No. of Recommendations: 56
I almost can't stand this subject any more. It's painful to watch the country screw itself up so bad and to think of my daughter and her peers trying to launch careers into these stagnant waters.

But here goes:

What's causing the deflation --

Not your pet peeve. There is a great tendency to take your favorite gripe hobby horse and hitch it to the great question of the day and see if you can get some mileage from it. Regulation is not causing the deflation. Healthcare reform is not causing the deflation. The deficit and the debt is not causing the deflation. Worry about future tax increases is not causing the deflation.

We had a housing bubble and it burst, ruining a lot of household balance sheets. These people cut back their spending trying to rebuild their finances. This put a lot of people out of work and so they cut back their spending, which put more people out of work, and so on.

It also put a big hole in the balance sheets of a lot of businesses and drove some of them under, and they laid people off and cut back investment spending to try to rebuild their balance sheets and because they saw demand for their goods and services plummeting due to factors in previous paragraph. The laid off employees cut back their spending, and that put more people out of work and cut demand perceived by more businesses so they cut back and so on.

State and local government suffered drops in tax revenue from income and sales taxes and capital gains taxes and increases in spending for social safety net programs. So they too cut discretionary spending and some raised taxes which caused households to cut spending. They laid off public employees and cut back on purchase of goods and services and this caused job losses in the private sector and so on.

Housing bubbles burst simultaneously in other countries, plus foreigners had tied themselves into our housing market by investing in our mortgage-related securities, so their economies went bust at the same time and they stopped buying our exports. World trade volume plunged.

Macroeconomics is not like microeconomics. If one man stands up to get a better view at the ballpark, he gets a better view. But if everyone stands up, no one gets a better view. Similarly, if one household or one business tries to rebuild its balance sheet by cutting back on spending, it works. If everyone tries to do so at the same time, it doesn't work. In fact, we all get poorer. Because everyone's spending is someone else's income and so on. When we all try to save more our collective saving goes down, not up.

The Federal Reserve tried to get people to spend again by cutting the cost of borrowing, but when people borrow, the interest rate is just one thing they consider. They also consider whether they can pay it back and if its borrowing for capital goods, whether anyone will buy the things the new capital goods would produce. And when lenders lend they consider these things too -- will the borrower pay it back and if its lending for capital goods, will the capital goods produce profits to enable the borrower to pay it back. The answer was no to these questions. So, the low interest rates aren't helping much. So the Fed cut more but then it hit zero and can't go any lower.

The Congress and the President tried to help the situation by increasing government spending and cutting taxes. If business and households aren't buying enough goods and services to keep everyone employed, then the government should fill the spending gap. There is no sense having people sit home and capital equipment sit idle. Lost output is lost forever. Government needs to prime the pump. But the size of the inrease in Federal government spending was not big enough to offset the drop in spending by state and local governments, businesses and our foreign trading partners. It made things less bad, but still bad. With state and local governments cutting back so much, there was little-to-no net govt. stimulus when you aggregate all 3 levels of govt. together. Just to make matters worse, much of the stimulus was in the form of tax cuts, and you don't get as much increase in spending from a tax cut as you do from a spending increase.

So, these are the things now leading toward deflation. We have a big deficiency of demand. Too many goods and services being chased by too few dollars of spending, so prices are dropping. Dropping prices leads to more reluctance to invest and hire, so the scenario perpetuates itself.

Now, instead of worrying about the gap between our labor force and the number of available jobs, and the gap between our productive potential and our actual GDP and the gap between what the opportunities should be for our children entering the workforce versus what they are and will be, we are focusing on the gap between government expenditure and government revenue. So, we will allow the stimulus spending to taper off even though the recovery is puny and we will get outselves into a deflationary spiral, which will lead to years of economic stagnation. And the stagnation will worsen the deficit, so our misplaced focus on the deficit won't even help lessen the deficit.

Now, I'll grant the other side:

When the economy is near full employment, government deficits are a bad thing.

When we are going through typical business fluctuations, attempting to do countercyclical fine tuning with fiscal policy is a bad idea.

When short-term interest rates are not zero, the best way to stimulate if you have high unemployment is with monetary stimulus, not fiscal stimulus.

When your primary concern is trying to increase the growth rate of the economy's supply potential -- repeat supply potential -- there is a plausible case to be made that lower marginal tax rates will increase the growth rate of supply potential.

But none of these "whens" applies now. At the present time, we need a big govt. deficit to offset the fact that everyone else is trying to save more, monetary policy has shot its wad, and our immediate problem is low DEMAND not SUPPLY.

There is not even a whiff of bond-market scare brewing on US Treasury debt, despite the debt and the deficit. But, apparently we will guide our policies from now on to prevent future problems in the bond market rather than to solve present problems in our labor market. We are not Greece. We have our own currency. The world is not reluctant to lend to the US Treasury. Look at Japan. Their borrowing cost is even lower than ours, yet their deficit and their debt is higher in relation to their economy.

PS, I sold all my TIPS yesterday and bought 30 year conventional treasuries at 4%. As agnostic about the future as I try to be in making investment decisions now that I am in the asset-protection phase of life, I just can't bring myself to even pretend to worry about inflation any more. And once the rest of the world wakes up to our deflationary future, I don't think it will be fun to own TIPs, even if I were satisfied with the 2% coupon.
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