The treatment (inflation) is worse than the disease (deflation)

In the early part of this new century, the United States started to spiral into deflation. This was the result of a series of bubbles created throughout the latter part of the previous century, enabled through loose lending standards. When these bubbles burst, and consumers were unable to request new money (loans) from banks, the amount of dollars in circulation started to decrease. Deflation is a terrible problem that induces asset destruction and results in severe hardship.

To combat this, Ben Bernanke and the US federal government worked in concert to support a series of inherently inflationary quantitive easing steps. However, as we are discovering now, the treatment is worse than the disease.

The inflation created by the United States has been exported to all the world economies, and that includes third world countries which are popular outsourcing destinations. This inflation has been exported in three ways:

1) Purchase of assets in these external countries, resulting in "hot money" inflows that are converted into local currency and dumped into the local markets. More local currency chasing the same products results in inflation.

2) The acceleration of investors de-leveraging from the dollar. For example, with the expected continuing appreciation of foreign currencies (i.e. the continuing decline of the dollar), investors are liquidating their US assets and moving into foreign investment. This is particularly true of sovereign wealth funds. This has only accelerated and exasperated the problem.

3) The rapid decline of the US dollar, which is actually being facilitated by the previous two

As you can see, it is not the US consumers who are being affected by this inflation (yet), but foreign countries.

Ironically, the biggest misunderstanding is the myth that the US government can "print money" and create inflation. In fact, governments have no power to do anything. Governments do not create wealth. Their income is derived from taxes, which is extracted from their citizens. Governments can only transfer wealth.

In the context of recent events, we see that the US government has transferred wealth in both directions in patterns that are as incoherent as the bickering between the political parties. Democrats seek to raise taxes on the wealthiest Americans - which is often times defined as the middle class, and transfer that wealth to lower income brackets through spending programs. Republicans seek to transfer wealth in the opposite direction, from bottom to top, through government bailouts of public entities who mismanaged their finances.

You see? Everybody gets screwed!

Both of these practices, in combination are part of the problem. Government intervention generally facilitates malinvestment and is very damaging to economies.

Why write about this topic in a technology/outsourcing blog? Because these inflationary pressures are hitting the third world with disastrous consequences.

The CPI in China is stated in single digits, but the working poor in China know better. Inflation there has resulted in the cost of basic goods to live - rent, food, gas, to rise to levels that are unaffordable. As those of you who read this blog know, I believe a serious crisis is looming for China in the next 24 months. One that will take most pundits by surprise, but not readers of this blog. China, for their part, are trying to offset this through new rules on the purchase of second and third homes and by raising interest rates. Too little, too late, I'm afraid.

Inflation is causing problems in South America as well, where the Brazilian president warned only last year of "currency wars". The Colombian peso has moved from 2000 pesos to the dollar on January 1 to 1750 as of this writing. That is 12.5% acceleration.

What is sad about all of this is that the inflationary tactics by the Federal Reserve, and the bickering in Washington over how to redistribute wealth, have not actually fixed the problem. Money dumped into the economy has not resolved the core issue, which is that American consumers are tapped out and cannot request any more money. At the end of this horrible inflationary spike, deflation is still looming. Only, this time, the medicine will be even more bitter.