9/8/2010 7:00 PM ET|
No inflation means no recovery
Companies, consumers, investors and banks are tucking away their cash, making it harder for the US economy to pull out of the doldrums. Rising prices could fix all of that.
Over the past three years, central bankers have flooded the U.S. financial system with money. Interest rates are at historical lows. But the economic recovery has stalled anyway.
Unemployment remains troublingly high. Home prices and stocks are still down a third from their pre-recession peaks.
The traditional approaches to stimulating the economy -- ultralow interest rates and government spending -- just aren't working.
What we need is a healthy dose of inflation.
Yes, I know that might sound crazy, but I'm not talking the Weimar-style hyperinflation that Germany suffered through during the 1920s or even the spike we saw at the end of the 1970s. A return to an annual inflation rate on the order of 3% to 4% is what's needed.
Because inflation and interest rates are so low right now, strange things are happening:
- Companies are hoarding cash instead of putting it to work, because, with capital so cheap, even the tiny return from saving it is a boon.
- Investors are tucking money into safe, low-return investments instead of feeding growth by buying company stocks.
- Consumers are saving instead of spending despite low interest rates, partly because prices may fall lower.
- Banks, scared to lend, are piling up excess reserves that are earning virtually nothing.
An increase in prices would force changes in these behaviors.
Without it, we risk a slide into a Japanese-style deflationary spiral in which the economy falters and the cost of our debt burden swells. And as I recently warned, reliving Japan's experience of the past 20 years wouldn't be pretty. The Dow Jones Industrial Average ($INDU) could drop below 4,000, and home prices could fall an additional 46% by 2030.
You might wonder why low interest rates, combined with budget-busting fiscal stimulus from the federal government, haven't been enough to get the job done this time around.
It's not like rates aren't low enough. By some measures, they are in negative territory. The yield on three-month Treasury bills has been below 0.2% since early 2009, a prolonged stay at levels that haven't been seen since the early 1940s. And it's not like there isn't plenty of money in the system. Since November 2007, the Federal Reserve has expanded the monetary base from $857 billion to more than $2 trillion.
The problem is extreme risk aversion. And it's being enabled by low inflation.
The hordes are hoarding
Instead of using cheap financing to invest and hire workers or even raise dividends or repurchase shares, corporations are hoarding cash. The ratio of liquid assets to total assets has jumped from 2.9% in 1980 to nearly 7%, a level not seen since 1960. As a result, the manufacturing capacity of the country is beginning to rust away as managers forgo even basic maintenance expenditures to stash money in the bank.
VIDEO ON MSN MONEY
I wouldnt worry about the inflation thing, With the FEDS printing funny money
7/24..Its sure to happen...But when living on a fixed income, inflation is NOT a good thing
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
[BRIEFING.COM] The S&P 500 (-0.3%) remains near its recent levels, while the Dow Jones Industrial Average (-0.4%) and Russell 2000 (-0.5%) underperform.
Even though nine sectors trade below their flat lines, only two groups have surrendered their week-to-date gains. Industrials and technology hold respective week-to-date losses of 0.5% and 0.2%, while the other eight sectors are up between 0.1% (consumer discretionary) and 1.2% (energy) for the week. For its part, the S&P 500 has ... More
More Market News
|There’s a problem getting this information right now. Please try again later.|
MUST-SEE ON MSN
- Video: Easy DIY smoked meats at home
A charcuterie master shares his process for cold-smoking meat at home.
- Jetpacks about to go mainstream
- Weird things covered by home insurance
- Bing: 70 percent of adults report 'digital eye strain'