A popular section of The Kelly Letter is called Situations. It’s a weekly collection of tidbits on a variety of subjects presented at varying length, but never more than one page for one situation. Sometimes, they’re only a paragraph or two. The following update on the recent concern that deflation is coming to America ran as a situation in yesterday’s letter, which was the 23rd note sent this year.
Japan reported last week that its economy grew less than expected in the first quarter. Its GDP rose only 4.9% when it was expected to rise 5.5%. After two decades of struggle, Japan is still fighting deflation and the country is screaming for the Bank of Japan to do something about it.
This is a scenario that may yet find its way to America. Even as many of us worry that inflation will show up from all the dollar printing that’s gone on, it so far hasn’t and possibly won’t.
At the April 27-28 Federal Open Market Committee meeting, it was decided that none of the $1.8 trillion in securities bought over the past year would be sold until after interest rates had begun to rise. The “extended period” to which the Fed has been referring when describing how long it will keep rates near zero seems destined to become an indefinite period.
From the minutes of the meeting comes this telling thought: “Given prepayments and the apparently distant prospect for the first rate hike, this implies a not particularly aggressive pace of asset sales.” As inflation data continue coming in benign — core CPI went unchanged last month — the attitude is morphing from relief to concern, as price trends look set to turn down rather than mildly up.
Ian Shepherdson, Chief US Economist at High Frequency Economics, told Randall Forsyth at Barron’s last Thursday that this could become disastrous. “If wages fall, everything changes. Falling incomes and fixed liabilities are a recipe for disaster, kicking off a debt-service debt spiral in which people cut spending in order to maintain their repayments. Unfortunately, if sufficient numbers of people take that approach the economy sinks further into the hole, job losses rise again and, in aggregate, people’s ability to keep up the payments deteriorates. This a true deflation, and it is very hard to escape; ask Japan.”
Paul Krugman touched on this theme as well. His Thursday column in the New York Times was titled “Lost Decade Looming?” which understates what’s in the balance. Japan has actually lost two decades in the wake of its asset bubble collapse in 1990. What did Japan do? Moved the mass of private debt from banks to the public balance sheet, where it still sits today as a permanent impediment to economic growth. How heavy is that impediment now resting on America’s economic shoulders?
About ebbing consumer prices in the US, Krugman wrote that their decline isn’t surprising because we should expect inflation to fall when unemployment is high. However, “it is nonetheless really bad news. Low inflation, or worse yet deflation, tends to perpetuate an economic slump, because it encourages people to hoard cash rather than spend, which keeps the economy depressed, which leads to more deflation. That vicious circle isn’t hypothetical: just ask the Japanese, who entered a deflationary trap in the 1990s and, despite occasional episodes of growth, still can’t get out.”
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