Expert Commentary

The Fed Actually Needs Price Deflation

The Fed has created a massive risk for the economy.

The Federal Reserve in the U.S., as with most other central banks, is obsessed with price inflation. Even though the Fed has a dual mandate whereby it has to ensure economic growth as well as price stability, the annual rate of price inflation is front and center in its deliberations. Central banks mostly want consumer prices to rise steadily over time because they think that this means the economy is growing. Let me rephrase that – they want YOU to think that this means the economy is growing. The thing is, prices can decline during economic growth. In fact, left alone, economic growth should lead to declining prices in many areas. An abundance of goods and services as a consequence of economic growth, for instance, leads to price declines. The problem is that governments, with central banks acting as their agents, require reasons to continually expand their debt and, therefore, their control over society. To do this, they have created an enemy – price deflation. In seeking to convince us that price deflation is a bad thing, central banks and governments have a ready excuse to crank up the printing presses to create the magic money that helps governments expand debt to whatever level they want.

But, think on this.

The debt of governments around the world, but particularly in the U.S., is now at such eye-watering levels that they cannot afford any hint of a loss of faith. They need to be able to issue debt and, therefore, for people to buy it. But what if price inflation starts to accelerate? That, for fixed-income investors, is one of the main reasons not to buy bonds. Should price inflation start to tick up, we could easily see “bondmageddon” in the U.S. Treasury market as buyers flee, with panic ensuing in many markets. Ah, no problem I hear the Modern Monetary Theorists say, the Fed will simply print the dollars to buy all the government bonds itself. The problem with that strategy is that, at some point, citizens realize they are living in a totalitarian regime and revolt, bringing down the fabric of society.

The irony of all this QE-infinity madness is that what the Fed actually wants, that is price inflation, could result in an even more dramatic deflation of the debt bubble than is currently underway.

U.S. Price Inflation Expectations