America's Economic Engine Heads for an Overhaul

Nothing short of a complete overhaul will get the U.S. economic engine purring again.

The financial mechanics have been trying to get that engine firing on all cylinders for five years now. They've used every tool at their disposal. Yet the engine continues to sputter.

Data ranging from employment to retail sales and manufacturing weakened substantially in March ... There are indications the weakness persisted into April.

The lack of inflation should come as welcome relief for American households, but it could cause some nervousness at the U.S. central bank, which may see it as a symptom of the economy's weakness.

Reuters, April 26

It hints of deflation. Even some in the mainstream financial media have recently acknowledged this. On April 22 on CNBC, UBS's Art Cashin said, "There are some deflationary pressures around."

Also consider that "the Thomson Reuters/University of Michigan final index of consumer sentiment fell to 76.4 in April from 78.6 in March." An April 26 Bloomberg article notes that "'People are nervous that another shoe could drop' in the form of another recession emanating from the European debt crisis, said ... the editor of the American Association of Individual Investors Journal. ... 'Many consumers remain risk-averse,' said ... a senior financial analyst at Bankrate Inc."

The psychological aspect of deflation and depression cannot be overstated. When the social mood trend changes from optimism to pessimism, creditors, debtors, producers and consumers change their primary orientation from expansion to conservation. As creditors become more conservative, they slow their lending. As debtors and potential debtors become more conservative, they borrow less or not at all. As producers become more conservative, they reduce expansion plans. As consumers become more conservative, they save more and spend less. These behaviors reduce the "velocity" of money, i.e., the speed with which it circulates to make purchases, thus putting downside pressure on prices. These forces reverse the former trend.

Conquer the Crash, second edition, p. 91

The former trend of inflation was the norm for so long that it's still the default economic reference. The few who do acknowledge the growing deflationary trend will soon be joined by others. But by then deflation will be obvious to everyone.