Friday, March 27, 2015

Greek Tragedy Nearing its Final Act

Despite occasionally falling out of the news for certain periods of time, the Greek debt problem has never gone away. In fact, the problem has grown continually worse.

Greece remains in a full blown depression. The economy suffered through a six-year recession (meaning output continually contracted), from which it only emerged last year. The unemployment rate is a staggering 26 percent, while youth unemployment stands at a whopping 60 percent.

That always leads to societal unrest, and rising crime. Leaving so many young men idle for so long is a recipe for disaster.

The European Commission, the International Monetary Fund (IMF) and the European Central Bank (the so-called Troika) have been granting loans to Greece for the past few years to keep it afloat.

Further increasing Greece's debt as a means of solving its debilitating debt problem is no solution at all. It is madness. It's akin to a son asking his parents for $100 to repay them the $100 he owes them.

Greece hid the magnitude of its debt problem prior to its entry into the European Union.

The 28 Member states of the European Union agreed to the Stability and Growth Pact in 1997, which limits government deficits to 3% of GDP and debt to 60% of GDP.

Greece was well above those limits at the time, which should have precluded it from inclusion. But no one outside the Greek government knew this back then. In fact, the Greek government didn't admit the falsifications of its predecessors until February 2010, years after the fact and well into its national crisis.

It is now known that by 1996, the Greek debt-to-GDP ratio stood at 95 percent. By the end of 2009, Greek government debt had reached 130 percent of gross domestic product, or more than twice the agreed upon limit. And by 2013, the debt-to-GDP ratio had soared to 175 percent.

About three quarters of Greek debt is owed to the EU and the IMF. In other words, Greece's creditors have given it just enough rope to hang itself.

Greece recorded an enormous government budget deficit equal to 12.7 percent of the country's gross domestic product in 2013.

While the country is expected to post a small budget surplus this year, that is before its debt payments are taken into account. Debt service won't allow Greece to get out of its cavernous hole. It is a country on its knees.

With such a weak economy, Greece cannot be expected to ever grow its way out of debt. During a recession, tax revenue shrinks along with economic output. Even in the absence of further annual deficits (which were still mounting), Greece hasn't possessed the means to service its existing debt for years.

Yet, it was continually adding to it, with the help of the Troika.

The IMF predicted the Greek economy would grow as the result of its 2010 aid package. Instead, the economy has shrunk by 25%. Wages are down by the same amount.

Meanwhile, Greece has a notorious tax evasion problem, which only makes its fiscal and debt problems worse. Greeks are fearless and defiant about not paying their taxes, yet the government lacks the resources, or infrastructure, or authority to do anything about it. The Greek government appears to be neutered.

Tax revenues so far this year are more than 1 billion euros below target; that's a lot of money for an economy that totaled just $179 billion last year.

The reality is that Greece has no means to ever repay its debts, and the Troika surely knows this. But the hope of central bankers everywhere is to create unlimited debts that can never be repaid, with interest payments continuing in perpetuity.

What we have right now is a game of chicken between the Troika and the new Greek government, which was elected on a mandate to rebel against the crippling austerity and debt payments imposed by its creditors. So, who will blink first?

Greece represents just 1.4% of the EU economy, so it really amounts to a bit player. If Greece were to leave the EU, economically it wouldn't be missed.

The trouble for the EU is the legal unwinding of a Greek exit. There is no mechanism in place for this because no one imagined such a scenario when the EU was created.

The other problem is that a Greek exit would set a precedent that could allow a much bigger economy, such as Spain or Italy, to make a similar exit. Such a scenario would be crippling, and it would set off a cascading series of government defaults and bank failures.

At present, there is no concern about either Italy or Spain exiting, as they are both enjoying cheap and easy access the debt markets, as seen below.

10-Year Government Bond Yields

United States 2.05%
Italy 1.26%
Spain 1.24%

It is patently absurd that yields in Italy and Spain are substantially lower than those in the US. There is no good reason for that. In a normal world, those yields would more than twice as high as the US. At some point, reality will set in and the bond market will realize that Italy and Spain are nearly as bad as Greece, with unsustainable debts and weak economies.

That's why the possibility of a Greek exit is so worrisome to EU leaders. It would set a very dangerous precedent.

This is the leverage the Greek government wields over the Troika.

At best, Greece's leadership failed its people through years of mismanagement and continual debt spending. At worst, they were a bunch of lying, duplicitous crooks and frauds.

