All about inflation, deflation, and reflation

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By Jim Flynn

Are the bank bailouts and the stimulus plan going to bring back carefree days of easy money? We don’t think so. Even the Walt Disney Company couldn’t reproduce the economic fantasy of this decade.

Stated bluntly, governments, consumers, banks, and businesses are over their heads in debt. Piling on trillions in additional debt isn’t going to cancel the consequences of our long orgy of spending more than we earn and produce.

The irony of our financial mess is that those who created it believed their own lies. The Bush administration financed two wars and massive tax reductions by adding five trillion dollars to the national debt. They deluded themselves and voters into believing their house of cards was a success of “the free market.”

With the consent and encouragement of Congress, the Federal Reserve, Fannie May, and Freddie Mac, banks came to believe that as fast as they could sell off a bundle of questionable loans, they could leverage more easy money and create twice as many looney loans in the next cycle, which they did.

Businesses convinced themselves that demand for new homes, malls, hotels and other commercial developments was limitless. Their looney bankers agreed.

Best of all, Wall Street investment houses came to believe they could earn billions in commissions and millions in bonuses by selling any promise they could write on paper. Their paper is now called “toxic assets,” and is owned by busted banks and brokerages around the world.

The problem no one in Washington wants to talk about is the wringing-out process. Home prices will fall until they reach realistic values. And $2.5 trillion of consumer debt isn’t going to disappear just because Washington sends out more stimulus checks.

The bailout and stimulus debates in Congress were depressing. Simple Simon Republicans still believe the economy can be made right by repealing all taxes. Dumbell Democrats believe unemployment can be cured by building bridges to anywhere and subsidizing public unions.

A third force to which the politicians have turned in this crisis are the financial wizards, such as former Treasury Secretary Henry Paulson and current secretary Timothy Geithner. In both cases their message when appearing before Congress was “Trust me. I’ll send you the details later.”

The main thrust of Congress and the financial wizards is to re-inflate the economy. There has been much talk about the dangers of doing nothing, but little discussion of the consequences of trying to spend the economy back to health.

While the Bush Administration was running up the national debt to $10.5 trillion, Americans were increasing their average debt from 98 percent of household income to 130 percent. After all, stocks, pension funds, and family home values were going up, up, up. So people spent their inflation, and then some.

The forbidden word to describe air leaking out of an inflation bubble is deflation. People have lost confidence in their home values, their investments, their pensions, and their government.

Until citizens, businesses, and banks regain confidence in their respective net worth, they are going to hold to a sideline strategy. They’ve already made the same mistake at least twice.

It is rumored that some people who still have jobs are actually saving some of their income for an even rainier day. In Washington saving is considered counterproductive, a bad sign, and unpatriotic.

Another bad sign is a Chinese tour group (“House Search”) coming to major U.S. cities to shop for bargain houses for their children to use while attending college. The Chinese have plenty of U.S. dollars and want to spend them while they still have some value.

Any mention that current conditions resemble the Great Depression is rejected as nonsense. Truth is that a real estate bubble preceded the Great Depression. At the same time, inexperienced thousands were playing the stock markets with borrowed money. After Wall Street crashed in 1929, lending dried up, foreclosures accelerated, consumers stopped buying, and prices kept falling.

The ides of the present government bailout and stimulation plans are to re-inflate the economy before deflation can take hold. It might work, but government will end up owning trillions of dollars of worthless assets, and may reduce the value of our currency to monopoly money.

Jim Flynn was formerly a corporate counsel, served in military intelligence during the Korean War, and once aspired to be a newspaper columnist.