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So, America clearly doesn't want to enter recession and let markets bottom out. The government appears to be solidly against this. Now, you can fight off the s

So, America clearly doesn't want to enter recession and let markets bottom out. The government appears to be solidly against this. Now, you can fight off the short term effects of recession, and it's typically popular politically. But there's some real ramifications. Here's how it probably goes: Causing inflation is extremely likely to weaken the dollar, which hits first and foremost the people making the lowest real wages. The people making the lowest real wages have little power to strike or collectively bargain that organized or semi-skilled labor has, little to no control over pricing like professionals have, and no places to invest money in real assets to shelter money from inflation. The poor get screwed the hardest in this whole inflationary gig, on the money supply of things. When quality of life drops in America, especially for the most poor of people, then the government needs to decide to try to counteract that. They do this by increasing subsidies and welfare. If these programs are large enough to counteract the heavy inflation, they're quite expensive. Ironically, this further increases inflation, and leads to either (1) a weaker U.S. dollar, or (2) higher taxes, or (3) both. In the case of a weaker dollar, you've now changed currency trading and interaction across the entire global economy. China and Japan are both looking at much stronger currencies vis-a-vis the dollar than in recent years, which sets off all sorts of unplanned chains of events. As for taxes - most people dislike being taxed simply by virtue of having less money and things. As far as I can tell, most people don't like paying taxes and instead prefer to keep their money. However, raising taxes while simultaneously intentionally raising inflation has a particularly interesting outcome: Money and capital flow out of your country really fast. Why? Due to inflation, people don't want to carry your currency or bonds. The value of the currency/bonds is going to be worth less next year than today, so you need to move it to an asset that you expect to increase in value or hold its value - a commodity, equity, or real estate perhaps. Now, due to higher taxes, people have less risk tolerance. This is because typically (unless you're a bank, or in good with Washington) government doesn't pay you if your business fails, and does tax you if you succeed. That means that people invest less. Which normally might mean people holding cash reserves while looking for a change, but during inflation - people need to put the money somewhere, or else it'd get inflated away and you'd have less at the end of the year. End result? Because people will seek to invest their capital (due to inflation), but be less inclined to do it in the USA (due to taxes), you get less long term investment in American industry. That means less long term employment created, less machinery bought, less real estate developed. Money that would get invested in Nebraska gets invested in Chengdu, or Goa, or Sophia. Now, I'm a global sort of guy, and I happen to quite like Chinese people, and Bulgarians seem quite cool to me, and I hear Goa's a great place. So it's not a net loss for the world. But it does seem like a curious policy for the U.S. government to pursue. It's especially ugly for for the poorest people who have the least control over their wages. And in a brutal double-edged fashion, Chinese, Indian, and Bulgarian industries become more efficient and cheaper which further causes less demand for American-made goods. The result? Greater unemployment. Which further depresses wages. Messing with the money supply right now might suit some special interests (maybe like a bank with lots of bad debt on their books, that's holding assets that have crashed from an artificial high, that needs to liquidate those assets in order to pay obligations while nearing insolvency... hmm...). But it doesn't seem to serve the poor, the middle class, or the wealthy Americans very well.