The new government is trying to come to grips with the sins of the past, and it seems to have remembered an age old principle: The best way to get out of a hole is to first stop digging.

A recent report says that Greece may run out of money as soon as April 9. Without another round of loans, the Greek government's coffers will soon run dry.

It's not simply a matter of it being unable to service its debt payments; Greece won't be able to pay government workers or retirees. Furthermore, Greek banks are running out of money. Fearful depositors are withdrawing their money en masse.

In other words, if Greece runs out of money, there will be societal chaos.

This is the leverage the Troika wields over Greece.

Under the current terms, there is no way for Greece to get out of its debt crisis. Yet, its creditors cannot stomach the notion of a debt write down.

The day of reckoning is near. Everyone involved has tried to avoid some uncomfortable realities, but those realities are now becoming unavoidable. The can has been kicked down the road for far too long, and they have finally run out of road.

So, who prevails and who buckles?

Well, it can be easily argued that Greece needs the EU more than the EU needs Greece. The Greek economy is so small that it is hardly important to the larger union. And the Greek crisis will reach entirely new levels of social catastrophe without further loans.

On the other hand, if Greece stops repaying its loans, its financial position would be greatly improved. That money could then be redirected into the Greek economy. Greece would have to go back to its former currency, the drachma, and it would lose access to the international debt markets for a few years. But keeping that money at home might be enough to at least help it get back on the road to solvency.

That said, not servicing its debts won't correct Greece's tax evasion and corruption problems. That requires a strong government committed to genuine reform.

The new Greek government is in a desperate situation, with its back is against the wall. That makes its response unpredictable. Since it is a new government with new leaders, elected on a platform of resistance — even defiance — there is no precedent to predict how they will act or what they will do next.

This Greek tragedy is at last entering its final act. Like all good dramas, it is both riveting and unpredictable.

Wednesday, March 18, 2015

Deflation, Not Inflation, Is the Fed's Big Threat

It was little surprise to me that the Federal Reserve announced today that it will not raise interest rates in June. In fact, the Fed gave no definitive timeline for a rate hike, but many market watchers presume the first bump will come in September.

The Fed wants more time to watch how things pan out.

There's good reason for the central bank's hesitation. According to the latest “nowcast” from the Atlanta Fed, first-quarter gross domestic product could come in at just 0.3%.

Given the continued weakness in the economy, tepid wage growth, plunging oil prices and the tendency toward deflation, a rate hike seems imprudent to me. In fact, in normal circumstances, a rate cut would be more likely.

But these aren't normal times we're living in.

Perhaps the central problem that central banks around the world are grappling with right now is a lack of consumer demand, which is leading to weak economic growth, low inflation and even deflation.

When inflation in the US was very high in the late '70s and early '80s, Fed Chairman Paul Volker raised rates repeatedly and vigorously to crush it, and the strategy worked.

In a time of low inflation, or even deflation, the opposite tactic (cutting rates) is typically employed. However, the US has been living with near-zero interest rates for over six years. There is little room left to maneuver without going into negative territory.

While low interest rates generally stimulate the economy, they have not really stimulated demand in recent years. Cautious consumers are wary of spending and have not been compelled to borrow at previous levels. After all, excessive borrowing is what ultimately blew up our economy in 2008.

People haven't forgotten that yet.

Perhaps they expect a crisis event, such as another war or market crash. One way or the other, people aren't spending strongly enough to reinvigorate our consumption-based economy.

Inflation over the past 12 months turned negative (0.1%) for the first time since 2009. With the menace of deflation becoming all too real, how will the Federal Reserve respond?

There is a fairly recent precedent for cutting rates to fight the specter of deflation.

The Federal Reserve cut its key interest-rate (the Federal Funds Rate) to 1% in 2003, which at the time was its lowest since 1958.

But as the Wall St. Journal noted at the time, "Below 0.25%, the market for Treasury bills, eurodollars and other short-term IOUs would function less smoothly."

Therein lies the problem: The Federal Funds Rate has been at 0.25% since December 2008.

A quartet-point reduction, which is the minimum level the Fed will typically raise or lower rates, would result in zero — no interest at all. That could kill the bond market, but it might just might stimulate the precious metals markets.

After all, why keep money in the bank if it earns nothing?

