The government released the Consumer Price Index report for April today and it showed that there was no inflation last month. On a year-over-year basis, prices fell by 0.7% which is the biggest drop in over 50 years.
As bad a problem as inflation is (and will be), deflation is even worse. The reason is that once deflation starts to get out of hand, it reinforces itself. As consumers see that prices are falling, they’ll stop buying. As a result, producers will cut prices even more and the cycle will begin again. That’s why it’s crucial for the Fed to prevent a deflationary spiral.
Ben Bernanke famously said that the Fed could easily stop deflation since it could drop money from helicopters. Well, these days Ben is practically dropping money from 747s! Now that the Fed is on board with the administration’s fiscal policies, it will start buying Treasury by printing money. The Fed creates this money out of thin air.
As a result, once the economy recovers, we’ll see rising inflation. Another result will be that the U.S. dollar will start to fall against other major currencies. However, this will benefit stocks in commodity sectors like energy. This will also benefit large multinationals that do a large share of their business in non-dollar currencies.