Join        Login             Stock Quote

The Third Way In The Inflation/Deflation Debate

 April 17, 2009 05:41 PM

The inflation vs. deflation call may well be the call of the decade for investment policy. On one side are the inflationists, who argue that all this fiscal and monetary stimulus is bound to create inflationary pressures once the world economy begins to recover. On the other side are the deflationists, who argue that the de-leveraging process has unleashed powerful deflationary forces.

There may be a Third Way out of this debate – and that Third Way is even more scary than either of the scenarios contemplated by the two factions.

Do you believe Warren Buffett?
The conventional economic view is exemplified by the likes Warren Buffett. In his latest letter to Berkshire shareholders, he wrote (emphasis mine):

This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone "all in." Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation.

The Federal Reserve is well aware of these concerns. In a speech on April 14, 2009, Ben Bernanke stated that:

I can assure you that monetary policy makers are fully committed to acting as needed to withdraw on a timely basis the extraordinary support now being provided to the economy, and we are confident in our ability to do so.

Avner Mandelman of Giraffe Capital suggested that the Obama Administration is positioning Paul Volcker in the wings for a liquidity mop-up once the financial crisis is over. It is unclear, however, how much political will there is to take the pain once it is clear that an economic recovery has begun.

Deflationists: Proof by counterexpample
When I went to school back in the Dark Ages, math classes had a technique of "proof by counterexample". Conventional wisdom holds that all this stimulus is going to result in inflation some time down the road.

Japan is the proof by counterexample. During the Lost Decade, the Japanese government spent like crazy and the BoJ adopted a policy of quantitative easing. Debt to GDP ballooned. The government built roads to nowhere. Yet the economy didn't recover.

One of the leaders of this deflationist movement is Richard Koo, whose webcast is long but well worth watching. He argues that as long as government spending displaces consumer spending (because consumers are saving and not spending), there will be no inflation. The appropriate policy in this case, according to Koo, is for government to spend until it hurts and spend some more.

The Third Way: Down the hyperinflation road?
Simon Johnson, formerly of the IMF, wrote a disturbing article about the current financial crisis that compares past emerging market crises to the current one (emphasis mine):

(T)o IMF officials, all of these crises looked depressingly similar.

Next Page >>123


Comments Closed

rss feed

Latest Stories

article imageTackling China's Debt Problem: Can Debt-Equity Conversions Help?

China’s high and rising corporate debt problem and how best to address it has received much attention read on...

article imageWill Job Growth Kill The Bear-Market Signal For Stocks?

It’s all about jobs now. Actually, it’s always been about jobs. But the stakes are even higher—perhaps more read on...

article imageAutomating Ourselves To Unemployment

In this current era of central planning, malincentives abound. We raced to frack as fast we could for the read on...

article imageFed: Waiting For June… Or Godot?

The Federal Reserve left interest rates unchanged yesterday, as widely expected. But the possibility of a read on...

Popular Articles

Daily Sector Scan
Partner Center

Related Articles:

Automating Ourselves To Unemployment
More Articles on: Finance

Fundamental data is provided by Zacks Investment Research, and Commentary, news and Press Releases provided by YellowBrix and Quotemedia.
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. iStockAnalyst.com is not an investment adviser and does not provide, endorse or review any information or data contained herein.
The blog articles are opinions by respective blogger. By using this site you are agreeing to terms and conditions posted on respective bloggers' website.
The postings/comments on the site may or may not be from reliable sources. Neither iStockAnalyst nor any of its independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. You are solely responsible for the investment decisions made by you and the consequences resulting therefrom. By accessing the iStockAnalyst.com site, you agree not to redistribute the information found therein.
The sector scan is based on 15-30 minutes delayed data. The Pattern scan is based on EOD data.