cchooper 18y ago
To be clear, the Fed is not trying to create inflation. It's trying to prevent deflation. The extreme measures it will have to take (such as the 'helicopter drop') might produce future inflation (it's not certain, as it depends on future demand for liquidity and the rate at which the Fed can recover the money it has injected), but in the choice between certain deflation and possible inflation, possible inflation will always be the right choice. In the choice between certain deflation and certain inflation, inflation would still be the right choice. Historically, inflation has not hit the lowest paid the hardest. That's because inflation causes a reasonably uniform increase in prices, which includes the price of labour. It may be that the weakening of unions means that this effect will not occur this time, but a fall in the value of the currency suggests that prices should rise across the board, so this should be our working assumption. Usually, inflation is a transfer of wealth from those with savings to those with debts. It could conceivably help the worst off. In comparison, deflation will certainly lead to mass unemployment and will hurt the poor very badly, especailly those with debts. You say that inflation will lead to higher welfare costs, but deflation will lead to far higher welfare costs due to mass bankruptcy and unemployment. Furthermore, deflation increases the real value of government debt, and the depression caused by it will destroy tax revenues. This results in a higher risk of soverign default, which potentially causes a run on the currency. In fact, almost all of the problems caused by inflation will also occur with deflation, only they will be far more severe. So that's why it makes sense for the Fed to pursue this policy. It has bad consequences, but they are minute in comparison to the deadly consequences of deflation and mass institutional failure.
- nuclear_eclipse 18y ago
  Why does deflation cause unemployment and bankruptcy? It would make logical sense (to me at least) that if the dollar increases in value, then that would be better than the dollar losing value?
  - cchooper 18y ago
    An increase in the value of the dollar is not an increase in total wealth (and similarly, a fall is not a loss of total wealth). A change in the value of assets is always a transfer of potential wealth from one person to another. This change may stimulate wealth-creating opportunities in the economy (e.g. increasing bond values will encourage the creation of more bonds, which means more investment in productive business) or it may thwart them (e.g. the loss of value of sub-prime securities has frightened people away from lending) but the price change itself doesn't create or destroy real wealth (goods and services). If dollars were to rise in value, it would constitute a transfer of wealth away from people with debts and towards people with cash savings. The first effect is that people will no longer be able to service the increasing real value of the interest on their debts, leading to default. But the more serious secondary effect is that a rising dollar encourages people to hoard money rather than spending it, as dollars tomorrow will be worth more than dollars today. The result is a liquidity crisis, where everyone refuses to consume or invest. The liquidity squeeze makes dollars even more valuable, and so the effect is self-perpetuating, until eventually the economy grinds to a halt. The worst historical example of deflation is the Great Depression, where local communities were having to invent their own currencies to make up for the extreme dollar shortage. The Great Depression is the reason central banks have positive inflation targets. Although inflation is bad, a small amount of inflation is a fair price if it reduces the risk of self-perpetuating deflation.

cchooper 18y ago

To be clear, the Fed is not trying to create inflation. It's trying to prevent deflation. The extreme measures it will have to take (such as the 'helicopter drop') might produce future inflation (it's not certain, as it depends on future demand for liquidity and the rate at which the Fed can recover the money it has injected), but in the choice between certain deflation and possible inflation, possible inflation will always be the right choice. In the choice between certain deflation and certain inflation, inflation would still be the right choice. Historically, inflation has not hit the lowest paid the hardest. That's because inflation causes a reasonably uniform increase in prices, which includes the price of labour. It may be that the weakening of unions means that this effect will not occur this time, but a fall in the value of the currency suggests that prices should rise across the board, so this should be our working assumption. Usually, inflation is a transfer of wealth from those with savings to those with debts. It could conceivably help the worst off. In comparison, deflation will certainly lead to mass unemployment and will hurt the poor very badly, especailly those with debts. You say that inflation will lead to higher welfare costs, but deflation will lead to far higher welfare costs due to mass bankruptcy and unemployment. Furthermore, deflation increases the real value of government debt, and the depression caused by it will destroy tax revenues. This results in a higher risk of soverign default, which potentially causes a run on the currency. In fact, almost all of the problems caused by inflation will also occur with deflation, only they will be far more severe. So that's why it makes sense for the Fed to pursue this policy. It has bad consequences, but they are minute in comparison to the deadly consequences of deflation and mass institutional failure.

nuclear_eclipse 18y ago
Why does deflation cause unemployment and bankruptcy? It would make logical sense (to me at least) that if the dollar increases in value, then that would be better than the dollar losing value?
- cchooper 18y ago
  An increase in the value of the dollar is not an increase in total wealth (and similarly, a fall is not a loss of total wealth). A change in the value of assets is always a transfer of potential wealth from one person to another. This change may stimulate wealth-creating opportunities in the economy (e.g. increasing bond values will encourage the creation of more bonds, which means more investment in productive business) or it may thwart them (e.g. the loss of value of sub-prime securities has frightened people away from lending) but the price change itself doesn't create or destroy real wealth (goods and services). If dollars were to rise in value, it would constitute a transfer of wealth away from people with debts and towards people with cash savings. The first effect is that people will no longer be able to service the increasing real value of the interest on their debts, leading to default. But the more serious secondary effect is that a rising dollar encourages people to hoard money rather than spending it, as dollars tomorrow will be worth more than dollars today. The result is a liquidity crisis, where everyone refuses to consume or invest. The liquidity squeeze makes dollars even more valuable, and so the effect is self-perpetuating, until eventually the economy grinds to a halt. The worst historical example of deflation is the Great Depression, where local communities were having to invent their own currencies to make up for the extreme dollar shortage. The Great Depression is the reason central banks have positive inflation targets. Although inflation is bad, a small amount of inflation is a fair price if it reduces the risk of self-perpetuating deflation.