Wednesday 19 November 2008

Deflation... we had better hope so

Dizzy has done some great work today producing a graph which shows just how wrong Gordon's debt forecasts have been each and every year. It turns out that the man was in cloud cuckoo land long before even City traders saw the crisis coming (which was about October 2006, by the way).

Which makes me worry even more when I hear him talking about deflation, and what he is going to do to avoid it.

Deflation on any substantial scale has been unknown since the 1930's. Of nine recessions in the US since 1950, none has been deflationary - and for good reasons.

Firstly, to enter a period of deflation willingly requires Government to accept acute Political pain today - almost certainly to the point of losing power, in return for economic wellbeing and a faster recovery later. Secondly, provided that countries act together (an option which was not available to Japan) it is eminently avoidable, and thirdly the "cure" feels pretty good for the electorate at least in the early stages.

This is Bernanke on the subject in 2002:

"I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States …"

"under a fiat money system, a government should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero. Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press , that allows it to produce as many U.S. dollars as it wishes at essentially no cost. "

You may conclude that the spending approach being taken by Gordon Brown (and notice how keen he is to ensure that others join him) is similar to the policy outlined by "Helicopter Ben"and being followed right now in the US.

The unpleasant side-effect is that when you devalue all the currencies in the world, inflation is the inevitable consequence as hard goods become the strong currency - and for the UK which starts the race at the back from a debt perspective, and with a negative balance of payments, the printing required is such that the resulting inflation could be really serious indeed.


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