The only upside to this is that India might see more relief from skyrocketing commodities price inflation. But mainly the US banking system is going to face a lot of hardship before things get better. Many small banks had a lot of shares riding on Fannie Mae and Freddie Mac -- but with the govt takeover, those shares will be wiped out. Even India will not be immune to the spreading effects.
Tuesday, September 09, 2008
Krugman: Debt Deflation Disaster
Paul Krugman again speaks the truth in his latest NYT column. The US is sinking into a debt deflation cycle, much like Japan did during the 1990s. It was this process that spawned the yen-carry trade, due to Japan's extremely low interest rates.
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I guess, that FED is bound to fail. Central Banks are designed to create controlled inflation. High inflation means that the money coming back to them would have less value, even after interest, than they lent.
But it is deflation which is always the mortal enemy of a central bank.
Strangely, deflation is perfectly natural in an economy particularly after long periods of inflation and growth.
Central Banks fear deflation most because it demolishes their reason'd'etre viz providing economic growth.
Experience of several countries including Japan proves that central banks are never able to fully control the deflation whose time has come. However the efforts by central bank to spur growth at any cost may lead to inflation in linked economies and stagflation in domestic economy, which would eventually cost the manipulating central bankers and central government their jobs.
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