Deflation, Inflation: Take Your Pick

U.S. stock markets rallied to recent highs on news that the U.S. Federal Reserve planned to pump up to $900 billion more cash into the economy. Financial markets reflect today’s appraisal of tomorrow’s cash flows. More cash means more flows.

Fed Chairman, Ben Bernanke, conceded early on in 2008 that the Fed was “printing money.” That candor proved unsettling. This latest cash infusion instead is “quantitative easing” or “QE2.”

“QE1” stabilized financial firms that cross-collateralized massive layers of debt and derivatives in a creative scheme that was destined to collapse without… more cash flow.

Insurance giant AIG booked profits by selling more than $440 billion in credit default swaps, a form of insurance, without setting aside reserves. That’s when the Fed stepped in with QE1.

Voicing his admiration for “financial creativity,” former Fed chair, Alan Greenspan, enabled this pyramiding of debt-on-debt with low interest rates and lax oversight during his 19-year tenure.

Greenspan concedes his high regard for Russian philosopher, Ayn Rand (né Alisa Rosenbaum), who famously wore an oversized dollar mark as a broach. Her philosophy: grant money the freedom to work its will worldwide and everything will work out just fine.

Reflecting on the debt-induced financial carnage he helped create, Greenspan recently marveled that financial markets were not, as he and Rand believed, “self correcting.” How could this True Believer have been so mistaken? Why does his successor not yet see the problem?

Answer: both men share a mindset from which the problem cannot be seen because that mindset is the filter through which they do their seeing.

This money-myopic perspective, embedded in American education over decades, first appeared in the U.S. as the “Chicago model.” The late University of Chicago Professor Milton Friedman, a Noble laureate economist, remains the patron saint of this “monetarist” perspective.

As this dollar-centric ideology was taken to global scale, it became the “Washington consensus.” Generally accepted truths are seldom revisited even when, as now, a reappraisal is long overdue.

Dollar Infatuation = Deflation or Inflation

The Fed is rightly worried that the economy is slipping into a debt-induced deflation akin to Japan’s “lost decade.” As the U.S. deleverages, it could face a similar fate. QE2 is meant to counter deflation yet it could trigger inflation. That’s the risk when banks start printing money.

WWII was triggered by an onerous reparations burden imposed on Germany at the Treaty of Versailles ending WWI. British economist John Maynard Keynes left those negotiations to publish a warning in 1919 titled The Economic Consequences of the Peace.

The resulting indignities of widespread poverty and hyper-inflation fueled a hyper-nationalism from which emerged the fascist forces that ravaged Europe. The U.S. emerged with an industrial base that ensured its bonds would become the world’s preferred gilt-edged security.

Keynes surfaced in the 1930s to advocate the debt-financed stimulation of demand. The 1980s saw a debt-financed “supply-side” successor—to stimulate investment. Both boosted cash flows.

With lower tax rates and faster depreciation, this Reagan-era ideology was projected to reduce government revenues by $872 billion over five years. With this stimulus, the former actor catalyzed a three-decade debt binge further enabled by the easy credit era of Alan Greenspan.

When Reagan was elected in 1980, securitized U.S. debt totaled $900 billion. The total is now on track to top $15.4 trillion. By 2020, annual interest payments alone could top $1 trillion.

Monetization of What for Whom?

How long before this cash infusion fuels inflation? That depends on how these Fed-boosted bank reserves are deployed. In the interim we’ll see another massive skimming of financial value from yet another Fed-inflated equity market.

By fixating on how debt-backed dollars can revive a deflating economy, those who induced the U.S. to embrace this mindset may yet induce a debilitating inflation. The year 2013 is the 100th anniversary of the Fed. The solution lies in a willingness to view the problem anew.

Who decreed debt the only way to catalyze demand? Who says all purchasing power must be limited to one-size-fits-all Federal Reserve notes? Why not encourage complementary currencies attuned to the needs of regions and communities?

Ecologically, are Americans expected to shop their way to sustainable prosperity with debt-backed dollars? Rather than debt, why not monetize the physical capital required for a clean energy economy?

Americans are witnessing record-breaking disparities in wealth and income. Why continue on the same path that enabled this fracturing of U.S. society? Why not monetize a sustainable future with means that ensure a shared prosperity?

To solve this problem, first we must acknowledge how the U.S. was induced to embrace a mindset that requires more debt to create more purchasing power.

This problem can only be solved “upstream” commencing with a candid reappraisal of its origins in a shared mindset.

Jeff Gates is author of Guilt By Association, Democracy at Risk, and The Ownership Solution. Read other articles by Jeff, or visit Jeff's website.

4 comments on this article so far ...

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  1. MichaelKenny said on December 18th, 2010 at 8:55am #

    The fundamental problem is the dollar’s role as world reserve currency, which, as far as I can see, is as big a disaster for Americans as it is for the rest of the world. The dollar’s role is what allows the US to make wars, bully governments, control the internet and prop up Israel. It underlies US political and military power. Thus, “dismantling” the dollar would seem to disserve only those whose interests are served by the continuance of one or other of those situations. Mindset is indeed a great part of that. That is, the “God’s annointed” mindset of the fundamentalist Protestants who predominate in US Christianity but are marginal to non-existent elsewhere (and its corresponding “chosen people” mindset among Jews) and the corollary of that, the “messiah” delusion, as represented by the idea of “manifest destiny”, and the broader Protestant fixation on the Old Testament and by extension, on the Jews. Thus, many Americans see themselves as the sole bearers of God’s one, true light, and as called upon by Him to spread that light to all mankind, who, naturally, will be delighted to receive it, unless, of course, they have fallen under the influence of Satan, from which they would surely ask to be freed, by force if necessary, if Satan wasn’t stopping them from doing so. Thus, the underlying logic of the American Empire is not self-interest but religious fervour. Hence the irrational clinging to dollar hegemony.

  2. Don Hawkins said on December 18th, 2010 at 9:20am #

    Rather than debt, why not monetize the physical capital required for a clean energy economy? Jeff

    It will take a lot of us.

  3. commoner3 said on December 18th, 2010 at 1:25pm #

    Michaelkenny wrote:
    “Thus, the underlying logic of the American Empire is not self-interest but religious fervour”
    May be some common folks and small town preachers think along this line, but I am sure that policy makers at the top don’t. Most of them are closet atheists or non religious at all. They use religion only to bullshit and direct the common people and as an excuse and cover for their political, military and economic plans.

  4. Deadbeat said on December 19th, 2010 at 9:03pm #

    I liked this article and found it informative. However I think we should purge the money mindset. We don’t need to go back to local currency. It caused problems the last time it was tried and with the level of mobility that exist in 2010 will cause even greater problems. We don’t need to “monetize” anything. Money is an anachronistic concept and money is mainly a tool of the powerful.

    What is needed is to eliminate the power of capital and to get rid of an economy based solely on commodity exchanges and to transform it into human exchange.

    I agree with Don that getting from here to there is the struggle but without a vision of what “there” looks like there will be no direction and no ideology. A struggle to reform the monetary system clearly is not it.