Which-flation?

So it seems as if the mainstream press is finally waking up to the deflation story. Marketwatch had the following headline on Monday: “Price Rollback in U.S. Economy.”  This morning, the producer price index (PPI) registered at -0.1% (that’s right, there is a negative sign in front of the 0.1%) and confirmed that contrary to the rhetoric, the unprecedented combination of aggressive monetary policy at the Fed and deficit spending by the government, rather than contributing to substantial upward pressure on prices, have merely maintained a floor under asset prices.  This was done in an effort to prevent a more viscous deflationary cycle than what we saw immediately preceding and following the Lehman Brothers collapse.  Sure enough, these policies have accomplished much by way of stabilizing the economy and increasing investor confidence to the point where “cash on the sidelines” really did step back into U.S. markets and little by way of increasing aggregate price levels.

Yet despite both the ailment and remedy confirming the true nature of our “problem,” characters like  Marc Faber to grab headlines (I don’t mean character in a condescending way, I am more alluding to his combination of smarts, charisma and an awesome accent in creating an appealing television persona) with warnings of Weimar-style inflation and wheelbarrows of cash.  Just this week Brandon was sent a Youtube video with a supposedly impressive and thoughtful take on why inflation was inevitable (read his smackdown of that video here).  Yes inflation is inevitable.  If we do not end up with inflation, then the Fed’s policies did not accomplish their goal.  The more relevant question is when and what form that inflation will take.

Aggregate debt levels in the U.S. have not increased during the crisis.  Instead, they have merely shifted from the private sector to the public sector.  This is incredibly consequential in that it is ultimately the public sector providing a floor under asset prices in the private sector (and yes, there is an element of Robin Hood in reverse with these tactics, considering the fact that asset ownership in the U.S. is so concentrated in the hands of a few), but it is not the massive undertaking of new debt.  The seeds of troubles from our nation’s debt-load were not sown by the government initiative in fighting deflation, but rather in the private sector bubble of credit that exploded in the 2000s.  The interrelation of global markets, asset classes and price levels will continue to put further downward pressure on prices in the United States.  Europe’s woes in particular have led to a plunge in the price of oil and copper–two very important input resources.

Anyone who tries to directly compare the United States to Weimar Germany, Greece, Zimbabwe or Japan in the deflationary camp are failing to acknowledge some key distinctions.  Unlike any of these other examples, the U.S. prints its own money, which is the world’s reserve currency (this makes up for the lack of domestic savings that has enabled Japan’s multi-decade battle with deflation), and its debt is denominated in its own currency.  If you want to read more about why I think we will not have Weimar-style inflation, take a look at my past writeup.  In this particular discussion I want to take a little different angle on the issue considering how strongly the facts and numbers confirm the deflationary argument.

More and more, the argument about the weakness of fiat currency and/or the inevitability of hyperinflation in the United States is based on ideological and partisan divisions rather than on real economic analysis.  The hyperinflationists often believe in a laissez-faire economic policies, with minimal regulation, a small government and an overall weak social contract between the government and its people.  These economic scare tactics are being used to influence policy decisions and unfortunately that campaign taking its toll on policy-makers.  We should take these statements for what they are worth and stopping building them up into something they are not.  When the word hyperinflation is invoked, everyone should take a step back and think “what policy position is the declarant and from which political camp is he making his point?”

At times I have been critical of the Obama Administration for its continuity of some of the Bush Administration’s policies; however, in the aggregate, I do believe they have done an excellent job of containing the economic crisis and mitigating its impact with prudent and timely policy decision in a difficult partisan environment.  These measures include the stimulus to kick start investment in the economy and the health care plan to provide a safety-net for people caught in the eye of a catastrophic economic storm.  Somehow the majority of  public discourse seems to focus on the problems that will result from these policy decisions, rather than the far more dire consequences of inaction and a deflationary spiral snowballing in the short-term.

A common refrain from the hyperinflationist camp is that we are just “delaying the inevitable” with government intervention.  One fact that should be abundantly clear from this crisis is that when you buy time, you also afford yourself the opportunity to make BETTER decisions.  The costs of the Greece Bondholder Bailout (on AZ, this will not be called the Greece bailout, as it is a TWO-SIDED AFFAIR) steadily increased as the depths of the panic increased.  When trying to make high-stakes decisions in the middle of an emotional panic, it is nearly impossible to make clear-headed and coherent choices (just think about the conception and evolution of TARP over time).

With slowing the pace of deflation we are affording ourselves the time necessary to adopt policies that can make a real difference in repairing some of the ailments afflicting our economy at this time.  We can’t accomplish some of these important goals in the middle of a panic.  America needs to focus on developing a product for export abroad.  In order to cut our deficit, we need to increase our exports and the primary product we have is American ingenuity.  The relative strength and health of the technology and biotech sectors over the last two years make me increasingly optimistic about our ability to overcome this financial crisis and once again inflate our economy.  Money is starting to flow into the areas that deserve our investment and this should lead to some sort of snowballing efect.  Before I get too long-winded on this particular line of thinking (I will definitely revisit shortly), if things do accelerate on the deflationary side of the coin, it will be in our interest to continue the shift of money out of the financial sector and into cutting edge innovation.