Thursday, April 16, 2009

Swimming against the deflationary tide

There was a small, unobtrusive article in today’s Wall Street Journal: “A Deflated Fed Battles to Keep Prices Up”

Here are the bullet points:

* “In March the consumer-price index slipped 0.4% below its year-earlier level, the first decline in over 50 years”

* “It is hard to imagine [consumers] returning to their spendthrift ways anytime soon”

* “Falling prices would make it tougher for borrowers to pay off debt, leading to even more defaults and even tougher lending standards”

* To fight back… “the Fed could buy the Treasuries issued to finance such moves. In practice, that is like printing money and handing it out to households, and it is pretty much what is happening now.”

* “When the fight is between falling prices and the Fed, it is hard to predict which will prevail.”

Add to this mix, 30-day T-Bills now yield nearly zero (0.02%). Soon, one may have to pay the Treasury to hold short-term deposits, but nonetheless if deflation persists or worsens, equities and bonds will not be able to compete with cash. Everyone is expecting inflation as a consequence of government spending, but prolonged deflation would be a Black Swan with potentially serious consequences. Gold fell more than $13 an ounce today, below a technical support level, another indication that inflation may not be the main worry.