Next Stop Inflation or Deflation?

Where is the country headed? We seem to be on the Sword of Damocles. Is it inflation or deflation? Where to from here?

In an inflationary scenario, debtors would benefit, it would be easier to pay back money borrowed. Those with savings would feel the tax of inflation. Each dollar would buy less than it use to (what’s new about that). Those on a fixed retirement income would suffer the most. Inflation is a way government can tax everyone. The neat thing is that there is no need for a tax collector. Plus you can’t cheat on your taxes. So when the government prints money, it’s kind of like taking a half bottle of whisky and topping it off with water to make a full quart. The buyer ends up with half the buzz at twice the price. Basically government is taxing one dollar and spending two.

Deflation on the other hand is a rough buggy ride for everyone. It tends to feed on itself and get worse (with government help). The economy slows down unemployment increases, bankruptcies and foreclosures increase. Prices drop and money buys more than it use to. Debts become harder to pay off when jobs are scarce. During the great depression, government services suffered greatly. Teachers, firemen, police and other services were cut severely. Congress could have a very serious problem if revenues from taxes collected decrease dramatically.

On the front page of today’s paper, San Diego readers saw a headline “Governor Schwartznegger set to declare fiscal emergency.” The State has a 14 billion dollar budget shortfall. That and all of the foreclosures suggest deflation is the current direction of travel.

There is just one fine wrinkle. Notice how government tax receipts are decreasing? There are a lot of fixed costs to be paid out, Social Security, Medicare and Medicaid. Uncle Sam has been spending the Social Security taxes as well as the regular taxes and even the gas tax on the yearly budget. When FDR wanted to stimulate the economy in the 1930’s with government spending, none of these liabilities were hanging around the government’s neck. The economy went to full power when Japan “remodeled” Pearl Harbor. Today's fixed costs for government entitlements, may force the government to print the funds necessary. That sort of inflation can spiral out of control.

Congress seems to think that spending is good, worry about the bill later. As government receipts decrease notice how the fixed costs consume a larger part of the pie. It’s a little like the foreclosure mess. Congress can barely pay the bills now, what happens when deflation takes hold? The expression “Between a Rock and a Hard place," comes to mind. Will they turn the dollar into Monopoly Money? Abu Dhabi just bought Baltic Avenue (Citigroup). Bye Bye worthless Dollar, Buy Buy our assets (a pun or two).