing contracts continued to slide despite record-low mortgage rates. The housing depression is ongoing and is adding to deflationary pressures in the broader economy.

Federal Reserve chairman Ben Bernanke claims the recovery is still "on track", but more than 60 per cent of last quarter's GDP can be attributed to fiscal stimulus and inventory adjustments. That means demand will drop as the stimulus runs out and restocking ends. Then the economy will have to stand on its own. Expect negative growth by the forth quarter 2010 or first quarter 2011.

Last week, Richmond Fed President Jeffrey Lacker summed up the Fed's position, saying that any consideration of further monetary easing "is very far away....It would take a very substantial, unanticipated adverse shock" for the Fed to resume its QE program. This appears to be the prevailing view at the Fed; wait-and-see while the economy tanks and the GOP takes congress in a landslide in November. The Fed is essentially a political institution.

Inflation is not a problem. The economy is in a depression. The historic low yields on Treasuries indicate an appetite for high-quality liquid assets. The Fed should satisfy that need by issuing more debt, selling more Treasuries, increasing inflation expectations. That would increase spending and pull the economy out of the doldrums. Instead, Bernanke preaches austerity, because the real objective is political--dismantling Social Security and other popular programs. Bernanke (a Republican) has aligned himself with the GOP and Wall Street who seek to bury Obama in the midterms by trashing the economy, keeping unemployment high, and increasing the prospect of another vicious downturn.

Read the full article at:

http://www.counterpunch.org/whitney07152010.html

Wouldn't deflation mean the dollar would be STRONGER, not weaker?

Wouldn't that mean the dollar would be stronger against the yen as apposed to weakening as it appears.

It seems to me that the strategy is to deflate the value of the dollar in the hopes of increasing the growth of manufacturing, thus reducing our trade imbalance.

Am I entirely wrong in this?

I have a friend who thinks the JPN yen will reach down to 60 yen: dollar. That is a weak dollar indeed.

Am I confusing issues?

You're comparing apples to oranges.

Here is what I have concluded after having been more than an interested spectator in the USD/JPY drama for a very long time.

The yen became the carry trade currency of choice because Japanese interest rates deflated to practically zero. Demand for carry trade yen on the world market boosted its value. Also, while Japan has a huge national debt, the vast majority of that debt is held by Japanese.

The problem with the dollar is that trillions have already been allocated for wars and bank bailouts, but where is that money coming from? In the last few years, there has been vastly increased fabrication of dollars, which raises the specter of inflation somewhere down the line. Deflating the value of the dollar is another way of saying inflating the money supply, which tends to bring the value of the currency down.

Do you see 60 or even 55 as a possibility someday soon?

To tell you the truth, though, I think the Japanese government should work to prevent that, because it would have a terrible effect on the Japanese economy. It would kill a lot of export industries, for example, and hasten the outsourcing of a lot of Japanese jobs. I would assume that a lot of the big exporters would put pressure on the Japanese government to stop the rise of the yen long before 60. It was difficult enough for them to compete at 80, it would be damn near impossible to compete at 60.

I think the Fed's pretty much out of options. It really can't lower the interest rates any more than they are, and if it jacks rates too early, it risks throttling the economy.

We won't be out of this mess until the housing market reaches bottom. I recall the last major recession in the early 1980's, housing took a dip for only a short time, then it sat there for a couple of years before rising slowly. Clearly, we've had some major declines in housing prices, with sustained foreclosure activity.

There's one big fat difference between the 1980's recession and the current one, and that's the baby boom. Boomers were starting and growing their families at that point, and needed more house. Today, their nest is empty (unless their adult children had to move back in), and they don't need three, four, or five bedroom houses anymore.

the rest of the world suffered from the rise in oil prices at the end of the 1970's, that brought on the early 1980's recession.

But the current crisis is indeed more widespread in its scope and its depth.

compete for depositors money, thus pointing out the lie about competition.

Msongs

I love seeing my monthly interest from the bank at .26 cents on an account with $2K in it. I look around for other options and there really are none.

like crazy couldn't they? Any economists here?

and the Fed would need to agree to more QE so we don't have to borrow the money. (I'm not an economist, btw.)

:hi:

but quantitative easing has little to no bearing on inflation or deflation. It's simply trading one asset for another.

It only borrows. But that requires appropriations from Congress.

That's what Quantitative Easing (QE for short) is.

