Friday, June 12, 2009

The Mailman Drop of Money - You've got Money

The Mailman Drop of Money Almost Guarantees The US Deflation Battle Can be Won

We hear a lot about helicopters dropping money from the sky in order to beat deflation, that kind of plan is not likely to be ever adopted since it would be unfair to all citizens not in the cities that is getting the cash rain, further more no government body(to my knowledge) has the authority to take such action. However the IRS has a paper check mailing authority that can and is likely to be used in the case deflation in the core CPI becomes a reality and is persistent.

Here's how it would work, the administration working with congress would receive a advice from the Fed chairman to go ahead and issue a tax cut to virtually all citizens for an gigantic amount(Say 50% of US consumer spending, $5T), the fed would stand behind the bond auctions and monetize to make sure the government would have no problem financing it. The US consumer would suffer an gitantic 'wealth effect' of receiving such windfall gains in networth and its very likely to spend a significant fraction of the tax cut(as the history of the wealth effect shows, people spend when they get big jumps in networth)

Immediately as those paper checks were deposited, the money supply would soar(checking accounts are a component of M1), total M1 as 04/2009 is $1.5T, that would jump to $6.5T(Which would be the largest jump in M1 in the history of the United States). Now keep in mind that no banking credit expansion would be necessary for this. To the extend that people spent some of that money(and there is no reason to expect that cash to have 0 velocity due the wealth effect and the fact that people spend some % of tax cuts) that would put A LOT of upward pressure on prices, we are talking an overnight huge jump in the money supply AND velocity, even if that didnt happen nothing prevents them from keep increasing the amount of money printed. They could print 1 quadrillion dollars if necessary, talk about wealth effect

In the meantime the banking system can be frozen and yet inflation on the moon. If you read the american central bank literature of the last decade there is simply no reason to expect Bernanke and Co to not go for these extreme plans in order to beat deflation, they already said they will if necessary.

Actually just the announcement of such intentions by the Fed chairmain is likely to send the dollar index plunging and everyone scared of inflation(therefore money velocity would rise), its possible that not a single check needs to be mailed

As of right now, there is no reason for the fed to take such action as the core inflation rate is in their comfort zone, inflation expectations are well anchored and the economy is showing signs of stabilization. But make no mistake, if those improvements reverse one of the easiest money fed chairman since Arthur Burns + politicians desire to spend without raising taxes(It shouldn't be too hard to convience congress and Obama that more stimulus is needed, specially with unemployment about 10%) and the IRS mailman drop of money(or direct deposits to bank accounts) virtually guarantees US deflation wont be here to stay(Or it would be cured naturally as the economy bottoms out)

That might not be the case in europe where deflation could be persistent as the ECB is not as extreme(plus they don't have a centralized mailman to send checks, they would have to pick a government and all sorts of problems could occur) they also have the German hyperinflation history which further creates political problems and criticism and certainly is not the case with the BOJ, which is run by incompetents who never tried extreme measures to reverse deflation and raise the money supply without depending on the banking system

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