They Won’t Take the Chance of Being Wrong

Today must be the day to add several nails to the coffin of the “we will see deflation” crowd.

John Mauldin recently came out with his regular column, “Thoughts From the Frontline.”  This one is entitled “We Can’t Take the Chance.”

In it, he describes a recent debate “between bond maven Jim Bianco and former Bank of England Monetary Policy Committee member David Blanchflower…”

The format for the debate between Bianco and Blanchflower was simple. The question revolved around Federal Reserve policy and what the Fed should do today. To taper or not to taper? In fact, should they even entertain further quantitative easing? Bianco made the case that quantitative easing has become the problem rather than the solution. Blanchflower argued that quantitative easing is the correct policy. Fairly standard arguments from both sides but well-reasoned and well-presented.

I like Bianco.

It was during the question-and-answer period that my interest was piqued. Bianco had made a forceful argument that big banks should have been allowed to fail rather than being bailed out.

I might really like Bianco.

The question from the floor to [David] was, in essence, "What if the Bianco is right? Wouldn't it have been better to let banks fail and then restructure them in bankruptcy? Wouldn't we have recovered faster, rather than suffering in the slow-growth, high-unemployment world where we find ourselves now?"

Blanchflower pointed his finger right at Jim and spoke forcefully. "It wasn't the possibility that he was right that preoccupied us. We couldn't take the chance that he was wrong. If he was wrong and we did nothing, the world would've ended and it would've been our fault. We had to act."

That sentence has stayed with me for the past week: "We couldn't take the chance that he was wrong." Whether or not you like the implications of what he said, the simple fact is that he was expressing the reigning paradigm of economic thought in the world of central bankers.

Setting aside one’s views on if the world would have ended absent action by central bankers, what do you think the central bankers will do next time?  Will they stand pat, letting deflation (of any stripe) do the necessary work of popping the bubble, or will they act? 

History at best ignores, if not actually piles abuse on those who didn’t act in crisis, even when the inaction resulted in a success: for example, the crash of 1920 has earned President Harding no praise.  At the same time, history praises those who take significant action, even if the action results in continuous and worsening failure – see FDR as a prime example.

A central bank doing nothing in the face of crisis?  Yet, this is what it will take to realize deflation.

I don’t know how or when this will end.  I am quite certain that as long as price inflation as measured by commonly accepted consumer indexes remains benign (and real price inflation does not trigger an aggressive response by consumers), central banks will do that which they have been trained to do: inflate, and that which they are paid to do: ensure survival of the money-center banks.

At minimum, this will result in an extended period of below average growth globally.  Technology won’t change this – we have lived through one of the biggest technological booms in history, and all that has occurred is that the wealthy and connected have captured the bulk of the improvement to the overall standard of living.  For the vast majority of individuals in the developed world, the standard of living remains stagnant at best. 

This will happen until it no longer does.  I just don’t know when that will be or what will trigger a change.  In the meantime, I am not concerned about deflation in any form.  We will see significant price inflation before we ever see any type of deflation.