jungle

Inflation Not a Threat -- Yet
By JIM MCTAGUE | Inflation's no problem -- yet.



STOW THE RED WHEELBARROW BACK IN THE SHED. DESPITE forebodings by Texas Rep. Ron Paul and other gold bugs about hyperinflation, your wallet will be sufficient to hold your spending money for the foreseeable future.

Paul and other inflation hawks correctly note that the Fed's printing presses are running full tilt. Nevertheless, some economic experts argue that we won't require wagonloads of debased currency to buy a stick of butter, mirroring Germany's 1923 nightmare. Reason: Deflation still hangs like a low, dark cloud over our sinking economy. Too few dollars are chasing too many goods, and this will worsen as unemployment hits 9% or more sometime next year. People fearful of losing their jobs are hoarding cash. Banks have become careful, stingy lenders. The danger is that, despite all the government stimulus, demand will stay weak.

Paul doesn't believe this. He argues that an estimated $8 trillion in bailout commitments by the Treasury and Federal Reserve and other government units has increased the monetary base by 75% over the past two months. "If something that is used as money becomes too plentiful, it loses value," writes Paul in a recent article. "That is how inflation and hyperinflation happens. Giving the central bank the power to create fiat money out of thin air creates the tremendous risk of eventual hyperinflation." He favors a return to the gold standard.

That $8 trillion represents committed funds, not actual loans and investments. You can't add it to the monetary base until it's in someone's bank account. Much of it is being used to cover losses on existing loans, not for new ones. The Fed demands lots of collateral to ensure that lending doesn't get out of hand. And most of its loans are short-term and can be unwound very quickly -- another mechanism to inhibit hyperinflation.

Some experts argue that Fed chief Ben Bernanke is simply replacing money annihilated in our economy's "Great Deleveraging" and that he should print even more. Retired securities lawyer Frederick Feldkamp, a Michigan native, says the Treasury's nationalization of Fannie Mae and Freddie Mac alone erased $33 billion in bank capital. The Treasury inadvertently wiped out the two mortgage giants' preferred stock, which hundreds of banks had held as core capital, and which was considered so safe that regulations let the banks leverage that capital by as much as 50 to 1 when making loans. Feldkamp reckons that when banks wrote off the $33 billion in preferred stock, support for about $1.65 billion in debt was erased -- a significant credit contraction.

FBR Capital Markets, in a Nov. 19 report, estimated that Goldman Sachs (ticker: GS), Morgan Stanley (MS), Citigroup (C), JPMorgan Chase (JPM), Wells Fargo (WFC), Bank of America (BAC), AIG (AIG) and GE Capital (GE) combined need $1 trillion to $1.2 trillion of equity capital to shore up their balance sheets so they can begin lending again. FBR estimates that the eight have $12.2 trillion in assets and just 3.4% of that -- $406 billion -- in tangible common capital. "The sheer size of the capital deficiency, coupled with the opaque nature of credit risk, will keep private capital sidelined... ." FBR says.

This isn't to say that inflation won't become a problem down the road. Paul Wachtel, a New York University economics professor, says the Fed should be planning an exit strategy, so that it can absorb cash reserves from lenders when the economy rebounds. Absent such a plan, you may get a chance to use your wheelbarrow when buying that stick of butter, after all.


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Cubdriver

It's funny thinking about money as a commodity but it is. When there is a shortage of it you have deflation, and when there is too much you have inflation. I will always remember the rampant inflation of the late 70's and early eighties. It tends to scare the heck out of people because they think their wages will be worthless in only a few months if the pace continues. My father was a college professor in the late 70's, and he was very, very worried about his salary becoming worthless due to inflation.

Deflation is the opposite, not enough money available. It means those who are still in business can buy more, great, but it means a lot of people are losing work because their companies are going out of business.

jungle

Not many people bother to think about what money really is, in a sense it is like a commodity and various currencies are traded much like other commodities. It has been many things in the past and many systems of money have been used.
In essence it is merely a convenient medium of exchange that represents our labor and is dependent on mutual trust to continue to do so.
How a system of money is constructed and managed is very complicated and the deeper you look into it, the more complex it becomes. Much like complex engineering problems or studying the weather there are huge numbers of variables, in addition there is a large element of human irrational behavior thrown into the mix. I would venture that not many humans actually understand it completely.

A brief summary for those wishing to start thinking about it:

Money - Wikipedia, the free encyclopedia

ryan1234

good article........deflation is far worse than inflation (or hyper inflation which we have not seen in the US)... deflation usually follows inflation (obviously)..... I would venture to say we will see inflation go up significantly over the next 6 years followed by a recession (but I guess all that is relative to the rest of the world)

jungle

Deflation or inflation, which is worse? It all depends on your point of view. In certain areas of the country housing prices had inflated to the point that only six percent of the population could actually afford a home. Deflation could then be considered a needed and good thing by many. Not so for those owning a home in that area.
Uncontrolled inflation is probably best illustrated by looking at Zimbabwe's current crisis.

A long deflationary cycle can be seen in the last 15 years of Japan's economy.

Neither deflation or inflation can be considered a good thing in a well run economy, but it is normal to see some inflation in an expanding economy and some deflation in a contracting economy.

ryan1234

Zimbabwe hyper-inflation (80 billion% monthly peak....it took 24.7 hours for prices to double!)... which I believe Hungary 1946 had the most with 13 quadrillion % inflation...15.6 hours for prices to double!

Despite that, it seems that deflation related unemployment, etc is catastropic and has less true quick fixes.......especially with how artificially low interest rates are now....true debt is being realized.

Like you mentioned before there are many factors for all of these things. A few things in America off of the top of my head recently would be banks underpricing risk based on federal guarantees...not to mention tons of artificial liquidity thanks to the FRB all directed toward the housing market...most all of the problems would have to do with the burden of government in economics (prevailing in uncertainty).
Perhaps we should rethink the Humphrey-Hawkins Full Employment Act...it seems as though government intervention seems to oscillate problems by credit (either promises or any like).

While some deflation is normal, the upcoming entitlement debacle could be the nail in the coffin... we'll see what happens.