[THS] Mike Whitney: The Fed is Steering the Economy into Deflation

[The Harder Stuff in news and commentary]

http://www.informationclearinghouse.info/article25933.htm

 The Fed is Steering the Economy into Deflation

By Mike Whitney

July 14, 2010 "Information Clearing House" --  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. C.P.I. continues to fall, bank lending is down 4
percent 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% 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.

There are things the Fed can do to fight deflation.  Bernanke can resume his bond
purchasing program (quantitative easing), this time buying US Treasuries to increase
inflation expectations and add to the money supply. Or the Fed can purchase
corporate bonds to increase business investment and hiring. Even a bit of jawboning
would help; like issuing a statement saying that the "extended period" for zero rates
will last for at least two years or more. That will assure businesses that their long-
term plans will not  disrupted by unforeseen rate hikes. Instead, the Fed chooses to
do nothing.

 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.

 Here's a thought from economist Bradford DeLong who warned early-on that the
Obama stimulus was too small to sustain a recovery and reverse the output gap and
soaring unemployment:

  "The Federal Reserve has already increased the monetary base to a previously
unimaginable extent and has doubled its balance sheet to $2 trillion. Even though
there is good reason to think that further increases in the money stock alone will have
little effect on the economy--that conventional monetary policy is tapped out--the
Federal Reserve could always further increase its balance sheet to $3 trillion or $4
trillion. Such quantitative easing would be highly likely to eliminate fears of possible
deflation or other lower tail risks and act as a powerful spur to investment. Such an
enormous expansion of the balance sheet would produce a qualitative improvement
in the assets held by the private sector, which would greatly reduce risk spreads and
make funding available to American companies on much more attractive terms." ("A
Keynesian voice crying in the wilderness", Bradford deLong, Grasping Reality with
Both Hands)

Bernanke has more arrows in his quiver, but he chooses not to use them.

The stock market is sending mixed signals, but volatility on low volume tells us
nothing about the state of the so-called "recovery". It's just noise.  Personal
consumption expenditures (PCE) and housing typically lead the way out of recession,
and both are still showing little sign of improvement. Housing is headed for a double
dip while personal spending is down. Consumers face a long period of deleveraging
and retrenchment ahead. Consumer demand will likely be weak for a decade or more
without wage growth and a better jobs market, neither of which are forthcoming.

    This is from the IMF's "World Economic Outlook" report:
    "Inflation pressures are expected to remain subdued in advanced economies. The
still-low levels of capacity utilization and well anchored inflation expectations should
contain inflation pressures in advanced economies, where headline inflation is
expected to remain around 1¼–1½ percent in 2010 and 2011. In a number of
advanced economies, the risks of deflation remain pertinent in light of the relatively
weak outlook for growth and the persistence of considerable economic slack."


  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.

Meanwhile, deflation looms larger by the day. Here's a clip from a recent article by
John H. Makin in the Wall Street Journal:

  "U.S. year-over-year core inflation has dropped to 0.9 percent--its lowest level in
forty-four years. The six-month annualized core consumer price index inflation level
has dropped even closer to zero, at 0.4 percent. Europe's year-over-year core
inflation rate has fallen to 0.8 percent--the lowest level ever reported in the series
that began in 1991....As commodity prices slip, inflation will become deflation globally
in short order....By later this year, persistent excess capacity will probably create
actual deflation in the United States and Europe....

The G20's shift toward rapid, global fiscal consolidation--a halving of deficits by
2013--threatens a public sector, Keynesian "paradox of thrift" whereby because all
governments are simultaneously tightening fiscal policy, growth is cut so much that
revenues collapse and budget deficits actually rise. The underlying hope or
expectation that easier money, a weaker currency, and higher exports can somehow
compensate for the negative impact on growth from rapid, global fiscal consolidation
cannot be realized everywhere at once. The combination of tighter fiscal policy, easy
money, and a weaker currency, which can work for a small open economy, cannot
work for the global economy." ("The Rising threat of deflation", John H. Makin, Wall
Street Journal)

Obama intends to double exports within the next decade. Every other nation has the
exact same plan. They'd rather weaken their own currencies and starve workers than
raise salaries and fund government work programs. Class warfare takes precedent
over productivity, a healthy economy or even national solvency. Contempt for workers
is the religion of elites.

  When wages increase, spending  increases, too. But wages cannot increase without
investment, so investment is key to the process. The problem is that businesses are
hoarding because consumers are deleveraging and repairing their balance sheets. So
sales are off and consumption levels do not warrant further expansion, additional
machinery, employees or products. The economy is in a holding-pattern. True, the
markets have improved and stocks have bounced off the bottom. But the real
economy has reached a high-water mark beyond which it cannot move without extra
stimulus.

The deficit hawks, the Bluedogs, the inflationistas and the Fed have taken us to the
brink. We now face a general decline in wages and prices and the real prospect of a
downward spiral. Digging out will not be easy.