Inflation becomes afterthought as credit crisis worsens

By Burton Frierson - Analysis

NEW YORK (Reuters) - Fire up the chopper and man the printing press, the government is now attacking the financial crisis head-on, with "helicopter Ben" Bernanke strapped in to the co-pilot's seat.

Before he became Federal Reserve chief, Bernanke incurred the ire of inflation vigilantes for his 2002 mention of a "helicopter drop" of money in a discussion of possible strategies for fighting a deflationary economic spiral like the Great Depression.

The comment may be ringing in the ears of some hardliners after the U.S. government approved a $700 billion bank bailout last week and the Federal Reserve announced a corporate finance rescue on Tuesday, but the financial system's dire condition has sounded a louder alarm.

"If this doesn't work then certainly deflation is a much bigger concern than inflation," said Brian Levitt, economist, OppenheimerFunds, New York.

Under last week's plan, the Treasury will attempt to revive paralyzed credit markets by buying up mortgage-related securities that have lost their value due to the worst U.S. housing slump since the Great Depression.

The Federal Reserve said on Tuesday it would begin buying the short-term debt many companies use to fund their day-to-day operations.

The initiatives were the latest in a series of other bailouts and rescues, including the nationalization of housing finance giants Fannie Mae and Freddie Mac.

The total cost of all of the government's efforts to avoid a financial collapse could approach $2 trillion.

PRINTING MONEY

Normally such a massive rise in government borrowing and spending might be inflationary. Indeed, Bernanke's 2002 comment was considered controversial because it suggested the Fed might resort to printing money to get out a deflationary rut.

In the near term, however, economists say the bigger danger is deflation. Consumer inflation remains elevated after record-high energy prices this year but the effects of the credit crisis are more likely to damp this down.

In fact, house prices and the stock market are tumbling while companies and consumers are finding credit more difficult to obtain as the crisis deepens.

These are hardly inflationary developments, and neither is the stunning $50-dollar drop oil prices have seen in the last three months, though by many measures, the government's plan would be considered inflationary.

"Right now we're getting the big benefits from the decline in oil prices, but the longer-term consequences of this are clearly going to be inflationary" said Conrad DeQuadros, senior economist at RDQ Economics.

"We have massive amounts of liquidity that is being pumped into the economy globally. Central banks are likely to remove this liquidity very slowly. So right now the focus is clearly not inflation but I think it will be down the road."