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With the government announcing programs to shore up financial institutions and halt falling asset prices almost daily and the growing likelihood that Washington will embark on a fiscal stimulus program of record proportions, the ultimate fear in the minds of investors is when – and how rapidly – inflation will surface.
Over the coming decade, no other issue will have more impact on advisor’s investment strategy decisions.
Answering this question requires an understanding of the delicate and complex relationship between deficits and inflation. Economist Horace “Woody” Brock, CEO and Founder of Strategic Economic Decisions (www.sedinc.com), offers a cogent explanation of the forces at play. He says inflation is not an inevitable result of huge deficits and, although economic growth will not resume for several quarters, fiscal and monetary policy can avert inflation.
Not everyone shares his views, and we also summarize the analysis of John Williams of Shadow Government Statistics, who says hyperinflation may be as little as a year away.
The Size of the Deficit and the Stimulus Package
The projected Federal deficit for FY 2008, which just ended in October, is $460 billion, or 3.5% of GDP. In absolute dollars that is an all-time record, nearly twice the 2007 deficit. But as a percentage of GDP it is fairly modest.
During the last recession, in 2000-2002, the US ran a 2% surplus. Spending your way out of a recession, Brock notes, is a lot easier in times of surpluses.
A fiscal stimulus must come from decreased taxes or increased government spending, and the incoming administration has made clear it plans to emphasize the latter. It is really not that difficult to estimate the size of the stimulus required, Brock says. He believes that GDP must be boosted by approximately 4%, which translates to a stimulus package of $570 billion, putting the deficit over the trillion dollar mark and at 7.4% of GDP, both record highs in recent decades.
But that figure does not include TARP spending or other bailout measures, such as the recently announced $800 billion program to purchase consumer credit loans and mortgage-backed securities.
Brock says these expenditures will push the deficit above the $2 trillion mark, possibly above $3 trillion if the recession or the ongoing housing price contraction are more severe than expected.
But there is a critical distinction between an operating fiscal stimulus package – such as for infrastructure improvements – and government programs, such as the TARP, that inject capital into or buy assets from financial institutions. In the latter case, the government is transferring the ownership of assets from the public to the private sector, and there is no net effect on GDP. Only an operating stimulus package can boost GDP.
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