Deficit is Not the Enemy, Deflation Is

As conservatives rock and rattle over unfunded federal spending that would bring relief to hundreds of thousands of American families that have been impacted by intractable unemployment, as they, in an amazing reversal of logic, shriek and wail over the loss of tax breaks to the wealthiest Americans – those tax breaks also being unfunded, both sides of the aisle are acutely aware of the growing federal deficit. Neither, however, can agree on what to do about it.

From my point of view, though, concentrating on the federal deficit is a distraction we can ill afford right now. As a matter of fact, having a deficit, something that is known to drive up inflation sometimes, is not altogether a bad thing right now.

That’s because we now face a more dire circumstance: deflation.

We haven’t seen deflation, that is, a decline in the prices of goods and services, since the Great Depression. Deflation is to a recession what a good barefoot jog in subfreezing weather while battling pneumonia is to health.

It makes it much worse.

But that is apparently where we are heading right now. From AP, through the Chron:

“Wholesale prices dropped 0.5 percent last month, following declines of 0.1 percent in April and 0.3 percent in May, the Labor Department reported Thursday. Core inflation, which excludes food and energy, posted a modest 0.1 percent increase.”

“The third month of declines in Labor's Producer Price Index raised new concerns about the possibility of deflation, a prolonged period of falling prices which has not been seen in the United States since the Great Depression of the 1930s.”

Want a preview of what deflation will do to the US economy? Behold Japan.

From Paul Krugman’s Op/Ed yesterday:  

“Back in 2002, a professor turned Federal Reserve official by the name of Ben Bernanke gave a widely quoted speech titled, ‘Deflation: Making Sure 'It' Doesn't Happen Here.’ Like other economists, myself included, Bernanke was deeply disturbed by Japan's stubborn, seemingly incurable deflation, which in turn was ‘associated with years of painfully slow growth, rising joblessness and apparently intractable financial problems.’”

Years of painfully slow growth.

Krugman offers that the Fed, which is unlike the Senate in that it doesn’t need 60 votes to do anything useful, is stalled on doing anything about deflation right now.

“Now that the nightmare has become reality, however – and yes, it is a nightmare for millions of Americans – Washington seems to feel absolutely no sense of urgency. Are hopes being destroyed, small businesses being driven into bankruptcy, lives being blighted? Never mind, let's talk about the evils of budget deficits.”

What should the Federal Reserve be doing right now? Anything other than what it is doing, according to Krugman, which is absolutely nothing. According to Krugman the Fed has some options.

“It can buy longer-term government debt. It can buy private-sector debt. It can try to move expectations by announcing that it will keep short-term rates low for a long time. It can raise its long-run inflation target, to help convince the private sector that borrowing is a good idea and hoarding cash a mistake.”

My guess is, however, that there is so much hand-wringing over the deficit, and no long-term memory over what exactly eventually drew America out of the Great Depression (a massive federal spending program known as World War II), that our fate has already been drawn in the sand above the swash zone.

And I sit here waiting in vain, I think, for a spring tide to erase our fate, because on the one hand, we have talked ourselves into this, and on the other hand, Republicans would like nothing else than a complete economic collapse to capitalize on in November.