The Big Inflation Scare By PAUL KRUGMAN

[Joanne98]

Suddenly it seems as if everyone is talking about inflation. Stern opinion pieces warn that hyperinflation is just around the corner. And markets may be heeding these warnings: Interest rates on long-term government bonds are up, with fear of future inflation one possible reason for the interest-rate spike.

But does the big inflation scare make any sense? Basically, no — with one caveat I’ll get to later. And I suspect that the scare is at least partly about politics rather than economics.

First things first. It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.

So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt.

The first story is just wrong. The second could be right, but isn’t.

Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.

But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all.

Still, don’t such actions have to be inflationary sooner or later? No. The Bank of Japan, faced with economic difficulties not too different from those we face today, purchased debt on a huge scale between 1997 and 2003. What happened to consumer prices? They fell.

All in all, much of the current inflation discussion calls to mind what happened during the early years of the Great Depression when many influential people were warning about inflation even as prices plunged. As the British economist Ralph Hawtrey wrote, “Fantastic fears of inflation were expressed. That was to cry, Fire, Fire in Noah’s Flood.” And he went on, “It is after depression and unemployment have subsided that inflation becomes dangerous.”

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http://www.nytimes.com/2009/05/29/opinion/29krugman.html?_r=1&ref=opinion

[Yupster]

1. The only thing I'm pretty sure of is that

interest rates will have to rise.

There's no way the government will keep finding buyers for $ 150 billion of treasuriers every month at 2 - 3 % interest rates.

Those rates will have to go up, and that will have nasty results for our already incredible deficit.

[clixtox]

7. The US Government through the "Federal" Reserve...

Already is and has been, and will continue ...

Ponzi schemes are legal for governments.

You are correct that no "investor" would be tempted, or likely to purchase, "Treasuries".

Not much in the way of treasure worth mentioning remains.

Everything fungible and not "nailed down" has been swindled away recently.

Even our formerly gigantic (albeit undeserved and ultimately flimsy) "goodwill" asset has no current value when "marked to market".

[pscot]

2. I don't know about inflation

But the dollar has been tumbling lately, and oil and gold are both up sharply. If gas prices follow oil it will make any recovery more difficult. Regular unleaded is back up to $2.70 a gallon around here. Not a good sign.

[wuvuj]

3. The hard road ahead?

The deficit....unwinding toxic assets....peak oil-food-water...costs related to global warming....mean a long uphill climb...or a new paradigm?

So it's inflation....higher taxes...or some of each?


http://www.frontlinethoughts.com/printarticle.asp?id=mwo052909

More and more we read about the growing concern over $1-trillion-dollar deficits. Stanford professor John Taylor (creator of the famous Taylor Rule) jumped into the debate with a rather alarming op-ed in the Financial Times this week, echoing much of what I wrote last week, but with some real insights into what trillion-dollar deficits mean. Quoting:

"I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor's considers. The deficit in 2019 is expected by the CBO to be $1,200bn (859bn euros, 754bn pounds). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

"Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth -- probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession."

...

A third path would be to simply go ahead and raise taxes on the rich, say no to increased spending on programs until we can afford them, hold the line on any new spending, and see if we can reintroduce the gradual budget control that was the result of the stand-off (and to some extent cooperation) between Gingrich and Clinton.

I put about a 5% probability on the third scenario happening. Better than the chances of a snowball in hell, but not much. The first disaster scenario is about a 35% probability, which is quite scary. If we do choose such a path, then short the dollar, buy gold, and invest abroad. It will be a very tricky and difficult environment.

I assign a 60% probability to the middle path. Maybe it's my basically optimistic nature and I am simply being naive, but I am hopeful that cooler heads will prevail and we will not run continual massive deficits larger than the growth of GDP. While that means rather large tax increases, since the current leadership wants to create massive new health-care entitlements and will do so, I would rather have to simply overcome higher taxes in my business rather than deal with a collapse of the dollar, high unemployment, high interest rates, and an extremely sluggish economy.