But what about rates of less than zero, as is the case at some European banks at present? Central banks cannot easily push their policy rates into negative territory.

Gold may not earn interest, but zero interest it still higher than negative interest.

Deflation is worrisome because falling prices make it hard for the government and companies to repay debts. It leads to falling wages and layoffs, and can be the prelude to a bad recession. Once it takes hold, deflation is very difficult to defeat, as the Japanese can attest.

Former Fed Chairman Alan Greenspan said in 2003 that the serious consequences of deflation required a wide "firebreak" against it and that the Fed would "lean over backwards" to prevent it.

Inflation is generally perceived as rising prices, while deflation is the opposite. However, while inflation is really a decline in the purchasing power of the dollar, deflation is ultimately an increase in the purchasing power of the dollar. That makes the current environment all the more troubling.

The dollar is at its highest level since 2003. In fact, the dollar is now reaching parity with the euro, after being less valuable for many years.

So, what's the Fed to do about this?

An interest rate hike would just make the dollar even stronger against other currencies. That would hurt the US export market even more than it's already hurting. It would also make American-made goods less competitive at home against cheaper imports.

An interest rate hike would also add to deflationary forces. In simple terms, a stronger dollar increases the risk of deflation.

A strong dollar makes imports cheaper, most critically oil. Cheaper oil lowers the cost of all transported goods, which means essentially everything.

Cheap oil is already a prime deflationary force. Crude plunged below $43 a barrel on Monday, the lowest price since 2009.

Deflation is the biggest fear of both governments and central bankers. But the primary means to fight it — a cut in interest rates— may not be that effective since we're just a quarter-point away from zero.

The possibility of negative interest rates should concern everyone. There is, however, current precedent; it's happening right now in Europe.

It costs money to leave deposits at some European banks. In essence, a depositor's principle is guaranteed to lose value.

That's something most Americans can't even imagine.

But neither could most Europeans, until recently.

Wednesday, March 11, 2015

Federal Reserve Has No Good Options in Rate/Currency War

There are many opposing forces at play in the global economy today. We are living in truly historic, and unprecedented, times.

Central banks around the world have been steadily cutting interest rates — some into negative territory, a stunning development — as they fight to stimulate their beleaguered economies.

This is seen as an antidote to weak consumer demand; low interest rates are meant to discourage saving and instead encourage spending.

Low rates also typically devalue a nation's currency, which keeps exports competitive.

Government bond yields in the eurozone have plummeted to record lows since the European Central Bank started purchasing government debt and other bonds this week. It's all part of a €60-billion-a-month quantitative-easing program aimed to stimulate the eurozone’s sluggish economy.

But yields in some european countries were already negative before the QE program began, and the market didn't seem to fully price in the arrival of QE. That means yields could be driven even lower — in some cases further into the negative.

Falling yields elsewhere in the world have drawn many investors into US Treaurys, which have a better return. However, this demand is only pushing Treasury yields lower. Call it an unintended consequence.

The flight from the euro and other currencies has pushed the dollar to 12-year highs.

The ICE dollar index, which measures the greenback’s strength against a basket of six rivals currencies, rose 0.66% to 99.26 on Wednesday. The index was on track to hit the 100-mark for the first time since April 2003.

The dollar has already gained nearly 13% versus the euro this year, and the two currencies are now nearing parity. That will hurt US companies that sell to Europe, one of our largest export customers.

Europe is a half-trillion dollar market for US exporters. A higher dollar makes US goods more expensive overseas.

Meanwhile, the Federal Reserve seems poised to raise interest rates this summer, which would only exacerbate the currency divergence.

Big American firms that generate a large portion of their sales overseas will likely to see the impact of the stronger dollar when they report their first quarter results. Many companies are already warning that the stronger greenback will hurt their sales and profits this year. Foreign revenues will wind up looking weaker when converted back into US dollars.

With foreign interest rates so historically low, investors will keep buying the dollar. Simply put, the dollar looks like a better, safer, store of value right now, compared to other currencies.

The other side of the coin is that a stronger dollar also makes imports cheaper, including oil and other commodities. While that sounds good for the US economy, there are other consequences.

The US is the world's No. 3 oil producer, so plunging prices are hurting a major domestic industry.

At roughly $50 per barrel, the price of oil is leading to layoffs in the energy sector, particularly in states like Texas and North Dakota, whose economies have boomed in recent years due to fracking. The real estate markets in these states are now imperiled.

