An excellent analysis of why we are in serious trouble, how we got here, and why we aren't correcting the problem. The links are a bit technical but it's worth wading through it.
As the economic crisis approaches the two-year point, it is apparent that "this time is different." Few analysts believe that we are going to recover from this Great Recession in a fashion that resembles prior recoveries. Most argue about how long it might run (Japan's recovery is now two decades old), and whether inflation or deflation results. Two years into the problem, these issues are still unclear.
It is understandable why the duration of the recovery might be moot. Less clear is why economists cannot agree as to whether there will be deflation or inflation. After all, these outcomes are polar opposites of one another and critical knowledge:
"I believe that getting the inflation/deflation story right is the single-most important investment decision that needs to be made. It will determine the investment outcome of portfolios over the next decade."
- Jim Puplava, FinancialSenseOnline, July 24, 2009
Inflation and deflation proponents have intelligent, reasoned arguments. Both have some representatives that were not "surprised" by the events of 2008. How is it possible that intelligent people can forecast such opposite outcomes? The differences, in my opinion, arise from two primary sources:
?1. The schools of economics themselves
?2. The time horizon
Schools of Economics
Each school is complex, and not as simplistic as this short treatment might suggest, but here are the basics:
The Keynesian school of economics believes that aggregate demand is the driver for economic outcomes. If aggregate demand is too low, an "output gap" (the difference between current demand and demand necessary for full employment) is said to exist. Because demand is "insufficient," upward price pressures are claimed to be not possible.
Monetarists and Austrians believe, as Milton Friedman was fond of stating, that "inflation is always and everywhere a monetary phenomenon." While these schools otherwise differ tremendously, both understand money to be the driver of inflation.
Virtually all Keynesians, as a result of the output gap, believe that deflation is the likely outcome of our current situation. Keynesians did not believe the stagflation of the late 1970s was possible. That period had "insufficient demand" but high inflation, theoretically an oxymoron in the Keynesian system. Their continued insistence on more stimuli suggests that their notion of "output gaps" still plays a central role in their thinking.
Monetarists and Austrians disagree with Keynesians on virtually everything and frequently disagree with each other -- except on the critical role of money in the economy. Their methodologies and monetary processes differ, but both monetarists and Austrians recognize the possibility of an "output gap" coexisting with inflation.
The Time Horizon
Current data support the deflationist position. Money supply is shrinking and there is no inflation, at least as measured by the government's CPI calculation. There are few signs of economic recovery despite the "green shoots" melody sung by government and their media minions.
Monetarists and Austrians would agree that price increases in a deflationary environment are impossible. (The original definitions of inflation and deflation were in terms of inflating or deflating money supply.) Those who expect inflation, therefore, also expect a rising money supply at some point.
Reconciliation of the different positions becomes tractable if one allows for different time horizons. In fact, I would argue that both sides of the debate are correct -- i.e., we will have deflation followed by inflation.
Argument for Deflation
Financial Armageddon describes government actions thus:
Throughout the financial crisis, policymakers have focused on keeping things afloat until the storm passes. They've spent vast sums of taxpayer funds trying to jumpstart growth until the economy is back on track. They've encouraged people to keep the faith until businesses start hiring again.
Servicing existing debt is impossible because income levels are not high enough to do so. The economy cannot grow large enough fast enough to offset this problem. Debt will be liquidated by default/forgiveness.
Government has been unwilling to accept a downturn, adding more debt in hopes of generating a miracle that cannot arrive. The danger, as expressed by Financial Armageddon, is that the presumed "untils" do not happen:
But what happens if all those "untils" turn out to be wide of the mark? What if the carnage we've experienced so far is structural, not cyclical? If that's the case, then Americans are going to find that instead of experiencing better times ahead,