Why FEDs Hands are Tied About Deflation

Normally, FED makes borrowing easier by making credit cheap. But it won’t work now because:

1. Banks do not want to lend because they think they may not get the money back.

2. Borrowers do not want to borrow because they think they may not be able to pay it back.

3. For inflation to happen consumer must chase too few products with too much money.

We have the opposite. We have wage reduction. We have unemployment. Consumer is a saver now.

This makes it very hard to expand the bank credit. Here is how banks create money out of thin air to inject into the economy:

http://www.tradingstocks.net/html/banks_create_money.html

FED has been inflating bank credit for the last 50 years. It needs to inflate exponentially, higher and higher compared to the GDP to have the same effect. In other words, to have $1 increase in GDP, it takes more and more debt every year. When debt is not increasing faster, it becomes impossible to have that $1 gain in GDP.

http://www.tradingstocks.net/html/inflation_deflation_credit_bub.html

To encourage borrowing, government has various programs such as mortgage interest deduction from income tax, 8K tax credit for first time home buyer etc. The government does not want Affordable Housing. As home prices are coming down, instead of celebrating, they try to inflate it right back up. Why?

Because when people borrow to buy a home, banks create new money, this new money makes the government look good. Government has been using this to get re-elected all the time. But the population has a borrowing limit. Now the home prices are lover, number of sales are less. The total amount of lending that can be done for the banks will not be sufficient to expand the credit supply to a level that can sustain the GDP growth.

This is why the current stock market and other asset prices are likely to be over priced now. We have not seen the stock market bottom in March 2009:

http://www.tradingstocks.net/html/near_bottom.html