So, what will the Federal Reserve do next?

Inflation is barely existant. In fact, deflation is a bigger concern at the moment.

Consumer prices fell 0.7%,in January, the third straight monthly decline, while inflation over the past 12 months turned negative (0.1%) for the first time since 2009.

While that was largely driven by the huge drop in oil prices, surely it has given pause to Fed policy makers. Interest rates are typically raised to thwart inflation. Clearly, that's not an issue at present.

Additionally, raising interest rates would only: 1. Strengthen the dollar; 2. Funnel more foreign money into the US; 3. Hurt US exports; 4. Drive crude prices even lower; and 5. Further prop up the stock market bubble.

The Fed's zero interest rate policy (ZIRP) has fueled increased risk-taking by borrowers and yield-hungry lenders. The result has been a massive mispricing of financial assets, such as housing and stocks.

Yet, even with near-zero interest rates, demand for credit remains weak. Consumers aren't spending as robustly as they were prior to the Great Recession, and consumer spending drives roughly 70% of our economy. Higher rates will ultimately hurt housing and autos, etc.

On the other hand, low rates are hurting savers and discouraging saving.

You can see why the decision to tighten (raise rates) has to be such a tough one for the Fed at present.

Deflation is the biggest nightmare of governments and central banks because it makes it harder for countries to pay off debts. The US is currently grappling with an $18 trillion national debt. That's why the Fed may feel compelled to act.

But there are so many wheels simultaneously in motion throughout the global economy. Any Fed action will have resulting reactions, not all of which will be intended or desired.

It's easy to argue that there are no good choices. Fed policy makers are damned if they do, and damned if they don't.

This is shaping up to be another stunning year for the global economy. Watching it all unfold will be equally fascinating and unpredictable.

Friday, February 06, 2015

US Economy Burdened by Perpetual, Massive Trade Deficits

The U.S. trade deficit soared 17.1% in December, reaching a two-year high. The trade gap spiked to $46.6 billion from a revised $39.8 billion in November, the Commerce Department said Thursday.

It was the biggest percentage increase since July 2009, and the largest month-over-month increase, in dollar terms, ever recorded.

U.S. exports slipped 0.8% to $194.9 billion, while imports increased 2.2% to $241.4 billion. The stronger dollar made imports more affordable, while making exports more expensive. The dollar has strengthened steadily since July, recording its second fastest acceleration in 20 years.

For all of 2014, the goods and services deficit was $505 billion, up $28.7 billion (6 percent) from $476.4 billion 2013, the Commerce Department reported. Exports were $2.35 trillion, up $65.2 billion or 2.9 percent. But imports were $2.85 trillion, up $93.9 billion or 3.4 percent.

So, imports were higher than exports in terms of total dollars, in terms of an increase in dollars, and as a percentage increase.

Annual trade deficits of half-a-trillion dollars are now the norm.

Year after year, the trade deficit sucks hundreds of billions of dollars, and millions of jobs, out of the U.S. as we continually buy products from overseas that could instead be made here at home.

The trade deficit in 2013 was $476.4 billion, which was the lowest since 2009. Think about that for a moment; the trade deficit in 2013 was nearly half a trillion dollars, yet it was the smallest in four years. It was down from $534.7 billion in 2012, according to the Commerce Department. The deficit shrank in 2013 due to lower petroleum imports.

The unfortunate reality is that the trade gap is a decades-old problem.

The United States has been running persistent trade deficits since 1974 due to high imports of oil and consumer products. The trade gap increases the debt held either by Americans or by the federal government.

Since a strong U.S. dollar makes American exports more expensive, the trade deficit will almost certainly increase again this year. As long as the trade deficit persists, the U.S. will continue borrowing from abroad to pay the difference between imports and exports.

Every $1 billion of a larger deficit subtracts about 0.1 of a percentage point from the annualized GDP growth rate. That's bad news for an economy that is currently struggling to eek out a mere 2 percent annual growth rate.

Traditionally, countries that have a trade surplus with the U.S. have used their surplus dollars to buy government or corporate bonds, to make investments in U.S. real estate, or to invest in the U.S. stock markets.

But what if a country, such as China, decides to use its surplus dollars to instead purchase gold? Unless that gold is purchased from the U.S., those dollars are never repatriated. In essence, they never come home.

