Are we headed for deflationary depression instead of hyperinflation?

At least one analyst thinks so.  According to financial advisor and author Dan Shaffer America and the rest of the world are currently at the beginning of a deflationary depression period.  He believes that we are presently seeing the beginning of this depression and it will last for many years to come.  Presumably overall prices will fall dramatically in this period according to Shaffer’s prediction.

He says that governments have borrowed huge amounts of money and this has driven up public debt dramatically.  We have had TARP and the stimulus package to name a few of these public spending programs but none of them have stimulated the economy.

We still have high unemployment and no sign of a real recovery.  According to an article posted online recently in Yahoo Finance the economy is sputtering.  Unemployment rose in May officially from 8.1% to 8.2%.  Far fewer jobs were created than were anticipated according to the article.

Shaffer points out that Chinese manufacturing is stalling and there is the European economic crisis.  Several countries in Europe have massive debt problems with Greece at the forefront but Spain, Italy and others are all in trouble too.  Manufacturing in Britain is shrinking at a fast pace and even France and Germany are showing a slowdown in the manufacturing sector according to the Yahoo Finance article.

Shaffer seems to indicate that all of this government spending has only served to pump more air into a series of bubbles.  We have already seen the housing bubble burst but their are others that are ready to burst he says.  There is the manufacturing bubble and the student loan bubble not to mention the overall consumer debt bubble.   He indicates that all of these bubbles must eventually burst when the air (government spending) is withdrawn as it inevitably must be.

In America the Fed has responded to this overall economic crisis by dropping interest rates to historic lows.  Interest rates are now lower than what they were even in the great depression and they are at the lowest level in history according to Dan Shaffer.  According to the Yahoo Finance article the Fed has bought $2.3 in bonds to help the recovery.  The Fed has also signaled that it will keep these interest rates low until late 2014 at least.

In the article they state that there is little more that the Fed can do as it has dropped interest rates as low as they can for the foreseeable future and it seems to have little effect.  The federal government too is in trouble too as it has borrowed and spent with TARP and the stimulus package around $2 trillion and this has not created growth in the economy.

So now the government is out of options.  They have borrowed, spent, and the fed has lowered the interest rate to zero.  What else can the government do?  We now have a $16 trillion public debt to show for these borrowing and spending policies and little economic recovery.  The spending has indeed left us with nothing but record large government debts.

I hear echoes of history here where FDR’s treasury secretary Henry Morgenthau, Jr. said “we have tried spending money.  We have spent more than we have ever spent before and it does not work”.  He was speaking here of FDR’s new deal which he was a primary architect of.  The new deal policy was to borrow and spend money endlessly in an attempt to stimulate the economy but at the end of 8 years the unemployment rate was just as high as it was when FDR’s administration began spending money.

Today we have done almost exactly what was done in the 1930s with similar results.  You think we would learn from history that this massive borrowing and then spending does not lead to recovery but just to massive debt.  Now with the heavy debt load and the lack of recovery the American public naturally wants to put a brake on the spending.

A public demand has been building for the last few years that government spending be curtailed.  We have seen this with groups like the Tea Party and others that have demanded an end to this spending and a reduction of deficits.  Whether you agree with these groups or not their demand have reached the ears of Congress.

This is where Shaffer seems to believe that we will get into trouble.  He claimed recently on Fox business that this government spending does eventually find its way into the private sector.  When government spending is lowered in the near future he says this will result in less buying power for world markets.  This could result in deflationary pressures throughout the world as the bubbles burst.  Prices could then dramatically decline instead of increase.

He seemed to say that government spending has propped up the stock market although temporarily.  Now that the times have changed and people want to put the brakes on borrowing and spending this removal of the government money will result in severe economic problems because of a collapsing of prices.

The government has also tried printing money with QE1 and QE2 and there are calls to do a QE3.  I argued in a previous blog that this will only lead to massive inflation and that could lead to disaster.  This is what lead Germany to Hitler through the massive money printing and inflation of the Weimar republic.  The National Socialists (NAZIs) were just another political party with limited influence until the money printing inflation cycle drove the German economy to a terrible crisis.  This all made people turn to Hitler for a solution and we all got the holocaust of World War Two with 60 million dead.

I believe that Shaffer’s theory of a massive price reducing deflation instead of hyperinflation must be considered as a real possibility.  It is certainly another possible outcome of the current economic crisis.  Prices could dramatically fall when government spending is inevitably withdrawn.

Is it more likely that prices will collapse as government withdraws spending?  Are we headed into a deflationary downward spiral or is it more likely that massive inflation will occur as governments print more money?

We don’t know for sure.  Our debt situation and money printing policies are similar to the Weimar Republic of the 1920s but the argument for deflation is also compelling.  Will prices drop dramatically or will they inflate beyond all expectations?  Either way we appear to be headed for a crisis in the world.  We have been there before but the results were not good.  When economies collapse and order is gone people yearn for someone to restore order.  That person or persons could become a detriment to the whole world like Hitler was in the 1940s.

I am a San Diego bankruptcy attorney.  For further questions please visit my websites at www.farquharlaw.com or www.freshstartsandiego.com.  Or call my office for a free consultation or for any other advice about bankruptcy or debt at (619) 702-5015.   Call now for free credit report and analysis!  For a free e-book on “13 things to do to prepare for your bankruptcy filing” please e-mail me at farquharesq@yahoo.com.