The nation's monetary base--consisting of bills and coins in circulation plus banks' deposits at the Fed--has climbed 114% over the past year through May. For comparison, the biggest annual increase before this crisis, going back as far as 1960, was a little under 16%.
Whether it's voluntary frugality or under the coercion of creditors, Americans have abruptly switched from living beyond their means to saving more and working down the debts they incurred during the bubble years. Normally, consumer spending accounts for about two-thirds of U.S. gross domestic product...and...when you're saving, you are not spending as much as you did before.
The dramatic pullback in consumer spending means money that otherwise would have gone into raising prices is going into propping up the faltering economy. Banks have drastically increased their reserves at the Fed rather than making new loans. That's the biggest cause for the increase in the monetary base. "At every level of the economy and every level of society, the demand for cash is unprecedented," says David A. Rosenberg, chief economist and strategist for Gluskin Sheff & Associates, a Toronto money manager. Says Rosenberg: ""If the Fed didn't meet that demand for cash, we'd have a destabilizing deflation on our hands."
As a matter of fact, the economy is making ends meet, creating a deflationary spiral...where cash is king.
Excluding food and energy, consumer prices rose a modest 1.8% in the 12 months through May--and including food and energy, they fell 1.3%, the most since 1950. Cutbacks by consumers are bringing about deflation in business, with unemployment in May at 9.4% and manufacturing using only 65% of their capacity, the lowest since recordkeeping began in 1948. Small businesses that were aggressively raising prices a year ago are now "worried about weak demand, the fact that they don't have many customers," says William C. Dunkelberg, chief economist of the National Federation of Independent Business.
Source: BUSINESSWEEK, June 29, 2009
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