Lately concern seems to be centered on the
“three D’s” – deflation, the dollar and deficits -and on all
three there has been plenty of discussion.
Lately concern seems to be centered on the “three D’s” – deflation, the dollar and deficits -and on all three there has been plenty of discussion.
So I thought I would try to shed some light on these issues. In my opinion, deflation, while it is a concern, is not a major one.
In retrospect, the Federal Reserve was too slow in lowering interest rates and may ease further, but most forward inflation indicators are not signaling deflation ahead. The M2 money supply is rising at a healthy 8 percent growth rate.
Gold prices are up sharply over the last two months to $370 an ounce. Most commodity price indexes are rising as well. And the dollar’s exchange rate value is down sharply, which brings us to the second D – the dollar.
From a peak in January 2002, the dollar has dropped about 20 percent in value versus a trade-weighted basket of other major currencies. And Treasury Secretary Snow recently commented that the dollar’s exchange rate value was less of a concern than maintaining low inflation and preventing counterfeiting.
At its peak in 2002, the super strong dollar contributed to the current deflationary tendency in the US, depressed exports and hurt some US companies’ profitability.
It also, in my opinion, helped dissuade foreign central banks from lowing interest rates.
The European Central Bank (ECB), for example, has kept short-term interest rates higher than the United States in part because of the (then) weak Euro. Now the Euro is very strong and could prompt the ECB to cut rates.
Given the current slump in both Europe and Japan, lower rates and faster money growth would, in my opinion, help global growth.
The U.S. budget deficit, now at about $300 billion, is the third D. Congress has just passed a new $350 billion tax cut and spending package that, in the short-run at least, will add to that deficit.
My feeling about this is that, while deficits are not a good long-term strategy, in the short-term with the economy weak and the stock market depressed, the tax cut may help.
It is not all that big – $350 billion over ten years – for an economy currently producing $11 trillion in GDP rising at about $400 billion a year.
But the tax cuts do, in my opinion, increase incentives to work, save and invest and do straighten out and reduce taxation on equity investments.
Longer-term, we will need to get back to running surpluses and retiring debt again, hopefully via a strong economy.
But, for now, I do not see the deficit as being an impediment to growth or pushing interest rates up.
