It’s been awhile since I’ve written about an economic and financial topic on the blog. I have not neglected to follow these issues recently as I still watch the global economy and financial markets rather closely. The reason I have not written about these issues is because there is not much new to say about these issues.
- The U.S. and global economy is still weakening with atrocious economic data to support this notion. For instance, homes sales in the U.S. plunged to a 15 year low in the month of July. The fear (and it’s a reasonable one to have) is that the U.S. real estate market is going to experience another downturn.
- The sovereign debt crisis remains as governments around the world still have major fiscal problems. Ireland’s credit rating was downgraded on Wednesday even though they have done more cutting back on spending than what the European Union and the International Monetary Fund has asked countries like Spain and Greece to do.
- Local governments also face huge fiscal problems. For instance, the state of California is going to withhold $3 billion from school districts across the state because they need money to pay bondholders. School districts across the state desperately need the money, but the state cannot afford to miss a debt payment or the situation will get much worse. California is likely going to issue IOUs soon if it cannot get its fiscal house in order.
A couple of days ago I read an article that does a great job of explaining a major problem that the U.S. Federal Reserve faces. The article explains that even if the Federal Reserve fixes the U.S. economy by returning it to a sustainable growth pattern the outcome could be much higher inflation or even hyperinflation. The reason much higher inflation could develop from a real (not an illusionary one like the U.S. government has touted for the past year) economic recovery is that banks would finally lend out the tremendous amount of money that has been deposited into them recently to people (up to this point banks have been very reluctant to lend money out to people-so much so that U.S. politicians are unhappy with the banks).
- The money lent out would lead to increased demand for items in the U.S. economy since Americans would have access to more money to buy items. This increased demand would lead to higher prices if supply cannot respond to meet this demand in time (which is probable since it takes time for companies to adjust to a new demand picture). If the process gets out of control (which is quite possible since so much money could potentially be lent out that is not being lent out right now) people will start believing that inflation is a major problem and will take steps to buy things they need before prices increase further. People’s desire to buy items before prices increase further increases the demand for these items, and as a result, prices increase even faster for these items. This is a vicious cycle that can lead to very high inflation or hyperinflation, especially if people lose faith in paper money during the process.
The article does a great job conveying the notion that if the Federal Reserve wins the battle (restoring the U.S. economy on a sustainable growth trajectory) they could still easily lose the war (maintaining people’s faith in paper money and maintaining price stability). You can read the article at the following link.
