Want to Fight deflation? Give a worker a raise

Linked with Mike Whitney – USA (the American writer).

Published on Global Research.ca, by Mike Whitney, September 10, 2009.

The slight rebound in housing looks a lot different when one considers how much the Fed is meddling in the market. Fed chair Ben Bernanke has purchased $240 billion in US Treasuries to keep long-term interest rates artificially low while–at the same time–buying $740 billion in Fannie Mae and Freddie Mac mortgage-backed securities (MBS) to provide the financing for new home buyers. It’s the double-whammy; and that’s not all. Bernanke plans to continue buying agency MBS (monetization) until he reaches $1.45 trillion, which will make Uncle Sam the biggest player in the housing market by far. How’s that for central planning? 

Ironically, the funds for Bernanke’s housing market rescue plan were never approved by Congress, which means that the Fed committed nearly-$2 trillion with “no down” payment. That makes the Fed’s Treasury buyback program the biggest subprime loan of all time.

The fact is, all the recent gains in home sales are all the result of direct government intervention. If interest rates were allowed to rise (as the would naturally) or if Congress withdrew its $8,000 first-time home-buyer subsidy, or if FHA tightened its loosey-goosey financing (which requires just 3.5% down payment and low FICO scores, the same as subprime!) home prices and sales would continue to drop at a 10 to 15 percent year-over-year rate. Housing has stopped plummeting for one reason alone; the Fed bought the market …

… John Bellamy Foster: “But the real fear of deflation has to do with the enormously bloated financial structure and the huge debt load of the economy… In a deflationary economy, debt has to be paid back with bigger dollars (worth more over time). This then creates a debt-deflation spiral, enormously accelerating financial meltdown. As Fisher put it, “deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debt cannot keep up with the fall of prices which it causes.” Stated differently, quoting from The Great Financial Crisis (p. 116), “prices fall as debtors sell assets to pay their debts, and as prices fall the remaining debts must be repaid in dollars more valuable than the ones borrowed, causing more defaults, leading to yet lower prices, and thus a deflationary spiral.” (Interview of John Bellamy Foster on the Great Financial Crisis, Monthly Review).

It is this “deflationary spiral” that Bernanke is trying to avoid at all cost, even if he destroys the currency in the process. (Which he appears to be doing) Despite the Fed chairman’s steely resolve, the economy has continued its historic nosedive. Consumer spending is falling and households are limiting themselves to the bare essentials. (US households lost $14 trillion in wealth in the last year alone.) Families everywhere are paring back their credit, paying down their debts and rebuilding their nest eggs with what’s left from their skimpy paychecks. Unfortunately, what’s good for the family balance sheet is poison for the economy.

From Bloomberg News: “U.S. consumer credit plunged more than five times as much as forecast in July as banks maintained more restrictive lending terms and job losses made households reluctant to borrow.

Consumer credit fell by a record $21.6 billion, or 10 percent at an annual rate, to $2.5 trillion, according to a Federal Reserve report released today in Washington. Credit dropped by $15.5 billion in June, more than previously estimated. Credit fell for a sixth month, the longest series of declines since 1991. (Bloomberg)

US households and consumers have never been as strapped as they are today. They’re dealing with recession the only way they can, by pulling back and hunkering down. That will make it even harder for Bernanke to resuscitate the economy. There’s simply no way to force people to borrow when they’re not interested.

Bernanke’s deflation-fighting strategy needs to be revamped. The country doesn’t need another credit bubble. The surge in delinquencies, defaults and personal bankruptcies all suggest that the era of easy money and lax lending standards is over. Why not “hang it up” for good. The Fed should be focused on rebuilding the economy from the ground up, paying particular attention to aggregate demand. Demand is what keeps the mighty GDP-flywheel in motion. Wall Street likes to stimulate demand through credit expansion and bubblenomics so they can skim fat bonuses on the front end and then bail out before stocks crash. But this perennial “boom and bust” cycle get’s old for ordinary working people, who just want a little stability and a paycheck that keeps pace with inflation. The best way to avoid “demand shock”–which is at the heart of every recession–is through wage growth and full employment. It’s that simple. When workers get better pay, they buy more more stuff and the economy thrives. Everybody wins! (full text).

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