China has a ravenous, and apparently growing, appetite for gold. While the world's second-largest economy has not formally disclosed any changes to its gold holdings since 2009, when it claimed to possess 1,054.1 tonnes of gold, it is now estimated by gold analysts to have around 2,000-3,000 tonnes of gold reserves.

As sovereign bond yields plummet, the tendency for gold will be to move higher. Though gold has a zero interest rate, that is still higher than the negative rates currently being offered in some countries.

When China diverts its dollar holdings for the purchase of gold, those dollars no longer have any beneficial investment affect in the U.S.

The danger of a trade deficit was spelled out quite clearly in Discourse of the Common Wealth of this Realm of England, in 1549: "We must always take heed that we buy no more from strangers than we sell them, for so should we impoverish ourselves and enrich them."

This is not a new concept. No nation can indefinitely buy more than it sells.

A wider trade deficit creates a drag on economic growth because more of the nation's consumption is coming from overseas rather than from domestic production.

The U.S. has led the world in imports for decades. Meanwhile, exports represent just 13.5% of our economy, according to the World Bank. It's a bad combination.

The massive U.S. trade deficit is emblematic of the fact that we are the world's biggest debtor nation.

For decades, we have imported more than we have exported, consumed more than we have produced, and spent more than we have saved. The result is that we must continually borrow to fund our nation — to fund our debt-driven ways.

It's all led to an unsustainable debt problem that will likely have a very bad ending.

Monday, January 19, 2015

Negative Interest Rates an Alarming Development

If you think you've got it bad because your bank pays you just 0.10 percent (or even 0.01 percent) for keeping your money in a savings account, consider the plight of European bank customers.

Many European banks (such as those in Sweden, Switzerland, Denmark, etc.) pay negative interest. Depositors are actually charged to keep their money in an account. In essence, depositors are lending money to borrowers for free. Consequently, the banks are making money coming and going; both borrowing and lending.

The idea is to dissuade people from saving and instead encourage spending, with the hope that this will stimulate the economy.

While high interest rates discourage borrowing and encourage saving, low rates have the inverse effect.

However, the central banks in some countries are also attempting to make their currencies less valuable. A lower valued currency makes exports cheaper, and increasing exports can also stimulate an economy.

The European Central Bank (ECB), for example, cut a key interest rate below zero in June — the rate it pays to banks on reserves held at the ECB. The idea is to compel banks to lend money, rather than lose principle by having it sit idly at the central bank.

The ECB will vote this week on whether to engage in a money-printing / bond-buying scheme known as "quantitative easing." However, due to Germany's history with hyperinflation after WWI, it has been hesitant to approve such a strategy, which is intended to stimulate the eurozone economy and combat deflation. Despite this, the plan is expected to pass.

A "quantitative easing" program of this type would drive down the value of the euro, pushing higher the value of other currencies, such as the dollar.

These are strange times indeed, and policy makers are willing to employ the most extreme measures to stimulate their economies, fight deflation, and boost exports.

However, negative interest rates can have unintended consequences, such as compelling depositors to remove their money from banks and seek higher yielding assets or investments.

Money market funds, for example, can plunge as investors exit. Yet, money markets are key sources of short term financing for banks and corporations. If money markets crash, the entire financial system would be thrown into turmoil.

Most critically, when a central bank offers negative interest rates, other banks are disinclined to keep deposits parked there. Rather than encouraging lending (the desired outcome), this can instead cause increased speculation and risk taking through "yield chasing."

While the Federal Reserve and US banks are not (yet) offering negative rates, they could be compelled to follow Europe's lead to fight deflation, or to help boost US exports and lower the massive trade deficit.

A financial crisis can quickly become an economic crisis, and both can lead to contagion. The 2008 financial crisis, which initiated in the US, quickly went global. The international response became a game of follow the leader.

With that in mind, the precedent for negative rates has been set, and it's not unimaginable that US banks might eventually offer negative interest rates as well. But that would just cause Americans to hoard cash in safes, vaults, and bank deposit boxes, rather than deposit it.

Though all export countries want a devalued currency to make their exports more desirable, such a strategy is a race to the bottom. Not everyone can have the cheapest currency and the cheapest exports.

A devalued currency also makes the repayment of fixed debts less painful, which is why governments generally favor devaluation.

But this is not a zero sum game. Every central bank is pursuing the same strategies, and hoping for the same outcomes. That is not possible.

