Inflation vs deflation.
The key argument with the people pointing to deflation as a result of this recession is the velocity of money. Quite frankly, it's a darn good one. They argue that for inflation to occur, you not only need an influx of money, but you need the velocity of that money to change hands in the system to be at least what it was before the money was added. If the speed it goes through the system slows, so does the inflationary impact. We definitely have a huge increase in the amount of money, but we aren't seeing inflation?
The fact is that the money that we pumped into the system did little to help the economy recover. It did stop the bleeding, so to speak, for the time being. A lot of that money sits in the hands of the banks right now. Instead of making loans with it, they are hoarding it to offset future losses. This hoarding of money from the banks is also helping to slow the velocity of money. "But what about the stimulus package?", you ask. Well the theory of stimulus should have accelerated the velocity of money by creating jobs and easing state hardships. It usually concentrates on infrastructure as well, so it helps the basic materials companies, builders and heavy machinery companies. We spent our stimulus package on pork though. I'm sorry, but a Tea-pot museum in North Carolina, or an arrow subsidy isn't gonna create a lot of jobs, help the states, or cyclical industry. It will help some politicians buy villas in Spain, but they usually wait till they are out of office to buy those. Most politicians need the money to cool off for a while, so they hoard it, slowing the velocity of money again.
Now the deflationists say that the beauty of quantitative easing is already taking shape and the banks are paying back tarp money and therefore taking money out of the system, and they are right to an extent. If this is true, even if the velocity of money increases, it would have to increase at a rate that is faster than the money is leaving the system, and if not, the economy has gone full circle.
I'm now going to say something that will contradict a lot of my other posts...
There will be deflation!
Now before you get all excited, it won't be here! A lot of the world will experience deflation, but it's mainly due to our inflation. There will be a shake-up of global economies and a new world order. A few countries will get ahead in the game and a lot of countries will lose ground. 5 countries I'm looking at as possible winners are Canada, Germany, Japan, Australia, and Brazil.
Why did I give you such a good example for deflation and then fall back to my same old inflation play?
1) We still didn't fix anything! Our citizens are still in debt to our eyeballs and we haven't saved anything. Some people argue that the savings rate has shot up drastically, but the measurment of savings makes it look better when we pay down debt. We have been paying down debt and that is a good thing, but we have also have had a ton of foreclosures. Foreclosures artifically remove debt from the system and inflate savings measurements. The consumer goes from building equity with a house payment, to paying rent. This puts the consumer in a poorer posistion even when our measurements point to an easing on the consumer.
2) Get used to the term, "Jobless recovery". You'll start hearing it a lot soon. I know it sounds like an oxymoron, but it is possible. I don't want to spoil further statements, so I'll save the details to later in this post, but the statement itself is inflationary. The more you hear it, the more inflation you're gonna get.
3) The working man. Here lies the second biggest problem! If we don't create jobs, the largest part of the consumer base can't spend money. Deflationists are reading this right now and thinking I'm proving their point for them. Again, with the velocity of money slowing, it should point to deflation. But, they are missing a not so small detail. The working man happens to be this particular president's voting base. They are a vocal voting base and these are the majority of people out of work. In November of last year, President Bush extended un-employment benefits 3 months. The crash was in October though, and the people that lost their jobs in October will have benefits expiring this month. The people that lost their unemployment benefits will increase every month after this one until at least November and probably more like January 2010. November is 9 months after the March Rally but most investors weren't confident of the rally until May. The romance with voters should be rubbing off this month. Expect to see news stories with "I can't feed my children" to hit papers soon. President Obama has no choice but to print money for these people and they will spend it all as quick as they recieve it and ask for more. Here's the first step in increasing money velocity.
4) Investment money on the sidelines. This is actually the biggest problem. Again the more you hear the words "jobless recovery" the worse it's going to be. Institutional investors simply have to invest money. They are hoarding cash now, because they believe that we haven't hit a bottom yet. If you take a look at the VIX, it's been at low volume for quite a long time. The problem that exists is when these funds start to jump back into the system the velocity of money will skyrocket. If you really want to see the velocity of money, it's going to hit light speed as soon as the institutionals get confident! These aren't hedge funds, these are mutual funds. When they invest it will have an inflationary impact that the deserted hedge funds can't keep up with.
5) The jobless people will cause another even bigger hit on the banks. When unemployment runs out, there will be a bigger hit on foreclosures. Some banks that were returning TARP funds will have to ask for a second round. The government will have to print this money on top of the money that they had to hand out to the jobless to begin with.
6) The returned TARP money won't be burned! The goverment has either borrowed this money from a foreign government or our future tax dollars. They should burn it, but history has proven that they will spend it somewhere else, especially in a democratic economy.
7) Global deflation. A lot of other countries placed bets on our continued ability to consume. This is a bubble that has to be corrected. China will take a big hit, but will still have slightly positive growth in a global Economy. The European countries will take the biggest hit and some might take a Japan length of time to recover. In my opinion, the UK, France, Ireland, Iceland, most of the independents from the Soviet block, and Switzerland lose in this scenario. Mexico will hit third world status again, and France will flirt with it.
8) Keysian economics will save the day in the end! We will hit hyper-inflation eventually, but once we hit this point, Keysian basics can carry us out of it. We will lose the title of being the global economic super power, but we won't fall as hard as Japan did. Our population will insure that we don't get the title back any time soon though. I'm betting that one of the commodity based economys takes over in the short term, but they all have their own flaws. Long term, I'm thinking that one of the tax havens not named Switzerland wins. Switzerland's loans killed them. Is anyone ready for a super power named Nevis?
I'm just a lonely squirell out there in the world, trying to find a nut. The only nuts I seem to find though are squirells with the opposite opinion.