DEFLATION: HOW TO SURVIVE IT

DEFLATION: HOW TO SURVIVE IT: "

By Elliott Wave International

Telegraph.go.uk, May 26: “US money supply plunges at 1930s pace… The M3 money supply in the U.S. is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history.”

Deflation is suddenly in the news again. It’s a good moment to catch up on a few definitions, as well as strategies on how to beat this rare economic condition.

And who better to ask than EWI’s president Robert Prechter? He predicted the first wave of deflation in the 2007-2009 “credit crunch” and has written on this topic extensively.

We’ve put together a great free resource for our Club EWI members: a 63-page “Deflation Survival Guide eBook,” Prechter’s most important deflation essays. Enjoy this excerpt.

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What Makes Deflation Likely Today?

Bob Prechter, Deflation Survival Guide, free Club EWI eBook

Following the Great Depression, the Fed and the U.S. government embarked on a program…both of increasing the creation of new money and credit and of fostering the confidence of lenders and borrowers so as to facilitate the expansion of credit. These policies both accommodated and encouraged the expansionary trend of the ’Teens and 1920s, which ended in bust, and the far larger expansionary trend that began in 1932 and which has accelerated over the past half-century. Other governments and central banks have followed similar policies. The International Monetary Fund, the World Bank and similar institutions, funded mostly by the U.S. taxpayer, have extended immense credit around the globe.

Their policies have supported nearly continuous worldwide inflation, particularly over the past thirty years. As a result, the global financial system is gorged with non-self-liquidating credit. Conventional economists excuse and praise this system under the erroneous belief that expanding money and credit promotes economic growth, which is terribly false. It appears to do so for a while, but in the long run, the swollen mass of debt collapses of its own weight, which is deflation, and destroys the economy. A devastated economy, moreover, encourages radical politics, which is even worse.

The value of credit that has been extended worldwide is unprecedented. Worse, most of this debt is the non-self-liquidating type. Much of it comprises loans to governments, investment loans for buying stock and real estate, and loans for everyday consumer items and services, none of which has any production tied to it. Even a lot of corporate debt is non-self-liquidating, since so much of corporate activity these days is related to finance rather than production.

Figure 11-5 is a stunning picture of the credit expansion of wave V of the 1920s (beginning the year that Congress authorized the Fed), which ended in a bust, and of wave V in the 1980s-1990s, which is even bigger.

…it has been the biggest credit expansion in history by a huge margin. Coextensively, not only is there a threat of deflation, but there is also the threat of the biggest deflation in history by a huge margin. …

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Deficit Arithmetic: Henry Blodget Needs to Do the Math

Deficit Arithmetic: Henry Blodget Needs to Do the Math: "

The intelligent and articulate Henry Blodget arouses my ire by failing to do his arithmetic.

Henry Blodget:

Paul Krugman: Lost Decade, Here We Come: Where are we on this fight between Krugman (Keynesians) and Niall Ferguson, et al (who argue that our ballooning debts and deficits will kill us in the end)? In the middle. We think Krugman is right about the short-term impact "austerity" will have on the global economy, and we never hear the Tea Party and other austerity pundits acknowledge that. At the same time, we don't think Krugman has yet offered a persuasive explanation for how we're going to climb out of the gigantic debt and spending hole we're digging without serious future pain.

Two observations:

1. We are not going to get out of our long-run health-care spending overcommitments without serious future pain. The pain--in the sense of severe spending cuts relative to baseline or tax increases--is already baked into the cake.




2. Whether we spend an extra $100 billion more (or less) this year on anti-recession measures is unimportant--is less than rounding error--in the long-term budget context.

Let's do the math:

Spend $1 billion today. Use the Treasury to borrow the money for 10 years at 3.20%. Expected inflation at 2 1/2% means that the real interest charges on the borrowing are only $7 million a year. And in 25 years the real American economy will be twice it's current size, and so the burden of raising taxes to actually pay off the debt will be half as big as it is today.

We do have enormous long-run deficit problems. They are not the result of any future difficulty in paying off what we are borrowing today. They will be the result of the enormous medical scare care spending that we have put in train for the 2020s, 2030s, and 2040s. To wonder how we will pay off the debt we are currently accumulating is to fundamentally misunderstand the situation we are in.

Suppose that we make decisions over the next two decades that mean that our current regime of excess Medicare and Medicaid spending growth--growth over and above inflation plus the growth in the real economy--ends not in 2030 but in 2031. Then the impact of those decisions will be to raise needed taxes in 2031 and every year thereafter by $70 billion a year. $70 billion--$7 million. A factor of 10,000. The effect on long-term budget sustainability of long-run health-care spending decisions is thousands and thousands of times greater than the effect of short-term recession-fighting fiscal stimulus decisions.

Why, then, do people talk as if not spending money fighting the recession now will materially ease the problem of getting our fiscal house in order? First of all, because they have not done the math.

But, Blodget might ask, what if interest rates spike? What if the real interest payment on $1 billion of government debt jumps from $7 million to $50 million a year, or even more?

It's unlikely--certainly nobody is betting on a spike in U.S. interest rates over any horizon priced into the observable yield curve. But it could happen. And then we would have a problem.

Since we are a reserve fiat currency it is almost surely our creditors' problem and not ours, but it is a problem. However, we have a bigger problem right now: 10% unemployment, five percentage points higher than it needs to be, something like $120 billion every month of wealth thrown away via unusued capacity and idle workers. Failing to do everything you can to solve a big problem now because the solution might--but probably won't--set us up for a smaller problem later does not seem to me to be wise policy. My answer would be different if the yield curve were flashing red, or even yellow. But it isn't.

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