Saturday, December 15, 2007

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).


Tyrone said...

In an inflationary scenario, debtors would benefit, it would be easier to pay back money borrowed.

Are you assuming 'wage inflation' is a part of the inflation? I don't believe that will to happen, at least not enough to help home debtors over-paying for houses.

Jim in San Marcos said...

Hi Tyrone

This model of what if's was on a very high abstract level. Step one is the decision. Step two is deflation and step three could be inflation with maybe the word hyper in front of it.

Another concept that has to be examined is a wage earner concept. He gets a wage increase for doing a good job and feels good about it. The truth is he's just keeping up with inflation. The inflation pay raise is the carrot on a stick approach of capitalism.

Anonymous said...

Seems to me that if infaltion is bad for savers then deflation must be good for. Deflation allows those with cash to pick up assets at highly deflated prices.

Jim in San Marcos said...

Hi Rbm411

You hit the nail on the head. Use money as a tool to get what you want at a discount.

Sackerson said...

Hi Jim

Now that you've set up an Atom feed, I've added you to my financial feed gallery for more frequent reading.

IN or DE is the big question, and other people like Karl Denninger and Michael Panzner are also convinced it'll be a deflationary bust first, quite possibly followed by currency inflation. So for the moment, it seems to me we should get out of debt and save cash.

Jim in San Marcos said...

Hi Sack

Thanks for the link.

I quite agree about deflation and then inflation. You have to take that with a pinch of salt, we'd all be rich if the market acted logically. We know that isn't going to happen.

Anonymous said...

Jim, could these "sovereign wealth funds" give the stock market a ride into new highs?
Could this possibly weaken our national sovereignty with these inroads?
The reason I ask is that I seen today (12/21/07) in the London Financial Times were Saudi Arabia plans to set up a fund that drawfs Abu Dhabi`s $900 billion dollar fund.
Any thoughts?

Kirk Timothy Mulhearn said...

I feel as if most Americans are starting to figure it out---that the dollar is just not buying what it used to: the consumer price index does not take into account the cost of energy and food, both of which have gone up about 25% in the last 12 months...when civil servants' wages are tied to this it is a pressure cooker for the retired and the middle class, the people on entitlment programs really don't care in that their checks just keep on coming. God help us if they stopped paying for section 8 housing in los angeles, you would see what riots really look like....

Jim in San Marcos said...

Hi Anon 5:31

I think that these off shore players by buying US assets, are adding money to the system which could be considered inflationary.

Also if they figured that selling dollars would depress the dollar and the rest of their holdings, what better way to convert weak paper into a hard U.S. asset.

Jim in San Marcos said...

Hi Newquest

I agree things are getting worse. It seems though that it is the young, just out of high school that are getting hit the hardest.

I'd love to be young again, but I don't think that I could afford it.