Deflation Coming?

In my opinion, the signs are now pointing more strongly toward deflation. Or in other words, to the next leg downward in the collapse of the housing bubble. The heroic efforts of government policymakers to deny reality and act as if they can forestall a necessary readjustment appear to be fizzling out. And the behavior of policymakers is an important clue to this situation. As usual, the focus falls on the mild personage of Fed Chairman Ben Bernanke.

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I had an interesting argument with a friend yesterday who is involved in politics. She asked me if the operations to save the banking system worked. I said yes, certainly. The world’s largest banks are no longer in danger of a cascade of collapses, as was threatened by the failures of Bear Stearns and Lehman Brothers. A moment later, she referred to this as a good thing, and there I stopped her. It worked, yes, but was it good? Only if you believe that it’s good to have a large raft of all-but-nationalized financial institutions kept fat and happy by exceptionally high reserve levels, and with no economic incentive to actually do their job, which is to intermediate credit, not to lobby Congress for higher salaries and bonuses. What Bernanke did was necessary to prevent a systemic collapse, but the aftermath isn’t pretty.

Still, that’s only half of the story. While the financial system has been rescued, the real-world economy is still in a deep funk. And it’s going to stay there for a while, because we all have to work off the effects of the credit bubble. Here, the policy responses of the Fed, the Administration and Congress are being less successful. But they won’t stop what they’re doing, because politically that would take a lot more courage than Barack Obama has.

via Bernanke vs. History: Our Economic Outlook | The New Ledger.