Fears of Deflation Guarantee Inflation
Bill Haynes
Never in the history of paper money has a country suffered deflation [a shrinking of the money supply resulting in falling prices] after its currency has been unhooked from gold or silver. And, despite all the concerns and fears of deflation, inflation will be the death of the dollar. Further, the dollar's death will result in the destruction of all fixed-dollar investments and the demise of many companies that cannot operate in an economic climate where prices cannot be accurately forecast. The Federal Reserve's Wednesday decision to lower interest rates is evidence that inflation-not deflation lies in our future.
In a highly anticipated move, the Fed cut its target for the federal funds rate, an overnight bank-to-bank lending rate, by a quarter percentage point to 1%, the lowest rate in 45 years. One news service reported, "In the statement accompanying its decision, closely watched by financial market participants for clues about future Fed policy, the Fed said it was worried about a dangerous 'substantial fall' in already-low inflation." This statement waves two red flags.
Since the Great Depression of the 1930s, the only adverse monetary development that Americans have had to worry about has been inflation, brought on by profligate FedGov deficit spending and the printing paper money to finance that deficit spending. The '30s saw deflation for two reasons. One, the Fed reduced the money supply to cool off "The Roaring Twenties." Two, when the economy slowed because of the Fed's drastic cuts in the money supply, banks failed, causing the money supply to fall even further. Things are different today.
First, for those who have not noticed, the Fed is pumping money into the system at unprecedented rates. Because the dollar is not redeemable in gold, or anything else, the Fed can do that. Additionally, even if banks were to fail, the FDIC (backed up by the Fed) stands ready to make good all deposits; consequently, the money supply will not suffer any declines because of failing banks.
So, the first red flag was the Fed's action of continuing to lower interest rates. No Fed member took the position that maybe--just maybe--the Fed has gone too far in the printing of paper dollars and the lowering of
interest rates. In fact, one Fed board member wanted a half-point reduction. The fear of deflation has put the fear of God in the Fed's board members.
The second red flag: Some economists wanted a larger cut that would have sunk long-term bond rates, which are critical to mortgage and corporate borrowing rates. The reasoning goes: If the fed funds rate had been cut to 0.75%, the Fed's next move would likely have been to buy longer-term Treasury bonds. Anticipation of that move would have caused traders to buy those bonds, driving their rates lower, since rates and bond prices move in opposite directions.
Supposedly, the Fed buys only short-term Treasury debt, but some Fed officials are calling for the purchase of long-term bonds, which would keep mortgage rates down. It would also increase the rate at which the Fed is pumping money into the system.
Instead, the Fed's statement signaled that its next probable move--if needed--would be to again lower rates. However, if another rate cut does not cause the economy to pick up, increasing the money supply at still faster rates will follow. And, somewhere along the line, we can expect still more FedGov deficit spending, which is already at record levels.
Unfortunately, Fed monetary maneuvers do not guarantee that the economy will pick up. The 1970s gave us stagflation, where we had both rising prices and a stagnant economy. Fed machinations do guarantee, however, the destruction of the dollar. Inflation, an increase in the supply of money and credit, is danger we have to guard again. The threat of deflation guarantees inflation.
Bill Haynes
June 29, 2003
Bill has been a precious metals dealer since 1973.
He can be emailed at bill@certifiedmint.com
His primary website is www.certifiedmint.com
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