The Fed clearly is not letting up on its battle against “deflation”, we continually witness the call for further monies to be spent, with congress approving of it. If you are a Keynesian economist this is the right thing to do. Many Keynesians believe the Japanese economic collapse in the early 90s could have been avoided if the government had intervened earlier on in stimulating the economy. The first question however is whether this is really a battle against deflation. The current bust cycle in the economy is viewed as necessary in wiping out all excesses that may have arisen during the economic boom. So rather than calling this deflation, is this just a situation were prices across board are resetting to more appropriate levels or is this the meaning of deflation?
Do we really believe the economy can continually grow for years at a steady rate without a painful correction? Yes, in theory this is possible, but like economics teaches us, human behavior cannot be predicted, hence there will always be excesses, the party will always get wild once there’s liquor and no cops around, and the recession or bust is supposed to end the party, and clean up the mess in the system. In addition, the beauty about an economic bubble bursting is that ideally, it provides an opportunity for wealth to be spread across broad, people who have been conservative now have an opportunity to make carefully analyzed investments that are currently at bargain prices. In times like this cash is king, for anyone who has been prudent enough to save cash, or anyone who has access to low cost funds, these monies will be handy in a time like this.
Given this exciting fact, where are the opportunities then? We are witnessing a situation in which there’s more of a social system in place, and cash injections are going to big corporations that have been irresponsible in their behavior (we all know this and I wont rant on this). If in a capitalist environment, the consumer is the key driver; won’t it make more sense to have a bigger bailout for the consumer? If more money was put in the pockets of the American tax payer, this money will ultimately be spent and there will be somewhat of a recovery in the system. The Fed’s balance sheet in the course of this economic crisis has grown by $1.2 trillion, which is approximately $4000 for every American. Compared with a $500 dollar check, that’s more likely to be stimulating.
Now with the measures being employed by the Fed to combat this “deflationary cycle”, 0% interest rate, stimulus checks, absorbing bad debt, all done by money printing, the expected result is to have a bounce back in the economy. But when does the Fed know when to stop? Is it when we begin to see CPI come in at 0.5% over a couple of quarters, what economic indicators will tell the Fed that they can take their feet of the economic gas pedal? At any point the Fed get’s to this discovery, they most likely would have shot too far in stabilizing the economy. So will inflation in the system say to us that the Fed has done a good job?
From the current look of things the market is pricing in a long deflationary period, this is evident from the spread between the 10 Year Treasury bond and the 10 Year Treasury Inflation Protected bond. The current spread is approximately zero, which signifies the bond market believes that over the period of 10 Years, the inflationary concerns of the economy is priced in, and this is very misleading. Except one believes that just enough money that’s needed to restore the economy will be printed, inflation is definitely going to rise. In which case there will be a new economic crisis to deal with, so then again, does inflation really symbolize a recovery in the economy?