The deflation time bomb

Published on Online Journal, by Mike Whitney, Jan 14, 2008.

… Last week, the Federal Reserve announced that it will increase the size of two scheduled auctions of emergency loans by 50 percent to $30 billion as part of a global attempt by central bankers to restore faith in the money markets. [AP] In other words, the Fed will provide an even bigger begging bowl to prop up the banks to maintain the appearance of solvency. It is an utter sham.

Inflation vs. deflation:

The size and scale of the approaching recession is impossible to forecast. The real estate and stock markets will undoubtedly see trillions of dollars in losses, but what about the estimated $300 trillion dollars of derivatives, credit default swaps and other abstruse counterparty options? Will the global economy freeze up when that ocean of cyber-capital suddenly evaporates? Will that virtual wealth simply vanish into the ether when the underlying assets (CDOs, MBSes, ABCP) are downgraded to pennies on the dollar, or when the number of home foreclosures catapults into the millions, or when the dollar slips to a fraction of its current value? No one really knows.


But Atlanta Fed President Dennis Lockhart summarized what we can expect in a speech he gave last week, titled The Economy in 2008.? He said, ?A sober assessment of risks must take account of the possibility of protracted financial market instability together with weakening housing prices, volatile and high energy prices, continued dollar depreciation, and elevated inflation.

Amen.

What the upcoming recession will look like has been the topic of a fierce debate on the Internet. Everyone seems to agree that this is not a typical economic downturn resulting from overproduction, under-consumption or malinvestment. Rather, it is the crashing of humongous equity bubbles that were generated by the Fed’s abusive expansion of credit and the unprecedented proliferation of opaque structured-debt instruments. Many believe that the unwinding of these bubbles will trigger a round of hyperinflation, which is already evident in soaring food, energy and health care costs. These prices are bound to increase substantially as the Fed continues to cut rates and further undermine the dollar …

… Summary: When banks don’t lend and consumers don’t borrow; the economy crashes. End of story. The whole system is predicated on the prudent use of credit. That system is now in terminal distress. Everyone to the bunkers.

Perhaps the whole inflation-deflation debate is academic. The real issue is the length and severity of the impending recession. That’s what we really want to know. And how many people will needlessly suffer.

Mike Whitney lives in Washington state. He can be reached by mail.

Comments are closed.