If every country has a cheap currency, then none of them do. And investors will always chase higher yields — even the highest yields — despite the risks involved.

Perhaps the most sobering takeaway is this: If central banks aren't intentionally reducing the value of your money through inflation, they are willing to depreciate the value of your savings with negative interest rates.

Heads, they win. Tails, you lose.

Friday, January 09, 2015

Americans Are Living On The Edge

Stagnant incomes have resulted in little or no emergency savings for most Americans.

Approximately 62% of Americans have no emergency savings for things such as a $1,000 emergency room visit or a $500 car repair, according to a new survey of 1,000 adults by personal finance website

In the event of an emergency, they say they would have to cover the cost by reducing spending elsewhere (26%), borrowing from family and/or friends (16%) or using credit cards (12%).

Financial planners typically recommend that people have a minimum of three to six month’s worth of living expenses in emergency savings. Clearly, $500 or $1,000 is far less than that, so this survey indicates that a significant majority of Americans are living on the edge, from paycheck to paycheck.

Last summer, in the same size survey, found that 26 percent of all Americans have no emergency savings whatsoever.

Personal savings are low by historical standards, and they are trending downwards.

Personal savings in the US decreased to 4.40 percent in November from 4.60 percent in October of 2014, as reported by the US Bureau of Economic Analysis. Personal savings averaged 6.81 percent from 1959 until 2014, reaching an all time high of 14.60 percent in May 1975 and a record low of 0.80 percent in April 2005.

The downward trend in savings is little surprise. If people don't have money to save, then they won't — or can't.

Americans are 40% poorer today than they were in 2007. The net worth of American families — that is, the difference between the values of their assets, including homes and investments, and liabilities — fell to $81,400 in 2013, down slightly from $82,300 in 2010, but a long way off the $135,700 in 2007, according to a report released last month by the nonprofit think tank Pew Research Center in Washington, DC.

The problem isn't isolated to the fact that most Americans suffered from the housing crash. The issue is also related to stagnant wages, which has been a big problem for decades.

After looking at five decades’ worth of government wage data, the Pew Research Center found that for most U.S. workers, real wages — that is, after inflation is taken into account — have been flat or even falling for decades.

Pew noted the following:

"After adjusting for inflation, today’s average hourly wage has just about the same purchasing power as it did in 1979, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms the average wage peaked more than 40 years ago: The $4.03-an-hour rate recorded in January 1973 has the same purchasing power as $22.41 would today."

The problem of stagnant wages has continued over the past year, with a mere 1.7% increase in average hourly earnings from December 2013 to December 2014. However, average hourly earnings fell 0.2% in December, the first drop since July 2013.

In November 2014, the average weekly wage was $853 versus $833 for November 2013, according to the Bureau of Labor Statistics.

This is not an environment that allows Americans to save for personal or family emergencies, much less plan for retirement.

So, the findings by should surprise no one.

Thursday, December 18, 2014

Deflation is Taking Hold in Some Economies. Is the US Next?

In response to the 2008 financial crisis and resulting Great Recession, the Federal Reserve (followed by central banks around the world) slashed interest rates to near zero and engaged in a policy of unprecedented money printing, know as "quantitative easing."

This combination spurred concerns that inflation would accelerate, perhaps rampantly.

But that hasn't occurred — at least not yet.

The pace of inflation over the past 12 months fell to 1.3% in November and is down sharply from 2.1% just five months ago.

The Federal Reserve has a publicly stated goal of 2% annual inflation. As recently as 2011, the US inflation rate averaged 3.2%. But the rate dropped to 2.1% in 2012 and then 1.5% in 2013. The steady decline is clear.

The financial world has been cautiously watching and waiting for any indication that the Federal Reserve will raise interest rates next year.

However, bond guru Bill Gross says the Fed may refrain from hiking rates in 2015 due to a lack of inflation.

"Why would the Federal Reserve raise interest rates in order to slow economic growth if inflation in fact was moving lower?"

It's an excellent question; one that many of us are asking. Oil is tumbling and cheaper energy means lower inflation.

In fact, the bigger concern at the moment is deflation, which is rearing its ugly head around the world.

Delation is the continual decline in prices and assets. It is often associated with a reduction in the money supply, or credit.

While the money supply has certainly expanded in an unprecedented manner (the Fed’s balance sheet has expanded from about $850 billion to more than $4.4 trillion since the 2008 financial crisis), economic demand and consumer spending remain weak.

