As dozens of countries slip deeper into financial distress, a new threat may be gathering force within the American economy ”” the prospect that goods will pile up waiting for buyers and prices will fall, suffocating fresh investment and worsening joblessness for months or even years.
The word for this is deflation, or declining prices, a term that gives economists chills.
Deflation accompanied the Depression of the 1930s. Persistently falling prices also were at the heart of Japan’s so-called lost decade after the catastrophic collapse of its real estate bubble at the end of the 1980s ”” a period in which some experts now find parallels to the American predicament.
“That certainly is the snapshot of the risk I see,” said Robert J. Barbera, chief economist at the research and trading firm ITG. “It is the crisis we face.”
[i]“If you print enough money, you can create inflation,†said Kenneth S. Rogoff[/i] … or maybe not.
Newly “printed” money must move into the economy. Because currency is only about one-tenth of the US “money” supply — and two-thirds of that is held overseas — the money supply is increased via lending.
The Federal Reserve has a checking account in which they can set the balance at whatever they wish. Subsequently they write a check on that account to inject in into the economy. Up until a few months ago, those checks almost always went to Fannie and Freddie, who then used the new funds to purchase bundles of mortgages on the secondary market.
The secondaries (think Countrywide) used the proceeds to buy up even more bundles of mortgages from places like the East Gopher Gulch State Bank of Nebraska. When Herbert and Wilma sold their house to move into a rental, they took the proceeds of their sale and deposited them into a money market account.
That money market fund, in order to back its deposited, bought stocks and bonds issued by Fannie and Freddie. The new money was thus laundered and injected. That process, however, has ground to a halt.
In today’s economy, “printing” money requires a lot of people both willing and able to [i]borrow[/i]. That pathway pretty much no longer exists. People don’t want to borrow, or the banks don’t want to lend.
Attempted injections of new money fail for lack of borrowers, and the deflationary forces continue to coalesce, whilst the Fed is powerless to change the dynamic without new borrowers. In classic economics this is called a Liquidity Trap … and we’re almost there.
It’s a horible based thought; but did it take WWII to pull us out of a depression?
In the States, yes, to some extent, but the Depression lasted rather longer here than elsewhere, particularly Britain.
Historians such as David Kennedy suggest FDR’s policies actually prolonged the suffering. That might or might not be the case, but what’s not up for debate is that the vast majority of FDR’s ‘New Deal’ programs and money were directed towards areas in which he wished to goose the Democrat vote … as opposed to those in greatest need, many of which were solidly Republican.
“Up until a few months ago, [Federal Reserve economic-stimulus] checks almost always went to Fannie and Freddie” —Bart [#1]
Why would the Fed write checks to Fannie and Freddie? What did the Fed receive in return?
As you know, when the Fed conducts open-market operations to increase the money supply, it buys marketable securities (typically U.S. Treasury securities) from its network of primary dealers. It pays for the securities by crediting the Federal Reserve Bank account of the seller’s bank. The credit does not come from redeploying existing cash; the Fed simply creates it. It represents a liability of the Fed and an asset of the bank. Yet the Fed’s books remain balanced because the Fed has acquired a valuable asset in exchange for the credit. The credit increases the reserves of the banking system and (insofar as it remains within the banking system) helps create additional money.
Do you contend that the Fed engaged in similar transactions directly with Fannie and Freddie? What, if anything, did the Fed buy from them?
[i]It’s a horible based thought; but did it take WWII to pull us out of a depression?[/i]
No. It took the end of WWII to pull us out of a depression.