Tuesday, August 10, 2010

The Unusual Suspects

The Federal Reserve is in a quandry. They've pretty much adjusted interest rates as low as possible (at the last meeting, nine banks requested an extension of the current near-zero percent rate, while three wanted it increased to one percent). They've loosened reserve requirements a little, but looser reserves are part of what got us into this mess in the first place.
And yet, the economy is stagnant. Sure, companies are showing stellar earnings growth, but revenues are lagging, sales are below expectations and most of the earnings gains have come from increased productivity, as firms have made more out of less, but that horse is being beaten to death.
Normally, we'd go declare war on someone, but the dirty little secret is this economic collapse happened despite two majors incursions in South Asia, in large part because of a bonehead President who lowered taxes during a period of war, thus soaking up any available surplus that could have been invested in economic stimulus now.
Indeed, part of why President Obama has been recalcitrant in bringing troops home is what he'd do with them. He'd be adding tens of thousands of people to the already bloated unemployed population. At least in Asia, they're doing some busy work under the political cover of two wars that Congress authorized, so therefore can't easily criticize.
The possible solution?
Normally, this is considered a way to kick off inflation, if not hyperinflation. The supply and demand of money works not a whole lot differently than the supply and demand for any commodity: the bigger the supply, the less "value" it has on the demand side. That means it will cost more to buy stuff. 
Here's the thing: right now, the economy is in dire danger of falling into deflation. You'd think that would be a good thing, and if there was full employment it might be. Deflation will lower earnings further, which will discourage companies from hiring more people. 
Probably. See, no one knows for certain because it's been such a long time since we've faced a truly deflationary economy. In an era where tax increases boosted the economy (see the Clinton tax increases of 1993), who's to say deflation is a negative for employment. 
This is what makes the Republican anti-tax mantra so ludicrous. Sure, no one likes paying more taxes but right now, lowering taxes on the wealthiest would be a little like adding sugar frosting to the glaze on a honey-dipped donut. It doesn't add anything but empty calories to the snack. The rich won't do much with this cash except stuff it in a mattress. 
Or worse, in China and other emerging markets. 
The Fed will gamble, and issue more money in the hopes that a little forced inflation now will mean a little more "real" inflation later. But not too much.