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To: palmer
My scenario is a battle between the two. Deflation has the upper hand right now, but inflation is going to manifest as a psychological phenomenon (bubble) like it did last winter and spring. The "wage push" part of inflation is dead of course, but the "use it or lose it" part will come into play. But there will also be borrowing to bid up commodities once the psychology changes.

The problem is that the Fed is pushing on a rope right now. The problem is that banks aren't lending, but this is not because interest rates are too high or that there is a Fed-imposed limit on lending. It's because the banks are scared.

The problem with the Fed's money regulatory mechanisms is that they all assume that banks will always lend as much as they are allowed at competitive rates. So what happens if they don't? The Fed can extend ever-increasing enticements to lend, but until the banks stop being scared, they won't respond. So then what happens when the banks snap out of it? The Fed's enticements suddenly start working and banks will overextend themselves and we will be in for another world of hurt. Also the increased money supply that the Fed pumped into the economy to offset the decrease in lending gets augmented by the new lending into a huge jump in inflation

I've been trying to think of a way for the Fed to "pull the rope" rather than push. One horrible but straightforward idea is to fine banks who fall below a certain lending percentage. It's kind of like a reverse reserve requirement. Another even worse idea is for the Fed to compete directly with banks in lending when private lending dries up. Another similarly bad idea is for the Fed to tell the banks that it will pay back a certain percentage of bad loans, taking the bank's risk away.

Whatever is done, I still expect the scenario to play out that deflation runs its course in a year or so, and then snaps back into a short period of very fast inflation before settling down.

58 posted on 01/27/2009 2:40:33 PM PST by dan1123 (Liberals sell it as "speech which is hateful" but it's really "speech I hate".)
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To: dan1123

All your self-described bad ideas are rooted in one bad idea which is not allowing the market to determine a reasonable amount of lending. Slowing down the massive deleveraging can be done without trying to pump new loans - it just requires traditional Fed loans with somewhat longer terms. The market is going to have to be allowed to properly price loans, the longer that is postponed, the worse the inevitable contraction (or hyperinflation) will be.


164 posted on 01/28/2009 4:48:10 AM PST by palmer (Some third party malcontents don't like Palin because she is a true conservative)
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