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at the bell

The conventional view on the Street is that the Federal Reserve's various rounds of monetary stimulus will eventually end in tears.

Those who hold this widespread view believe something like this: All the new money the Fed is pumping into the financial system will inevitably drive commodity and consumer prices higher. After all, inflation is always a monetary phenomenon, and the Fed is creating a lot of fresh cash that could be used to chase goods around the economy.

For the conspiratorially minded, inflation has a desirable silver lining. More inflation would lighten the burden of Washington's huge debt load, allowing the repayment of the government's bloated borrowings with some of the money Fed chairman Ben Bernanke is conjuring out of thin air. The approach has even been given a colourful, suggestive name – it's the "financial repression" of creditors.

But before rushing to embrace the idea that we're facing a Weimar-on-the-Potomac future, it might be worthwhile to get some sober second thought on the mainstream view.

For that, who better to turn to than the prominent forecaster Gary Shilling? He runs an eponymous New Jersey-based money management firm, and has been predicting deflation – inflation's opposite number – as the most likely outcome of current economic conditions. He's also correctly played the idea of falling rates of inflation over the past three decades by loading up on U.S. Treasury bonds, which have soared in value.

Mr. Shilling says investors should remain on deflation alert, believing that the Fed is only delaying falling consumer price levels through its latest effort at money creation, known as QE3, which was announced early in September.

The two previous rounds of quantitative easing, or QE, goosed stocks and commodity returns in the short term, but haven't altered the fact that global growth is anemic, he says. An indication of just how weak the U.S. economy is will arrive later this week, with Friday's release of September employment data.

"You get these [QE-induced] spikes in stocks that continue until some shock comes along. I rather suspect that's what will happen now," Mr. Shilling says. "I think that's when deflation would likely come back to the fore."

Among the possible shocks that could usher in deflation would be anything from the collapse of a major European bank with derivatives exposures that ensnares other institutions, to a blow-up in the Middle East that sends oil soaring, or a hard landing in China.

In his view, the Fed's money-printing hasn't led to inflation because the private sector is still deleveraging, or paying back debt, which suppresses money creation.

To see what's happening, it's worthwhile pondering what the Fed is actually doing in its open market operations. When the Fed buys securities through quantitative easing, it creates new money out of thin air, crediting the funds to financial institutions. In normal economic times, banks take this fresh money and lend it, creating even more money through the resulting proliferation of loans and deposits in the financial system.

But because the private sector is trying to repay debt, this money creation process is impaired, and the economy can't reach strong growth through debt-financed consumption. The Fed's newly minted cash has ended up as idle, excess reserves frozen in the banking system.

As proof that this is happening, Mr. Shilling points to the enormous amount of money printing in recent years, combined with huge government deficits. In normal times, these activities would surely have led to an economic boom. That currently isn't happening, Mr. Shilling says, because "the deleveraging in the private sector is just so huge that it is overwhelming" all the stimulus.

Mr. Shilling says de-leveraging is likely to continue for another five to seven years. During this period, he believes that rather than seeing inflation, we're more likely to experience deflation of about 2 per cent to 3 per cent a year.