The Fed Is Trying To Avert A Deflationary Spiral

The other morning CNBC had an interview with an analyst. I forgot his name as it was very early. But what he said made a lot of sense to me. He said that people (investors, traders) are underestimating the collective brain power of the Fed. His point was that those who thought the Fed had been asleep at the wheel were mistaken. He believed that the Fed would eventually figure a way out of the large economic problems facing the United States.

I recall that now as I think about where the US economy is at the moment. My line of thinking is that the US residential real estate market's rapid decline if left unchecked could spread through the system creating a possible deflationary spiral. If that were to happen money would become scarce and therefore much more valuable. Consumers would have a tendency to hold onto their cash thinking that prices would drop. Consumers would also begin to worry about how they were going to replace those precious dollars. A scenario like this would be devastating to the US economy. At the moment a scenario like this is also hard to imagine when commodities have been soaring along with prices of almost everything else. In my view today's inflation is past history and was caused by monetary policy errors made in the past. It is unlikely to continue. The possibility of a deflationary spiral though is real. It is real because cash and debt have become harder to get and because asset price deflation is occurring in many areas of the economy. The assets deflating include the US residential housing market, the US equity markets, and most importantly the US credit markets.

Ben Bernanke as leader of the Fed studied the Great Depression and is an expert on the problems to watch out for in the economy if deflation tried to gain a foothold. Unfortunately Bernanke gets a misplaced nick-name, 'Helicopter Ben' by traders and others in the business because many years ago he made a reference to monetary policy stating that to avert a deflationary spiral the Fed could drop dollars from helicopters. I believe that Bernanke through the thick smoke screen of current inflation really sees the possibility of a deflationary spiral and that this is what is driving his and the Fed's current thinking. The Fed and Bernanke do get it and know what the real threats to the economy are. It is still too early to see if the remedies offered are going to work though. Consumers can be offered cash but if they are not going to spend it then that can be troublesome. But at least the right man and is on the job. And to quote that guest on CNBC the collective brain power at the Fed should not be underestimated. The commodity markets sure received a dose of the Fed's brainpower the past couple of days.