All transactions between the Government sector and the private sector involve the creation and destruction of dollar-denominated financial assets.

Under QE, the central bank is just creating excess reserves to loan for a positive rate of return. They are merely swapping low interest bearing assets for higher interest bearing assets. In other words, it's an accounting adjustment.

When the Government buys something from the private sector they usually just credit numbers electronically to a bank account somewhere. The net financial assets in the private sector are in fact unchanged although the portfolio composition of those assets is altered (maturity substitution) which changes yields and returns.

QE is pushing on a string in the current economic environment. Building bank reserves will not increase the bank’s capacity to lend because bank lending is not reserve constrained (banks lend money first, then adjust reserve ratios later). The reason that banks have reduced lending is because there is lower demand for loans and fewer credit-worthy borrowers.

Quantitative easing amounts to more failed neo-lib nonsense. I doubt policy makers will admit it doesn't work and they've run out of bullets, though.

from anyone because the Fed buys the bonds, that is essentially printing money.

Isn't that usually for short-term periods, though? For the longer period of time needed for economic recovery, is some kind of authorization needed for the funds to purchase the bonds?

usually, the fed BUYS treasuries when it wants to inject cash into the economy and stimulate spending and inflation.

moreover, selling treasuries drives prices down and yields up, which will contract the economy even more -- why would corporations, let alone banks, risk trying to make money in a fragile economy when the high quality yield that they were already willing to buy for just a fraction of a percent interest is suddenly offering a much greater yield?


bernanke is no greenspan. greenie certainly took some partisan actions, most notably crying "the sky is falling" at the notion that the government would pay off the ENTIRE multitrillion dollar national debt, the minute it started to make the tiniest dent in that gargantuan debt. but bernanke has barely paid heed to inflation, which is the usual republican bugaboo. normally, fed chairs who push for easy money are accused of trying to prop up the president by avoiding putting the country into a recession, but this guy somehow comes to the opposite conclusion.


the real villain here is fiscal policy, not monetary policy. we are suffering from a dearth of demand, and the fed can't do much about that, because money is mostly about supply and the grease for the machine. congress needs to SERIOUSLY increase spending, especially for the poor. THAT'S the way to stimulate the economy.

i'm not saying i'm a big bernanke fan, but i am saying that the fed doesn't have many bullets left and what this guy is advocating is using those few bullets to shoot ourselves in the feet and possibly the head as well.

I have no idea who this idiot is, but BUYING treasuries is the usual way of stimulating the economy.

IMHO the fed is doing about as much as can be done. Low interest rates, etc. Fiscal policy needs to kick in, including both support for the poor and tax cuts for those investing in the economy (hiring employees, building inventory, buying equipment, etc.).

I'm not sure what I would do if I could waive a magic wand, but I would probably go further than the standard "increase the 179 deduction". I would also look at giving credit on FUTA and FICA for any new jobs created.

But I don't see why the author thinks that is so important - just because the banks have more cash doesn't mean they will lend it out to the people.

The banks aren't lending. They're hoarding and/or speculating with the money they borrow from the Fed. If the Fed gives them more money to lend, they (the banks) will just hoard/speculate more. The money isn't circulating, and it's circulating money that makes the world go round.

Stimulus needs to go directly to the people who will spend money. The government needs to get going on all those major public works projects Obama talked about, and more:

Where's the high speed rail connecting the country?
How about large, public-owned wind, geothermal and solar energy farms?
Sanders had gotten 13,000 new community health centers added to health insurance reform. Have they started building them?
What became of the conservation initiative -- to update every public building and private home to conserve energy? (I know here in Maine it translated into a bogus $250 course (including things like stuffing the attic with newspaper -- no freakin' lie :eyes:) to get a certificate so you could go out and look for work insulating homes)

And encourage older people to retire -- don't punish them for it -- so their jobs are available for younger people.

All those projects, investing in an infrastructure to support new business and investing in clean, renewable energy sources, would:

1. create jobs today
2. prepare us for sustainable future tomorrow

It's all about them and their investors.

Kill Capitalism

I would have to agree. And I don't think we are going to make it to 2012.. I think the world economy is going to crash well before that... nothing has been done to change things.

From day one.. I could never understand why Mr. Obama surrounded himself with Bush-Bots and Republicans? It has been nothing but one disaster after another.

Maybe he's not as "liberal" as you thought.