Civil Truth posed some questions recently, and in attempting to answer them I developed this blog entry.  His questions were about today’s deflationary pressures and inflationary expectations.

I don’t think we have deflationary pressures and inflationary expectations.  We have primarily deflationary “pressures,” creating deflationary expectations today.  I don’t think our fiscal and monetary policies are at odds–they are both inflationary at the moment, about the only inflationary features of the current economy.

Deflation is the result of deflationary expectations and a long-term contracting economy.  Those expectations result in the general husbanding of cash and lowered rates of spending.  This implies a reduction of buying on credit, too. Reduced consumer and commercial spending of any kind tends to contract the economy.  A contracting economy results in lost jobs, more contraction, late payments, more foreclosures, declining home prices, declining tax revenues, you name it, more deflationary expectations.

There is no way any specific government program can guarantee to stop it, unless it is to print plenty more money without trying to borrow anything to back it.  That is what they’re trying to do I think, but the economy hasn’t yet responded to the inflationary pressure of expanding the money supply.   It eventually will take market forces to do it right and end it.

IMHO, although all the reasons put forth by the experts for our predicament so far are likely to be correct, there is another fundamental problem that’s never mentioned.  We are just now paying the price for having “bought forward” on credit for I don’t know how many years.  I have no data to support this idea, but I suspect that from a macroeconomic perspective we reached some ratio of debt to expected income that couldn’t sustain economic optimism (inflationary expectations) once the effects of the sub-prime mortgages started to take effect on the economy.

The spike in gasoline prices last summer entered into the equation, too.  As the deflationary effect compounded with the downward spiral in home values, auto industry problems, and bank and financial industry near meltdown, the economy fell more and more behind the power curve.  It also may or may not be coincidence that everything came to a head at the same time it was becoming a good bet that Barack Obama was going to be the next President.

Again, IMHO, we aren’t going to get out of the mess until that debt to expected income ratio returns to “normal” and the economy is generally expected to keep expanding, perhaps at a lower but more sustainable rate than before, without the benefit of excessive borrowing.  For that to happen, all those deflationary expectations have to be dispelled.

Long-term government spending for major infrastructure projects that won’t start for years and will continue to cost the Treasury for more years will not help.  What is needed is to put money into circulation now, in the United States, and create confidence that the economy will grow, jobs will be created, and that all the growth will NOT be siphoned off by taxes, neither sooner nor later.  The most efficient way to do that is a permanent business and personal tax rate cut combined with a multi-year reduction or even a moratorium in withholding requirements.  Putting the money out this way would guarantee that it goes into the hands of taxpayers, to spend on what they need.  I would also recommend that all non-essential government expenditures be reduced or eliminated to offset the reduction in revenue and to evoke confidence that the government is responsible (hah).

Oh, yes, also buy up the toxic MBS packages as they promised to do with the first TARP bill.  Who cares how they price them?  Just do it so it’s “transparent” and doesn’t favor one lender over another one.

I admit this is all conjecture, but I suspect our CongressCritters are guessing about what to do, just like I am.  OK, they probably have experts helping them guess.  But it’s obvious that they aren’t really interested in solving the problem, they’re primarily interested in paying off special interest groups in the hope of being re-elected.  I’m just sayin’ that the solution they’ve proposed, the Pelosi-Reid-Obama Debt and Porkulus Bill, has little to do with lessening a recession and a lot to do with posturing for the home folks.