Money From the Sky

Yesterday, we talked about how the “recovery” may not be all it is cracked up to be.  Unemployment continues to be a problem and small businesses are finding it hard to get loans.  That is indeed a problem, but what I am worried about is the solution.

The government really only has one way to go–dropping money out of helicopters.  That phrase is what gave Ben Bernanke, Chair of the Federal Reserve, his nickname “Helicopter Ben.”  He is famous for having suggested that he would drop money out of helicopters if required to avoid another Great Depression.

That would work in the same way that staying drunk prevents hangovers.  The short-term solution is a long-term death sentence.  This week, the Fed has already signaled that pumping more money into the economy is preferred to having a lackluster recovery.  We won’t go into the mechanics here, but a little research will show you that the Fed has any number of ways to increase the money supply other than simply printing more bills.  They are willing to do most anything to prevent deflation.

Deflation–rapidly falling prices–sounds good at first.  Who wouldn’t want to pay less for goods and services?  The problem is, businesses (the people who actually provide those things) start delaying investment and supply purchases.  They figure, rightly, that it is better to wait a while until prices fall.  As they delay, the demand for raw materials decreases, leading to lower prices and an accelerating cycle of price-lowering.  The result is not pretty.  We citizens should not want deflation for that reason.

Government hates deflation, but for different reasons than you or me.  They can’t tax people who are broke.  Whereas inflation allows them to tax us stealthily by printing money to fund their obsessive spending, deflation brings the party to an unceremonious end.  The solution?  Print more money!  And presumably, drop it from helicopters.

I predict we will see more deflationary pressures on the economy.  No amount of begging on the part of the current administration will get banks to loan more if they risk getting clobbered by regulators.  Few businesses will expand as long as government is busy figuring out how to confiscate their earnings.  Even fewer people will be proactive in a job search or start a new business as long it pays more to be on the government dole.

In the end, government will do the only thing it really knows how to do.  It will create and release more money into the economy to break the grip of deflation.  It will devalue the dollar to the point where that piece of paper in your wallet will be worthless.  At that point, their only tool will be broken and you and I will pay the price.

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About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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One Response to Money From the Sky

  1. madboy says:

    Hoenig gave a speech two weeks ago that summed up the situation:

    “One final note about deflation: The consumer price index was a mere 18 in 1945 but was 172 at the start of this century. Today, despite our most recent crisis, the CPI is over 219. Not once during more than half a century has the index systematically declined. I find no evidence that deflation is the most serious threat to the recovery today.”

    People commonly mistake asset price deflation with general price deflation. Asset price deflation is part of the credit cycle and what, I think, you are referring to. General price inflation is alive and well. (Wal-Mart’s raising prices on many items!)

    Like

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