Monday, January 12, 2009

More on the Deflation vs. Inflation Debate

What a crazy NFL playoff weekend! Only one home team won their game in the divisional round. The Baltimore Ravens have the same look that took them to a Superbowl win in 2000. The Phoenix Cardinals look like an entirely different team. Who knows what is going to happen this weekend, but I am sure it will be fun.

When Transparency Collides with Systemic Risk
If you can recall so far back as this Fall Treasury head Hank Paulson stated that the threat of having a "bazooka" in terms of money to bail out the financial system would be enough to smooth things over. Then we got his 3 page letter asking for an actual bazooka of 700 Billion dollars! While Congress did something at least mildly smart in only handing over half of the cash up front, Paulson said he probably would not need the other half anyway.

And so today we are informed that the president elect Barack Obama has asked Mr. Bush to request the 350 Billion from Congress so the money will be warm and ready to go when Obama takes office. That is quite a journey, but you knew we would end up here, didn't you?

Leaving aside the debate about whether the money should be released (we do not debate anymore, just act FAST!) I would point your attention to a more baloney being spoken by the incoming president who seems on a mission to become as much of a failure economically as the last guy. From Yahoo Finance:
Obama promises changes in use of bailout billions
Monday January 12, 4:26 pm ET
By Andrew Taylor and Jim Kuhnhenn, Associated Press Writers
Obama pledges to change goals of bailout as Bush agrees to ask for remaining $350 billion
WASHINGTON (AP) -- Seeking to reassure wary lawmakers, President-elect Barack Obama said Monday he will fundamentally change the way the second half of the $700 billion financial bailout fund is spent, focusing some of the relief on housing and small businesses.
Obama asked President George W. Bush to submit a request to Congress so that the remaining $350 billion would be available quickly after the inauguration next Tuesday. Bush agreed to do so.
"I think many of us have been disappointed with the absence of clarity, the lack of transparency," Obama told reporters after a meeting with Mexico's president, Felipe Calderon. He said some of the money should have been spent on helping people avoid foreclosure.
"It is clear that the financial system, although improved from where it was in September, is still fragile," Obama said.
Separately, Larry Summers, Obama's choice for National Economic Council director, said the new president intends to broaden the goals of the remaining bailout package and impose tougher restrictions and oversight on how the money is spent.
Earlier Monday, Bush told reporters he would not make a request for the money form Congress unless Obama "specifically asked me to make it." Obama called Bush at 10:25 a.m. EST, after Bush's news conference ended, Obama transition officials said.
Bush's assertion that the decision to tap the money rests with Obama was an acknowledgment of what has been an extraordinary ceding of power to the incoming administration. Bush in recent weeks has let Obama be the driving force behind most recovery efforts.
A vote in Congress is likely soon, possibly this week, several senators said after a briefing from Summers Sunday on the Wall Street bailout, as well as on Obama's separate plan for roughly $800 billion more in spending and tax breaks to spur the economy.
At his news conference, Bush said, "I readily concede I chucked aside some of my free market principles when I was told by chief economic advisers that the situation we were facing could be worse than the Great Depression."
But he credited the program so far with improving the credit environment, saying that "lending is just beginning to pick up."

I have a question: How is there going to be more clarity and transparency with the second half of the TARP funds when after two lawsuits to get information have been unable to pry any data out of the FED or the Treasury? Mr. Paulson and Mr. Bernanke have both said that to tell where the money is going could pose a "systemic risk" for those institutions that have been given free cash.

So what will win out in the battle of transparency versus systemic risk? I am going to bet on systemic risk here. We will never get details on where the money was poured until way, way later. I imagine it does not matter, just assume every bank and almost any corporation has their hands in that pie and you will be about right. Mr. Obama and others in Congress want to spend the money directly by "stopping foreclosures". How many houses does 350 Billion buy anyway?

Powerful Essay on Deflation Versus Inflation
Over at The Mess That Greenspan Made today Tim Iacono excerpts and links to a wonderful piece by Rich Toscano and John Simon of Pacific Capital Associates. The entire post is a must read if you want to see both sides of the deflation/inflation debate. The logic and reason of the article is very persuasive.

I have been of the mind that the US government is in a panic stage. Deflation terrifies central banks like nothing else it seems. The policy moves to this point have not worked as yet, but there are more tricks on the way. I highly recommend the entire article as a good slow read. Full link here.

There is too much great stuff to excerpt, but I will present their summation:
We in the United States have been dumping our dollars into the world for years and we continue to do so. We owe a staggering amount of foreign debt denominated in dollars and we are gearing up to borrow even more. Our legislators and the stewards of our currency are rabidly hostile to deflation -- they are hostile, in other words, to the idea of the dollar gaining purchasing power. They have shown via word and deed that they will do whatever it takes to prevent deflation from taking hold. When deflation is viewed as even a remote possibility, there are effectively no limits to the amount of money the government can create nor to what they can do with that newly minted money.
Under these circumstances, we just don't believe that the dollar is going to gain purchasing power in any sustainable way. The current deflationary storm could continue for a while yet, but the longer it goes on, the more violent and severe its reversal is likely to be.
Deflation is a choice within the current monetary regime. It is a choice that our government has shown it will not make. There are serious long-term risks inherent in our dysfunctional monetary system, to be sure -- but deflation isn't one of them.

Again, read the whole thing. Leave your thoughts on the debate in the comments section.

Have a good night.


watchtower said...

The inflation vs deflation debate is over in my mind, I'm gearing up for an extreme debasement of the USD or possibly a full on currency collapse.

Because that's just how I roll.

getyourselfconnected said...

I hear you. The article I referenced goes over in detail the Ben Bernanke "helicopter" speech as well as the now accepted "money printing" fall back. As the world seems to be on board I guess we realy can make as much money as we please. Stick that in your economic pipe and smoke it Krugman!

Rob Dawg said...

The Phoenix Cardinals look like an entirely different team.

Word. Almost like the Patriots of a few years ago where everyone did their job. Besides, Phoenix needs anything it can hold onto for hope.

The prospect of deflation is not influenced one whit by the fact that the Fed is afraid of it. Likewise the inevitability of inflating away our debt is not avoidable. We can no more prevent short term deflation than we can avoid long term inflation. One caveat, very little wage inflation as part of the global wage leveling and those most affected won't even understand.

GawainsGhost said...

Even more interesting was an article over at naked capitalism on Irving Fisher's theory of the cause of the Great Depression. Basically, Fisher boiled it down to over indebtedness followed by deflation.

This is why the government is so fearful of deflation, because the entire country is up to its eyeballs in debt. The problem is that the government's solution is to create even more debt, mountains of it.

I really don't see how this situation is going to end well.

That's why I voted against every incumbent. These people in office, either they're responsible for getting us into this mess, or they're responsible for not getting us out of it. Either way, I want them gone.

Anonymous said...

The Toscano article is informative only in the sense that it displays the delusionary ideas of writers who do not understand money. Plus, their conclusions about Japan vs. USA are just plain stupid.

What the Toscanos of the world don't understand is this: value is relative. Give me a $100k money gift, and I am going to pay off my fixed rate loans. Then, I will sell the properties to my newly enriched neighbors for a fantastic profit. Because all prices will immediately go up in a "debased money" scenario. Think the banks who made those fixed rate loans are going to like that?

Denninger is oft overwrought and long-winded. However, he has a definitive take on the deflation question. Link:

Anonymous said...

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Anonymous said...

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And according to this article, I totally agree with your opinion, but only this time! :)