Little Inflation With A 0% Fed Funds Rate…Is A Hyper-Inflation Scenario On The Horizon? Or Maybe Deflation?

By | December 7, 2020

Reading an Op-Ed from the American Enterprise Institute concerning the issues facing the European economy and the tools (or lack thereof) available to the ECB for fighting them, I was reminded of a conversation that I had over the weekend.

How I was asked, do you know when it tis time to get out of the stock market? A market I might add, that’s trading at what might be considered to be nosebleed levels. Levels that have been reached in large part due to the fact that there are few if any alternatives for anyone seeking a return on their money.

My answer? It’s likely time to get out when the Fed is using whatever tools it may still have at its disposal trying to maintain the fed funds rate at 0% (or possibly pushing rates into negative territory), and despite that treasury yields begin rising in an aggressive way. The reality is that the money-printing spigot pouring liquidity into the economy has been wide open since 2010 or so, with inflation issues nowhere in sight.

At some point, however, inflation will spike, and it’s the ‘smart money’ of the treasury market is an excellent metric to follow.

This is a real estate story, mortgage market story and certainly an economic story as well.

But at some point could the U.S. market potentially face a situation like that Europe presently finds itself in, deflation and recession?

Let’s hope not, but read more in the article from American Enterprise Institute below…

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From American Enterprise Institute (AEI) and written by Desmond Lachman, ‘Amidst the coronavirus, can Europe escape its debt-deflation problem?

‘Amidst the coronavirus, can Europe escape its debt-deflation problem?’

A specter is haunting the European economy. It is the specter of a debt-price deflationary spiral. Unless Europe’s Northern European countries soon come to the European Central Bank’s (ECB) aid to fight deflation with further aggressive budget stimulus, the world economy should brace itself for another round of the European sovereign debt crisis.

A central bank’s worst nightmare is to have to deal with falling prices at a time that the economy is both highly indebted and in the grips of a deep recession. This is all more so the case at the time that the central bank has largely run out of ammunition to do much about that situation.

Falling prices in the middle of a recession tend to lengthen that recession by encouraging consumers to defer purchases in the hope of yet lower prices. At the same time, falling prices and a weakening economy make it all the more difficult for debtors to service their debt. That in turn has the effect of causing yet another headwind to any economic recovery, which tends to prolong the deflation.

Unfortunately, it would now seem that the ECB finds itself facing a nightmare economic situation.

Even before the pandemic’s recent European resurgence, the European economy found itself in its worst economic recession in the past ninety years. That deep recession brought falling prices in its wake. At the same time, European public debt skyrocketed to record levels, especially in the Eurozone’s economic periphery. It did so as budget deficits ballooned to their widest peacetime levels.

Following the pandemic’s resurgence, official forecasts now suggest that the European economy will experience another leg down in the current quarter. That is likely to deepen Europe’s deflationary problem in the months ahead since unemployment will remain unusually high and excess capacity will characterize the economy. The Euro’s 10 percent appreciation over the past year is bound to further exacerbate its deflationary problem by continuing to exert downward pressure on import prices.

The ECB’s major problem in dealing with this difficult deflationary situation is that it all too likely has run out of monetary policy road to be effective. Not only is its policy interest rate already well into negative territory. So too are long-run government bond yields for most of Europe’s northern member countries. This means that the ECB has little room left to promote economic recovery by further lowering interest rates, since pushing interest rates further into negative territory could create serious problems for the European banking system.

To be sure the ECB, could try to support the European economy through pushing down the Euro by a further round of aggressive money printing. However, especially at a time of a global recession, any such endeavor to weaken the Euro is bound to run into serious objections from Europe’s trading partners. Needless to add, more ECB money printing would not go down well with the German Bundesbank, which is the ECB’s largest shareholder.

With the ECB now rendered largely ineffective on its own to halt deflation, Europe’s only real hope is that its northern European countries soon provide further meaningful budget support to the economy. This would especially seem to be the case considering that those very highly indebted southern European countries, like Italy, Portugal, and Spain, are in no position to provide further budget support to their economies. Any additional budget stimulus from those countries would only heighten questions that are already being asked about their public debt sustainability.

The longer that the northern European countries wait before engaging in another round of large-scale budget stimulus, the deeper will be the deflationary hole out of which European governments will have to dig themselves. That in turn would risk triggering another round of the European sovereign debt crisis at a time that the world economy could least afford it.

For all of our sakes, we must hope that the northern European countries rise to the occasion and provide major support to the ECB in its efforts to revitalize the European economy before it is too late to avoid another Eurozone sovereign debt crisis.

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