Oh No, There Goes Tokyo

If Central Bankers Are to Succeed, Positive Inflation Must Return.

The threat of deflationary downward spiral is enough to give any central banker nightmares. When a trend of falling prices for wages, goods and services gets locked in long enough, the result can be economic disaster.

Deflation is especially scary because the system is designed to have an inflationary bias. There are always new workers coming in, new jobs to be created, new investments to be made, new taxes to levy and so on. The wheels of the capitalist system are greased by a positive price trend as wages and earnings slowly rise.

With deflation, all that gets thrown into reverse. The pain is especially intense for economies that need to steadily add jobs and investment just to avoid popular discontent. (If the labor pool is growing, then a lack of growth means unemployment is rising too.)

This is why deflation is not an acceptable phenomenon. The longer deflation persists, the greater the risk of its long-lasting destructive effects. And so, in Bernanke and Co.’s battle against deflationary pressure, the stakes get a little higher with each passing day.

If the stakes get high enough, we could see some REALLY crazy shit go down.

The Fed Has Not Gone Crazy Yet.

BY now you've probably seen the monetary chart that looks like a hockey stick, showing the huge quantity of reserves the Fed has pumped into the system. You’ve also heard about the multi-trillion-dollar expansion in the Fed's balance sheet, and everyone by now has heard about the big government stimulus plans.

But, when it comes to inflation-producing efforts, everything so far is just a warm-up.

The big fear is that America winds up like Japan, so let’s use a Japanese analogy: the classic monster movie.

Picture deflation as a 200-foot-tall monster. Mothra, maybe. Except instead of attacking cities, this Mothra is laying waste to whole chunks of the U.S. economy.

What the Fed has done so far is equivalent to standard military response, albeit on a large scale. They’ve called in the tanks and the fighter planes. They’ve sent the bombers in to drop napalm on Mothra’s head. Next up for the Fed is the multi-trillion-dollar TALF lending facility. If that doesn’t work, they will have run out of options... except for one.

They can call in Godzilla.

If Mothra represents deflation, then Godzilla, by way of our little analogy, represents real inflation... stomping, screeching, fire-spewing, melt-your-eyeballs inflation.

If the Fed and Treasury were to truly go crazy and raise Godzilla up from the deep, what would that look like? Here are a few possibilities:

* The government could announce a massive payroll tax holiday, at a cost that would blow everyone's mind, that would not have to be paid back.
* The government could announce a one-fell-swoop effort to pay off tens of thousands or even hundreds of thousands of underwater mortgages.
* The Federal Reserve could hit the banks with a draconian holding tax – sort of like the vigorish a loan shark charges except in reverse. Every day that goes by where bank ABC hasn’t lent out the $100 million in its reserves, a $50,000 holding penalty is assessed. Or something to that effect.
* The Fed and Treasury could just say “You know what, screw it. We’re gonna write y’all some checks. Every American citizen age 18 or over with a social security number gets $10,000 – look for that in the mail.”

Why haven’t we seen anything like this already? Because, again, the above options are the equivalent of calling in Godzilla. Could Godzilla kick Mothra’s butt? Oh, most certainly. The problem is, after Mothra is dead you’ve got the little matter of dealing with Godzilla.