Opinion: Is It Twilight in America?

In my opinion, concerns about long-term deflation in America are unfounded. There may be some short-term deflation for a few quarters due to a severe recession combined with a collapse in commodities. However, long-term inflation is determined by increases in the money supply, which is continuing to grow even now during the recession, the commodity bust, and numerous bank failures that also cause the money supply to shrink.

The Fed is basically printing so much money that it is staying ahead of what would naturally be a short-term deflationary period as the economy tries to adjust from years of rampant asset and commodity inflation.

After this downturn runs its course -- probably over the next few quarters -- all of this excess liquidity created by the Fed is going to cause a tremendous surge in inflationary pressure. At that point, the Fed will either need to dramatically raise interest rates to fight inflation or allow a collapse in the purchasing power of the dollar and a stampede out of U.S. assets by foreign investors.

Neither of those choices is going to be very appealing. In the unlikely event that this recession lasts for several years and we have real deflation, our zero- interest- rate policy may be appropriate, but it is even more important that the government promote savings and debt reduction. This is because in a deflationary economy the value of debts actually increases over time because cash appreciates against almost all other assets except precious metals.