By Endre Dobozy

Click here to read part 1 of this article

Even though the Federal Reserve doubled the monetary base and the US Government continues to spend money it doesn’t have, none of this is likely to lead to inflation because the deflationary forces of the private sector (which is the paying back or nullification of loans by consumers and businesses) and the slowing of the “velocity of money” are more than offsetting any inflationary actions of the Fed and Congress.

The graph below shows that total private debt peaked in 2008 at $42 trillion. What’s interesting is that between 1997 and 2002 debt was only half this. It doubled within 7 short years due to lax credit standards and an overall feeling of euphoria by the investing public at large. Now the bill is coming due and the only way it can be paid is by writing down much of this excess credit. One estimate I saw recently was that 19 to 20 trillion and as much as $24 trillion of this debt will need to be written off.

So, if you look at it this way, there is no way that the US government could print enough money to induce an inflationary environment. Besides, the trend of governments around the world at the moment is towards austerity not stimulus. So, any government that tried to stimulate to this extent would have its interest rates soar as the bond market demanded a higher rate to compensate for the increased risk. Furthermore, there is no way the government could get permission to print this amount of money in the timeframe required to stave of deflation.

Now, on the brighter side of deflation, we look at the king of the discount stores, Wal-Mart. If you want a gauge of where, everyday items are going, Wal-Mart is a pretty good barometer and the “Wal-Mart indicator” still points to lower prices.

In an Associated Press headline from the end of May: “Wal-Mart makes splashy price cuts to get mojo back”

Wal-Mart dropped the price of ketchup bottles to $1 and the price of cases of Coke to less than $4, among other cuts. If taken in isolation this would simply be a marketing ploy, but when Wal-Mart does this other retail chains have to follow. According to the Associated Press “The sharp cuts at its U.S. Wal-Mart stores have already pushed rivals such as Target into price wars. And the markdowns are expected to keep coming throughout the summer.”

The good news is these price wars breed more and more competition like what’s happening with the growth of discount stores like Aldi and Save-A-Lot which specialize in low prices on a limited selection of items. These stores are taking market share away from Wal-Mart so, in retaliation, towards their competitors Wal-Mart slashed the price on nearly 10,000 items. In fact, Wal-Mart hopes to slash prices even further by taking over the shipping of their suppliers.

Of course, price wars among major retailers are good for consumers because they result in lower prices. This is great, if your income is secure and you have no risk of job loss. The problem is that many people in the US don’t have this kind of security. And as economic reality forces companies to keep prices low, they also have to keep a tight rein on their own costs, which includes the cost of labour.

This means that US unemployment is likely to remain high for years. It may improve slightly from its current levels, but the days of 4% unemployment are most certainly gone for the foreseeable future. High unemployment, in turn, means weak consumer demand and, thus, weaker consumer prices, causing the cycle to continue.

On top of this, you get an unintended consequence as can be evidenced in Japan, which has been in deflation on and off for 20 years now. What retailers are finding in Japan is that there is no urgency to make purchases. Consumers only buy the bare minimum or the essentials because they know that tomorrow the price will likely be cheaper than it is today. This, then, becomes a self-fulfilling prophecy and keeps the economy mired in deflation for longer because no one wants to spend any money now when you buy more for less tomorrow.