James Grant, editor of Grant's Interest Rate Observer, argues in a Wall Street Journal editorial that the economic recovery is likely to surprise — on the upside. Grant invokes historical experience in making the point that "the deeper the slump, the zippier the recovery." He cites economist Michael Darda's research, which shows that "the last time a recession ravaged the labor market as badly as this one has, the years were 1957-58 — after which, payrolls climbed by a hefty 4.5% in the first year of an ensuing 24-month expansion."
Grant also notes that "[t]his time out, the fiscal stimulus is likely to measure 10% of GDP, monetary stimulus 9.5% of GDP, for a combined pick-me-up equivalent to 19.5% of GDP." This represents unprecedented stimulus, introducing a wild card into attempts at forecasting the economy. We reckon that if the government wants to revive the economy, it can do so with the sheer determination to print and spend money. "Print and spend" may indeed be the new "tax and spend." The consequences of this behavior could be more dangerous than than slump we have gone through over the past year or so.
In Grant's words,
by driving money market interest rates to zero and by setting all-time American records in money-printing ($1.2 trillion conjured in the past 12 months), the Fed is putting the value of the dollar at risk. Its wide-open policy all but begs our foreign creditors to ask the fatal question, What is the dollar, anyway? Why, the dollar is a scrap of paper, or an electronic impulse, the value of which is anchored by the analytical acuity of the monetary bureaucracy that failed to predict the greatest financial crackup since the 1930s.
While we agree on most of Grant's points, we take issue with one assertion: Grant writes that a "1920-21 crackup [in the U.S. economy] featured a deflationary collapse — wholesale prices plunged by 37% — and, by 21st century lights, a highly unconventional set of government measures to set things right. To meet the downturn, the Fed raised, not lowered, interest rates and Congress balanced the budget — indeed, ran a surplus. Yet the depression ended. How, exactly, did it end? Falling prices opened wallets, the monetary historian Allan H. Meltzer explains."
We take issue with the view that deflation aids consumer spending by helping individuals find more "bargains." On the contrary, deflation generally makes people save more, as they predict that they'll be able to buy goods more cheaply in the future. Meanwhile, an inflationary environment makes people spend today, as the prices of goods are expected to rise while the purchasing power of paper money declines.
In any case, Jim Grant is usually worth listening to, and it's no different in this case.