The Fed is Steering U.S. Economy into Deflation

The Fed is steering the economy into deflation. It's a political calculation that will keep unemployment high, increase excess capacity, and deepen the recession. C.P.I. continues to fall, bank lending is down 4 percent year-over-year, housing prices are slipping, business investment is off, and consumer credit continues to shrink.  On Wednesday, the Commerce Dept reported that retail sales fell 0.5 percent, more than analysts expected. This is the second drop in retail purchases in the last two months signaling weakness in consumer demand.

The slowdown hit nearly every sector including auto sales, furniture, computers, building materials, clothing and sporting goods. There was also bad news on housing on Wednesday. The Mortgage Brokers' Association reported that loans purchase applications fell to a 13-year low last week, and refinancing contracts continued to slide despite record-low mortgage rates. The housing depression is ongoing and is adding to deflationary pressures in the broader economy.

Federal Reserve chairman Ben Bernanke claims the recovery is still "on track", but more than 60% of last quarter's GDP can be attributed to fiscal stimulus and inventory adjustments. That means demand will drop as the stimulus runs out and restocking ends. Then the economy will have to stand on its own.  Expect negative growth by the forth quarter 2010 or first quarter 2011.

There are things the Fed can do to fight deflation.  Bernanke can resume his bond purchasing program (quantitative easing), this time buying US Treasuries to increase inflation expectations and add to the money supply. Or the Fed can purchase corporate bonds to increase business investment and hiring.

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