Though Americans have paid down much of their household debts (including car loans, credit cards, student loans and home mortgages) from 130% of disposable personal income in 2007 to 103% today, it means that households still have more debt than disposable income. That is holding back spending.

Ultra low interest rates were supposed to be a temporary inducement to get households borrowing again and reverse the housing bust. But six years later, though rates remain at historic lows, mortgage lending remains weak.

The US homeownership rate fell to 64.4 percent in the third quarter, the lowest level since early 1995. First-time buyers have been kept out of the market by strict lending standards and low wages.

Weak and steadily falling inflation, plus weak demand, is raising fears of deflation.

Investopedia explains deflation this way:

"Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies and individuals."

Japan, most famously, has been battling deflation for two decades. The Bank of Japan had a zero interest rate policy in affect for many years, which didn't cure the problem. Then the BOJ initiated its own massive money-printing scheme last year, which has also failed.

Falling prices have hurt consumption in Japan, as consumers wait for prices to keep dropping before spending. If consumers refrain from spending long enough, it hurts corporate profits. That limits hiring and can even lead to layoffs. This vicious circle has led Japan back into recession.

There are concerns that the euro zone could be plagued by deflation in 2015. As it stands, Sweden and Spain are already grappling with its menace.

Now, some economists and analysts are concerned about the possibility of deflation arising in the US. It may not be that far-fetched, as the specter of deflation is growing globally.

Commodities — such as oil, gold and copper — have experienced serious declines this year.

The US economy has remained one of the lone bright spots on the global stage in 2014, but in a highly interconnected global economy, that could change quickly in 2015.

A lack of economic demand is a pernicious problem, which leads to a lack of consumption, fewer jobs, and a lower GDP.

Since consumer spending accounts for more than two-thirds of US economic activity (GDP), it's no surprise that this has been the weakest recovery since the Great Depression.

In fact, this is the first economic “recovery” in which median family income continues to drop. That is holding back consumer spending, which, in turn, is holding back economic growth.

Though the Great Recession is officially over, Americans are still 40% poorer today than they were in 2007, the year before the global financial crisis.

The net worth of American families — the difference between the values of their assets, including homes and investments, and liabilities — fell to $81,400 in 2013, a long way off from the $135,700 in 2007, according to a new report released this month by the nonprofit think-tank Pew Research Center in Washington, DC.

Over just the past year, incomes have barely budged. In November 2014, the average weekly wage was $853 versus $833 for November 2013, according to the Bureau of Labor Statistics.

Falling oil prices should allow Americans to spend more of their incomes on other things, which should buoy the economy. But if broader deflation sets in, lower oil prices won't matter.

While much of the decline in oil prices has been attributed to higher supplies, demand has also fallen around the world. The International Energy Agency has cut its estimates for demand for crude five times in the past six months, The Wall Street Journal reports.

Oil is the lubricant of the global economy and a lower demand indicates a slowing economy. Demand has fallen even in the US, where motorists are driving more fuel efficient vehicles and using less gas.

However, those trends could change in the face of tumbling oil and gas prices. Americans could revert to buying bigger, less efficient vehicles.

The diminishing demand for oil, and the robust drop in prices that has ensued, is sparking deflation concerns around the world.

The bond market has taken notice, as reported by Bloomberg:

"The difference in yields between Treasury two-year notes and comparable maturity inflation-indexed securities turned negative yesterday for the first time since the aftermath of the global financial crisis in 2009. The measure, known as the break-even rate, is generally seen as reflecting investors’ expectations for inflation over the life of the securities."

In other words, investors have abandoned all fears of inflation in the short term.

To be clear, the US is not in deflation at present, and it may not face it in 2015. But there are plenty of reasons to be concerned. Inflation, already below the Fed's target, is steadily declining.

The consumer price index fell by a seasonally adjusted 0.3% in November to mark the largest drop since December 2008, during the depths of the Great Recession.

The decline was driven by the sharp slide in gasoline prices. Energy costs fell for the fifth straight month, said the Labor Department, led by a 6.6% decline in the price of gasoline.

Here's the thing that really jumps out at me: If the Federal Reserve can add $4.4 trillion to the money supply in just six years — while dropping interest rates to near zero — without sparking rampant price inflation, some very powerful deflationary forces are surely working against it.

In other words, the US economy remains quite fragile as we head into 2015.