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Inflation, Not Deflation, Mr. Bernanke

Discussion in 'BBS Hangout: Debate & Discussion' started by Air Langhi, Aug 18, 2010.

  1. Air Langhi

    Air Langhi Contributing Member

    Aug 26, 2000
    Likes Received:
    Kind of long article


    In the wake of a barrage of bad economic data, the yield on two-year U.S. treasury notes has tumbled to 0.5 percent and the 10-year note to 2.8 percent, almost reaching the levels after Lehman's collapse. Pundits in the U.S. and other Western countries are talking about deflation again. The decline in CPI for the past three months gives this view ammunition. The Fed is coming under pressure to resume quantitative easing (QE). In anticipation of the Fed resuming QE, nicknamed "QE 2," the dollar has declined quickly by 10 percent from its recent high. Both the treasury and currency markets have already priced in "QE 2." It just downgraded the U.S.'s economic outlook and decided to reinvest its proceeds from its huge mortgage bond holdings in treasuries. It is not quite "QE 2," as it doesn't involve additional QE, just maintaining the past liquidity injection. But it leaves much for the market to imagine.

    Economic news from Europe has been surprisingly positive. This is to be expected. First, its short-term economic problems are less serious than the U.S.'s. The property bubble was restricted to Ireland and Spain. Second, the sovereign debt crisis is mostly about small southern countries and is less serious than the fiscal crisis of the state governments in the U.S. And, the average budget deficit is much lower than the U.S.'s. Third, the euro's decline has boosted export-oriented economies like Germany. While Europe's long term problems remain serious, it looks better than the U.S. or Japan in the short term. This is why euro has performed well lately.

    But, Europe's economic performance may deteriorate in the next twelve months. The euro has rebounded and won't help its exports like before. Its fiscal contractions will negatively affect its domestic demand. Europe's employment situation has always been poor. The U.S.'s employment data has been poor relative to its past but is still better than Europe's. The U.S.'s private sector is still adding jobs. The odds are that Europe's private sector will still lose jobs.

    Similarly, Japan's situation has improved but remains poor. Its nominal GDP has stopped declining. But, if the yen remains as strong as it is now, it could decline again. Japan's employment has stabilized, thanks to strong exports. As the yen's strength drags down its exports, employment will resume its decline. With national debt above 200 percent of GDP and annual fiscal deficits at 8 percent of GDP, Japan urgently needs to rein in its debt growth. Hence, if its economy improves, it will likely increase its consumption tax to decrease its fiscal deficit, which would slow the economy. Japan is essentially structured to not have a good economy.

    The developed world is essentially competing on bad economic news. Major currencies move on who is worse at the moment. The Greek debt crisis caused the euro to plunge. Now the weak employment and resuming property weaknesses have caused the dollar to plunge. Maybe the yen is next.

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