Each scenario will create a different investment environment. Ironically, the middle scenario could be good for the dollar over the long term. But it will be hell on corporate profits from US sources. Given the above, it seems like a 95% chance that we should start looking at investing a significant percentage outside of the US and Europe. Think Canada, Australia, Asia (not Japan), Brazil, South Africa, etc.

[Yupster]

4. Yes I don't think people realize the scale

of the proposed deficits over the next 10 years.

I think people just hear deficit and feel that we've always had deficits and nothing bad's ever happened before.

The scale has changed completely though.

We used to be like a family making $ 40,000 a year who spent $ 42,000 a year. Now we're a family making $ 40,000 and spending $ 70,000 every year. Those are very different things.

The story above says we are expecting to bring in $ 2 billion in tax revenues and year after year we're expecting to spend over $ 1 billion more than we take in.

That just can't happen year after year, but that's what's being proposed and government projections always turn out to be optimistic.

[westerebus]

5. Here we go again.

Chicken or egg? We are in a period of deflation, agreed. We were handed a bill we can't pay to cover a bail out that will increase government ( read: taxpayer ) debt that will require more borrowing, agreed.

If our economic model is contracting, which it is, and you have to increase reserves ( read: expand the money supply) to maintain the balance sheets of banks that are not lending, which their not, what's left as FED/White House policy?

Monetize the debt. That's on going now. Underwrite and back stop every financial institution with few exceptions. Been there done that. Pump a stimulus infrastructure package into the economy to get it jump started. Trickling down some time in the future.

Planned inflation. That might work. FED policy was 2% inflation (growth) under normal conditions. So under abnormal condition in a deflationary period, they would do what?

The return to prosperity will come as we grow our way out of this mess. I don't have to quote who said that, do I?

So if the safe haven of US debt looks shaky, interest rates go where? What will slow the recovery more becomes the next topic for discussion? Higher interest rates or higher oil prices?

When the FED lends at ZERO percent and dollars pile up on the side lines and the economy continues to shed jobs because no one's got any confidence that a recovery will arrive any time soon, what's the incentive to buy more US debt?

When too much money chases to few goods, what do you get?

Can you say: inflation.

[roamer65]

6. Krugman: It's called monetary inflation.

You double the money supply and the currency is devalued by half. Doesn't matter who is holding the money and the Fed is not going to remove it from the system. Monetary inflation is the tax we are all going to pay in order to try to fix this crisis.

[Odin2005]

8. The Libertarian nit-wits and anti-Fed conspiracy nuts are always screaming "Inflation".

The fear of inflation is based on ignorance (OMG, they are printing money!!!), paranoia (More proof that the Fed is a conspiracy by Jewish bankers!!!), and Austrian School Gold-Bug ideology.

[Art_from_Ark]

10. The fear of inflation is NOT based on ignorance

at least, for those of us who have witnessed it with our own eyes.

In 1968, in my hometown:
An ice cream cone (from an ice cream truck) cost 10 cents.
A 10-ounce bottle of soda cost 10 cents
A gallon of gasoline cost 25 cents (and was sometimes as low as 19 cents during "gas wars")
A semester's tuition at the local state university was about $200
Visits to the doctor were $5 or sometimes less
It cost just 6 cents to mail a letter
A full loaf of bread could be had for as little as 10 cents (on sale). The regular price was 19 cents.
Saturday movie matinees were 25 cents
It also cost just 25 cents to get into the public swimming pool.
A fairly decent house in my neighborhood (very close to schools and downtown shopping) could be bought for $10,000
A retirement nest egg of $30,000 was considered to be quite comfortable
There was a mailman on TV bragging about how he had been able to save $300 in one year by buying US Savings Bonds

Today, the prices of all those things are multiples of what they were 40 years ago, often 10 times or more. In other words, in 40 years, the cumulative inflation rate for most of these things has been 1000% or more. And while the prices of some things like electronics have come down, the overall trend is for continuously increasing prices for goods and services that cannot be outsourced.

[Psephos]

9. Prices aren't rising? Apparently he doesn't drive a car. n/t