In previous posts I shared my views regarding the shape of the recovery and shape of employment in the future.

The President and Congress have told us, this recovery will also cost a few trillion, so the open question is: how the value of the dollar will change in the months and years ahead? Deflation, inflation, or both?

The following is what I think may happen.

First, the Fed Rebuilds the Banks

According to the Fed, total mortgage debt exceeded $14 Trillion as of Dec. 31, 2007.The best estimate is that 10-20% of that debt must be written off due to the drop in house values. That’s $1.4-$2.8 Trillion. Assuming US banks hold only 50% of that debt, that’s $700 Billion to $1.4 Trillion that needs to be removed from their balance sheets for mortgage debt alone. That does not include credit card debt, auto loan debt, student loans, or business debt. The Fed will have to print enough funds to cover the debt, lending to the chosen banks. Those funds will not provide any stimulus, as the dollars will simply re-establish the reserve levels that banks are legally required to carry.

Second, Consumers Start Saving—Near Term Deflation

Of the US $14 Trillion GDP, 70% ($10 Trillion) is driven by consumer spending. If consumers increase their savings rate from -2% to +5%, another $700 Billion (7% of $10 Trillion) will be removed from the economy, creating an additional 5% drop in the GDP. In the short term we will have deflation, driven by declining demand. Sure enough, that’s just what has happened in the past four quarters.

Third, the World Redeems Dollars—Long Term Inflation

With over $7 Trillion dollars flowing internationally as global reserves outside the US ($2 in China, $2 in Japan, $2 in OPEC, and $1 in Europe), plus the $7 Trillion the Fed has already printed in the past year, over $14 Trillion (1x GDP) in cash is beyond the control of the US.

Sometime in 2010-2011, the US may see currency deflation as other countries spend their dollar reserves to dig out of their own recessions. Remember that we produce very little of our own hard goods, They come from China, Japan, Korea and other countries. We buy energy from OPEC. If the dollar drops vis-à-vis Korea, Japan, China, and OPEC, then the US may see an increase in the price of hard goods and energy.

Granted, any price rise will be moderated by the domestic drop in consumption, but the US no longer controls the price of global goods, services, and energy. The US share of global commerce is 23%, and declining. Global consumption will increase, regardless of the US. Prices will rise, and the dollar will likely decline against other currencies—a one-two punch for the US.

What Do You Think?

What is your forecast for GDP and deflation/inflation? How does it affect your business planning?

This entry was posted on Tuesday, May 12th, 2009 at 5:30 am and is filed under Business info, Strategy. You can follow any responses to this entry through the RSS 2.0 feed.
Tags: bailout, economy, future
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