Fed's Easing Is Just Beginning

04/29/2009 11:00 am EST


John Mauldin

Chairman, Mauldin Economics

John Mauldin, editor of Thoughts from the Frontline, says the Federal Reserve will have to print lots more money than it already has to stave off deflation.

If we increase the supply of money and velocity stays the same, and if GDP does not grow, that means we'll have inflation, because this equation always balances. But if you reduce velocity (which is happening today) and if you don't increase the supply of money, you are going to see deflation.

To fight this deflation, the Federal Reserve is going to print money. The Fed has announced they intend to print $300 billion (quantitative easing, they call it). That is different than buying mortgages and securitized credit card debt—that money (credit) already exists.

Sports fans, $300 billion is just a down payment on the "quantitative easing" they will eventually need to do. We are going to get quarterly or semiannual announcements, saying, we are going to do another $300 billion here, another $500 billion there. Pretty soon it will be a really large total number. A trillion is a lot. And the total guarantees and backups and all this stuff we are into—I saw an estimate of $10-12 trillion. That's a lot of money.

Understand, the Fed is going to keep pumping money until we get inflation. You can count on it. I don't know what that number is; I'm guessing maybe as much as $2 trillion. Ray Dalio of Bridgewater thinks it's about $1.5 trillion. 

Consumer spending is slowing, and it's going to slow for years as savings increase. At one time we were saving 7%-10% of our incomes, back in the early 1980s. We grew from 63% of the economy being consumer spending to 71% in 2006. We are going back to the mid- to low 60s. It’s going to take years, but we are hitting the reset button.

We have too many stores to sell "stuff," all sorts of stuff. We have too many factories to build too many cars, too many plants to build too many. When we built all that capacity, it was for an economy in which consumer spending was 71%, and because we were enthusiastic and believed we would grow at 3% forever, we probably built it for 73% or 74%.

We are watching capacity utilization fall off the table. It is down to 67%, fully 15% below normal. What happens when you see that? You start closing factories. We are going to have fewer restaurants, fewer clothing stores. The survivors will get bigger market shares; that's just what happens. Schumpeter called it creative destruction.

The Fed at some point is going to come to a crossroads. They can allow inflation, like the 1970s. We figure out how to muddle through, even during periods like the 1970s. So, the Fed can bring that back—which they all swear they won't do—or they can withdraw liquidity. Just as higher interest rates begin to take a toll on the economy, they will have to start pulling money out of the system to avoid higher inflation.

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