Simon Johnson is quickly becoming one of my favorite economists. Not because I think he's necessarily right all of the time, but more because he unabashedly says exactly what he thinks, without sugar coating a thing. Few economists, for example, would be so brazen as to say the U.S. is behaving like a "middle-income emerging market," as opposed to the most robust financial market in the world with has a little case of the hiccups. In a piece from the New York Times' Economix blog today, he explains why the mainstream economists who say a heinous level of inflation could never happen in the U.S. might be wrong:
Our financial sector became supersized, took on too much risk, received the mother of all bailouts, and we still struggle to recover from the ensuing instability. What if our inflation dynamics have also changed to become more like those of Argentina, Russia or Ukraine?
He also comments on his own blog about banks behaving badly, which will contribute to the problem. Here, he explains how banks' continued shenanigans like replacing huge bonuses with huge salaries to sustain high compensation and attempting to use the Treasury's Public-Private Investment Partnership program to buy back their own toxic assets will cause the financial system to stay weak, and the result:
Big banks that pay higher wages will have less capital for the next round of difficulties. Banks that keep legacy assets close at hand will likely find out (again) why these loans and securities were called toxic. A weaker set of big banks will encourage the Fed to allow the yield curve to steepen, so monetary tightening happens later and perhaps too late to prevent inflation from taking off. Tunneling makes it harder for the Fed to tighten when inflationary pressures appear.
His Economix piece contains additional explanation, including other factors that might contribute to inflation. But what's the gist of his argument? That, because the U.S. is behaving more like a country where shady government and business dealings are the status quo, the kind of bad inflation that those other countries experience could happen here too.
This seems to me a strong argument to counter those with an "it could never happen here" attitude, because the "here" they're referring to might be a place of the past. It speaks to the question of whether the U.S. economy is fundamentally different now when compared to the past few decades. I'm not entirely convinced, but if Johnson is right, then the U.S. may be in for some very ugly inflation, even if it isn't the really scary hyperinflation that the doomsday crowd frets about.
The people who think we can control inflation are the same ones who thought we could control the banking industry and the economy. Although I majored in accounting, not economics, I did takes Economics 101 and this is pretty basic. If we continue to dump vast amounts of money into the economy, sooner or later we will get inflation. I don’t think anybody can make a reliable prediction when. On TV Bernanke explained how the Fed provided more money to banks. They just increase the bank’s balances in their Fed accounts. If this isn’t just “magic money,” I don’t know what is. If the money supply continues to increase far in advance of productivity, it’s impossible to avoid inflation. www.santaclaussyndrome.com
It still seems to me that when there's bad economic management in Argentina, Russia or Ukraine there's really obvious places to take your investments, hence causing their currencies to weaken.
Where can that happen, with the US dollar, on a significant scale? The most obvious place would be the EuroZone. But "Our financial sector became supersized, took on too much risk, received the mother of all bailouts, and we still struggle to recover from the ensuing instability" and that also applies to Europe, and they have been slower to address the crisis. In the UK it might apply more than here. So Euro and Pound are out.
Japan is export dependent, and strengthening Yen ruins their ability to export and damages their economy (which is already nearing Depression levels of 10% GDP decline). Would China reverse course and allow its currency to quickly appreciate? Do investors trust the People's Bank of China more than the Fed? I don't think Canada or Australia or South Africa are big enough (or independent enough from US economy).
So it would seem to me that the real situation Simon envisions isn't anything about the US being an emerging market but instead a global collapse of fiat money.