That Deflated Feeling

Hey look, after folks like myself and the Kroog and Roubini and anyone who's been paying attention to the economic situation at hand here, even the Wall Street Journal's cementheads have figured out that the problem is not inflation, it's deflation and it always has been.

Deflation makes it harder for consumers, businesses and governments to pay off debts. Principal repayments on debt are fixed but deflation is marked by falling incomes, so as deflation sets in the burden of paying off old debts gets greater.

Officials fret about deflation because it is hard to stop. Interest rates are already near zero in the U.S. and elsewhere, so policy makers can't use the traditional tool of rate cuts to spur growth and stop deflation.

That's an acute worry today. In addition to government debt, U.S. households are still trying to work off large debt burdens built up in the last two decades. A Federal Reserve report Thursday showed households cut their borrowings in the first quarter to $13.5 trillion, down from a peak of $13.9 trillion in 2008.

One leading indicator, Ireland, which has already experienced deflation amid severe fiscal austerity, reported Thursday that consumer prices were down 1.1% from a year earlier in May, though the declines have moderated in the past few months.

In the U.S. the threat looks more remote, but economists are beginning to warn that if the recovery falters, the risk of a deflation bout will increase.

In one sign of rising alertness to the threat, yields on 10-year Treasury bonds—which fall when inflation worries recede and rise when inflation worries increase—have dropped from nearly 4% in early April to about 3.3%.

We can't cut interest rates to stimulate the economy because we're already at zero.  Demand is dropping due to increasing unemployment.  Increasing unemployment is making people nervous and they are buying less stuff...hence a decrease in demand, prices have to be pushed down, and deflation rears its ugly head.

We're at the point where government spending to defibrillate the economy is the last resort.  Yes, this will mean raising short-term deficits.  We have to put money back into the economy because so much wealth has been removed by falling real estate prices and the banks losing trillions more playing the Big Casino.  This is going to mean more spending is necessary, or we're going to lock up like an engine without any oil.

If even the WSJ is talking about deflation, then you know it's a concern to the big players in the financial world.  The pushback against the deficit hawks is beginning, and not a moment too soon.  Let's hope that the Democrats are listening.