Issue of the week: Avoiding the deflation trap

Bankers and some big-time investors are becoming concerned about a deflationary cycle in the economy.

Even the Fed’s fiercest inflation hawks are changing their tune, said Sewell Chan in The New York Times. James Bullard, president of the St. Louis Federal Reserve Bank, is best known for urging the Fed to increase interest rates at the first sign of inflation, “the central bank’s traditional enemy.” So when he writes, as he did in a paper last week, that deflation is a grave threat to the U.S. economy, policymakers listen. The paper, “ominously titled ‘Seven Faces of the Peril,’” sketches a frightening scenario, said Neil Irwin in The Washington Post. “In a deflationary cycle, a weak economy leaves companies little ability to raise prices for their goods.” Anticipating lower prices, “households and businesses hold onto their cash rather than spend it, creating a self-reinforcing cycle of misery.”

The prospect scares even big-time investors, said Gregory Zuckerman in The Wall Street Journal. Bill Gross, who runs the $239 billion Pimco Total Return Fund, notes that the U.S. consumer price index has fallen 0.1 percent, annualized, over the past two years. “Deflation isn’t just a topic of intellectual curiosity,” Gross says. “It’s happening.” And not just in the U.S. Around the world, austerity is the watchword, as governments slash debt, raise taxes, and aim for zero inflation. This large-scale penny-pinching “could cripple global economies and world stock markets.”

How much more bad news can we take? asked William Greider in The Nation. As painful as this recession has been for “the weak and defenseless,” deflation “would generate the pain more widely, more ferociously,” as even the well-off get caught in the whirlpool of falling incomes and shrinking payrolls. That’s why it’s so heartening that “we may be witnessing the opening of an authentic economic debate.” If the Fed’s Bullard and his allies in the deflation camp continue to sound the alarm, they could give President Obama and Congress cover to take the “aggressive fiscal measures” needed to keep us out of danger, even if that means temporarily living with bigger deficits.

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You must be joking, said Michael Pento in Forbes.com. “We have much more to fear from inflation,” which is often described as too much money chasing too few goods. That’s certainly an apt description of the current U.S. economy, in which the money supply has swollen in the past 10 years to $2 trillion from $600 billion. Over the same period, the price of gold has risen from $300 an ounce to $1,200, and that of oil from $25 a barrel to $78. That, friends, is not deflation, it’s inflation. And though long-term interest rates haven’t spiked—yet—inflation remains “a clear and present danger” until we bring America’s spiraling debt under control.

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