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Do We Really Need a Recession?

By: Steve Johnson

1/28/2008 - 15 Comments

Some say the Fed should do everything they can to avoid a recession – even if it creates inflation and another bubble that will only create a bigger problem down the road.

It is very rare for elected officials to willing enter a recession. Elected officials are always under a lot of pressure when the economy is under financial stress. Back in the 70’s early 80’s, when inflation was out of control, the Fed raised interest rates and willingly entered a recession. They did that by first convincing the public that inflation was the enemy and raising interest rates would stop inflation.

Even thought the Fed caused the inflation in the first place, the Fed could not have raised interest rates until the public was knee deep fighting inflation – and calling for a solution. Years before, the Fed knew inflation was coming, but without the public behind them, they didn't fight it.  The public wanted more spending and more government benefits.

We are soon going to be in a similar situation, as inflation is creeping up on us. Lowering the interest rates and giving everyone an $800 check is only going to help inflation. But, that’s what the public wants. We want to avoid a recession as long as possible.

The root problem with our financial system is that both the Federal government and the public are spending more money then we make. America loves to spend money. It’s paying it back that we don’t like so much.

Do we really need a Recession?

Yes – because we as a nation have spent a lot more money than we had, by borrowing money from the rest of the world. Printing more money or inflating the dollar is a means of paying back some of our debt and it appears to be less painful than actually paying it back.  When we print more money, the value of existing dollars floating around the world are decreased, which means our debt has been reduced. Reducing our debt allows us to continue to borrow and spend even more. But, printing more money also creates inflation because we have to pay more dollars for the stuff we buy from other nations as each dollar is worth less value. They want the same value for their products, so they have to charge us more dollars. This is why we have a record trade deficit.

The increase in oil prices has had the biggest impact on our trade deficit for the last few years. The primary reason for oil price increases is because of the drop in the value of the dollar, caused by the US Federal government printing too much money.

Inflation is coming

Once more money has been added to a currency (by printing more or lowering interest rates), it is eventually going to create inflation that will decrease the value of the money you have in hand. Saving and retirement accounts are the big losers, because the money they saved years ago is now worth less value then when they worked for the money. That’s why they say to spend your money as soon as you can when you have a falling currency, because tomorrow the money will have less value.

Inflation must be stopped

The inflation that is coming in the next few years will not be fun.  It will eventually force the Fed to tighten up the money supply (increase interest rates). This will put further burden on the recession we are in and make it last longer.  The only thing the Fed can do is try to take the edge off the downturn. They can try to stop the financial markets from crashing overnight and try to bring us down easy.  But, when we get to the bottom, it’s not going to be fun and there isn’t much the Fed will be able to do other then what we will all be doing – spending less, saving more.

What about the tax-rebates?

The tax rebates of $600-$1200 will help people pay bills and some will go shopping, which will help retailers and perhaps increase consumer confidence. But, it will not help house prices – which are the root cause of the slowing economy. Interest rates are again approaching all time lows, as they were in 2003-2005. The difference is that the lending rules have changed. People now need 10-20% down with proof of employment.

The banks have lost billions of dollars from the drop in house values and are no longer willing to take the risks they took in 2003-2005. Another risk to the housing market is the teetering bond market. Today, because of the falling dollar, the bond market is negative. Negative because when a foreign nation invests in US bonds at 4% and the value of the dollar drops 6%, the result is a negative 2%.  This is not sustainable.  Very soon the bond market will have to change. Interest rates will rise and mortgages will have to remain affordable, which means housing prices will need to continue to fall.  Probably for a few more years.

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