Is the Federal Reserve Blind To Deflation?

Recently there has been some talk by a few members of the Federal Reserve Board that there may be deflation in our future. Federal Reserve voting member James Bullard recently released a paper revealing that the U.S. risks the potential of falling into a Japan-like deflation period.

I agree with him.

As a result of his analysis, Bullard gave a solution if signs of deflation started to appear by stating, “the U.S. quantitative easing program may be the best tool to avoid the low nominal interest rate, deflationary outcome.”

This, of course, I do not agree with.

Boston Federal Reserve President Eric S. Rosengren says that while not anticipating we will be in a deflationary period, it’s a risk that he does take seriously. He said, “A heightened risk of deflation is something that we should react to.”

And react they will. Head Fed cheerleader, Ben Bernanke has been quite clear on this.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

The fact that he even relates the U.S. dollar as equal to gold by saying “like gold,” could be the subject of a future article, but what he’s hinting at, is that he believes the Fed can fight deflation with the printing of money. The question is, how much money can they print without causing people to lose faith in the monetary system? Additionally,  for the Fed now, is will they be able to do enough printing to stimulate the economy?

They think they can. I think they can not.

The system has already had trillions pumped into it yet it has done nothing to stimulate the economy.

But understand, this is the minority view at the Federal Reserve. Most of the members don’t see any signs of deflation. Of course these are the members who react to problems AFTER they occur.

From the NY Times:

Thomas M. Hoenig, president of the Kansas City Fed and an inflation hawk, said in an interview Thursday that the comparisons to Japan were overstated. He likened the debate to the situation in mid-2003, when a sluggish recovery from the 2001 recession prompted predictions of deflation that did not come to pass. “I don’t think we should find ourselves picking up every piece of short-term data and jumping to conclusions,” he said.

Hoenig states that the U.S. comparisons to Japan are overstated. I’m going to send him my article Is the U.S. Following in Japan’s Deflationary Footsteps?

While Hoenig laments looking at short-term data and jumping to conclusions, my analysis goes back to the beginning of the Japanese deflation and compares where they were then to where the U.S. is today with their episode of deflationary credit contraction. The similarities are quite remarkable.

More importantly, the fact that Japan’s Debt to GDP ratio is the largest in the world, at 227% shows that the Fed has a lot of debt creation wiggle room to catch up to the Japanese example. I believe the Yen will crack up sooner than later because of it, but so far it has been quite resistant to any government stimulus.

I’ve written to the Fed before when Dallas President Richard Fisher was the lone dissenter in lowering interest rates during one of the votes last year. I do know they reply to inquiries as Fisher did respond in thanking me “for my astute observations.” Of course he proceeded from that point forward to vote with the rest of the board to lower interest rates. Fisher must have just caved in to the rest of the Keynesian clowns as Mish Shedlock calls them.

More from the NY Times:

“I think the fear of deflation in and of itself is probably overblown,” Charles I. Plosser, president of the Philadelphia Fed, said last week. He said that inflation expectations were “well anchored” and noted that $1 trillion in bank reserves was sitting at the Fed. “It’s hard to imagine with that much money sitting around, you would have a prolonged period of deflation,” he said. And Richard W. Fisher, president of the Dallas Fed, said this week, “Reasonable people can argue that there’s a risk of deflation, but we haven’t seen it in the numbers yet.”

The fact of the matter is, the $1 trillion that is “just sitting there” that Plosser speaks of, is small potatoes compared to the multiple trillions of credit unwinding and being defaulted upon. It’s like the ant trying to fend off an elephant.

And what numbers is Fisher not seeing that everyone else is? Remember, the Fed’s definition of deflation is falling prices, wrong as it is. Twenty three days ago I wrote Are We Experiencing Deflation? giving the proper definition of deflation, from an Austrian Economic point of view, and showing how prices were falling and have been for a a few months.

Since writing that article, prices continue to fall led by consumer prices which fell  for the third straight month.

Sign Sign everywhere a sign
Blocking out the scenery breaking my mind
Do this, don’t do that, can’t you read the sign
-Five Man Electrical Band

Evidently the Federal Reserve is Blind to the signs of Deflation.

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About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534


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About Doug Eberhardt
Doug Eberhardt is 20 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how to buy gold and silver, what metals to buy, how gold and silver fit into a diversified portfolio as well as exposing the gold dealers tactics to separate you from your money. The book; “Buy Gold and Silver Safely” is available by clicking here. Doug can be reached at 888-604-6534
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