Foreign Investors, Get Ready To Be Paid Back In Cheaper Dollars
>>But, because we are the biggest net-debtor nation in the world, deflation could beget more deflation as it would make it more difficult for us to service our debt. So, as net debtors, we Americans want inflation, not deflation. And Greenspan aims to please us now, just as he did when he created the credit to inflate the stock market.<<
July 08, 2002
Well, it looks as though the fix is in. Greenspan has gotten the go-ahead from none other than his unbiased staff to step up US inflation. I am referring to the recent Fed staff study that everyone else is referring to these days, "Preventing Deflation: Lesson from Japan's Experience in the 1990s." One of the conclusions of the study is that when inflation gets closer to zero, the odds of deflation increase. Duh! If a price index is exhibiting no growth, then, of course, it is more likely to contract a 1% than if it were initially growing at 6%. The study goes on to speculate that if interest rates also are near zero when there is price-index stability, then monetary policy could be rendered impotent if deflation should occur. Why? Because with nominal interest rates at zero and accompanied with deflation, then the Fed would not be able to lower "real" interest rates. This is the conventional wisdom. Of course, the Fed could crank up the money printing presses, even at a zero nominal interest rate, and create more inflation. This would lower the real rate of interest even with a zero interest rate.
But the last comment is mine, not those of the study's authors. And it is the comments of the authors that Greenspan wants to hear. Now, judging from the nearly 8% year-over-year growth in M2 and the rise in commodity prices, as shown in Chart 1, there is little reason to be concerned about deflation here in the US of A. But, because we are the biggest net-debtor nation in the world, deflation could beget more deflation as it would make it more difficult for us to service our debt. So, as net debtors, we Americans want inflation, not deflation. And Greenspan aims to please us now, just as he did when he created the credit to inflate the stock market.
I said that we are the world's largest net-debtor nation. Chart 2 shows that the rest of the world now owns almost 12% of our total outstanding debt - up from less than 2% thirty years ago. When foreign creditors - and domestic ones, too -- get wind of Greenspan's intent to lower US inflation-adjusted interest rates, which today are only 0.55% in terms of the fed funds rate -- by stepping up US inflation, how do you think they will react? My bet is that they will run to the currency that will give them a positive inflation-adjusted return on their short-term money. And if all central banks join in with the Fed in pushing inflation-adjusted interest rates into negative territory, then there always is gold.
Paul Kasriel
Director of Economic Research
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