What is really happening with the money supply? Conventional wisdom says that huge deficits lead to inflation. On the other hand, so far, we have not seen inflation, but some sign of deflation. So what's going on with the money supply?
The government is printing dollars (and borrowing) like crazy to pay for their frenzied spending spree, but we aren't seeing inflation because businesses and households are hording dollars (gasp: "Savings"? What's that?). Business is holding more cash than at anytime in my lifetime, over $1.8 trillion: http://bit.ly/b91TFE The household savings rate is up to 4%, while it had been negative in recent years past. This would be great if it represented a permanent change in American savings psychology, but unfortunately what it seems to reflect short term uncertainty about the economy.
We could really use a long-term psychology that said saving for a rainy day is the responsible thing to do, rather than expanding public safety nets like unemployment insurance and so on. Individuals would be infinitely more responsible about providing for their own emergency needs than any government program can ever be. Unfortunately there is no reason to believe that this is what has happened.
Despite the massive printing of dollars, we're actually seeing deflation due to the currency being withheld from circulation. When individuals cannot keep up with their debts, they face debt judgements, wage garnishment, and loss of savings. In these extreme circumstances, people hold more cash as security. With less cash in circulation, prices tend to come down.Many key prices are actually in decline; gasoline, housing, cars, wages, etc.
Once business and consumers regain confidence, the great likelihood is that all of this horded currency will flush into the economy very quickly, causing a huge spike of inflation. This cycle of deflation pressure followed by an inflationary spike is quite classic and historic.
This will cause the Fed to raise interest rates to try to contract the money supply, but they will find it very difficult to control the expansion because the cash is already pre-positioned in the market. As interest rates go up, perhaps sharply, the debt service cost goes way up, and we could very easily see another bout of stagflation like we had under Carter. With rising interest rates you get another whole round of credit defaults because all this debt is still sitting out there, but now the debt service becomes MUCH more expensive and can't be afforded. Both government debt and personal debt service sucks up a great deal more income and we're right back in recession.
With it's debt service costs rising, the government debt becomes more and more difficult. There are two opposite instincts about how to deal with this on the political Left and the Right. The Left only sees tax increases, because cuts to spending represent cuts to their patronage power base. The Right knows that cuts to the size and scope of government are the only real solution.
The real question becomes, where can we find conservative politicians with the will and the rhetorical skills to champion the severe cuts to government spending and enttitlement programs that are desparately needed?
For now, investing in real estate is a real good bargain if you can qualify for a fixed 30yr mortgage at 4.5% and if you buy a bank-owned at a 30% discount. Gold is at least safe against inflation. Most dollar-denominated assets will go up in price under inflation, but they'll be declining while we're under deflation. Equities are tempting because with inflation their prices will go up, but it is hard to know how long we'll be in deflationary pressure and this severe market uncertainty.
Many entrepreneurs would love to start a business about now. Many creative people have become unemployed, and risk-taking becomes easier when you don't see many other choices, but you'd have to get your head examined to want to dive into this tax and regulation environment with a startup.
The uncertainty we keep hearing about is not misplaced. It would appear we're in for quite a wild ride.
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