Posts in "Deflation"

By John Galt at 5:38PM

Aug 10, 2010

Quantitative Easing, Version 2.0

Per the FOMC announcement:

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.

Here, we see an attempt by the Federal Reserve to prevent price deflation. Whether or not you believe price deflation will occur (I would wager that the readers of this website tend to view price inflation as the likely outcome), this particular move is inflationary as the Federal Reserve has not committed to reducing the size of its balance sheet.

Many intelligent people (e.g., Mish) are forecasting that price deflation will occur in the short-term. I tend to agree with Mish (in regards to the short-term). As noted in one of the Mises Daily articles for today:

After the crisis arrives and the depression begins, various secondary developments often occur. In particular, for reasons that will be discussed further below, the crisis is often marked not only by a halt to credit expansion, but by an actual deflation — a contraction in the supply of money. The deflation causes a further decline in prices. Any increase in the demand for money will speed up adjustment to the lower prices. Furthermore, when deflation takes place first on the loan market, i.e., as credit contraction by the banks — and this is almost always the case — this will have the beneficial effect of speeding up the depression-adjustment process.

The above quotation is courtesy of Murray Rothbard's book: Man, Economy, & State.

Fed News Friday: The Fed's Self-Fulfilling Prophecy

As last week's Fed News Friday article read, deflation has been the trending topic through the week. The funny part about that is economists and Fed members alone can't decide whether it is the actual threat or not.

The other possibility is the complete opposite: inflation. The broad range of this argument leaves me wondering, didn't the administration appoint these people for their expertise?

From articles I have seen and previous knowledge of the Fed's behavior, my guess is either economic phenomenon will occur. The only deciding factor is: Which one does the Federal Reserve want to occur?

That's right. The Fed officials know they hold the power to expel their preferred self-fulfilling prophecy. Once they publicly announce which the larger threat is, deflation or inflation, the market and their personal printing press will react accordingly.

A Leap of Faith from the Bunning Affair

Yes, bear with me on this one.

First I want to give Bunning some credit. If you don't know what's going on, he is halting the Senate essentially (although they could vote today regardless of his objection) on a 30 day extension for jobless benefits funds. He's getting a lot of heat because he just up and decided that this is what he would raise objection on, yet he supported the Bush tax cuts, war funding, etc. In that aspect suspicion is rightly placed. However, I've been watching alot of news programs twist this into partisan politic, wickedness, etc. This is what he is really doing. He's not trying to halt jobless benefits; he wants to take the money for it from allocated funds, like stimulus funds, instead of increasing the debt. That's it. So, I'll give him a pat on the back for sticking to a principle (even if it just suddenly appeared).

The Decline of the Dollar

For most experts, deflation is bad news since it generates expectations for a further decline in prices. As a result, they believe, consumers postpone their buying of goods at present since they expect to buy these goods at a lower prices in the future. This weakens the overall flow of spending and in turn weakens the economy. Hence, such commentators believe that policies that counter deflation will also counter the slump.

But does it make sense that a fall in prices should actually cause people to postpone buying goods? To maintain their life and wellbeing individuals must live at present, hence they buy goods at present regardless of the fact that prices are falling.

From December 1997 to August 2009, the prices of personal computers have fallen by 93%. Did this fall in prices cause people to postpone buying personal computers? On the contrary, since December 1997 consumer outlays on personal computers have increased massively. These outlays stood at $83.2 billion in August 2009 as compared to $3.4 billion in December 1997.

Read more on the need for a better understanding of inflation and deflation here.

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