Be Very Afraid of Deflation 20 comments
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Great article in Minyanville last Friday. Agree with author on almost everything. Yes,the world economy is in big trouble. Yes, people and businesses are taking on less debt and this is going all the way to the top, i.e. Fed. As a result, inflation in the current situation is close to impossible, despite all attempts by Fed and Treasury. The only thing I disagree with is the premise that deflation is good.
Everybody might agree that prices going down is a good thing. And in some sectors of economy it's a decades long reality (computers, for example). Unfortunately, what's good for a person is bad for the economy, and as a result, for everybody. In a deflationary environment, everybody tries to delay purchases. Why hurry, this thing will cost less later! When the economy slows down, companies cut expenses the usual way: laying off employees. Less paid employees means less demand for goods, creating positive feedback, or as it's known since Great Depression, deflationary spiral.
Eventually the economy might find equilibrium in deflationary environment, but this equilibrium will not be happy one, with unemployment much higher than in inflationary environment. An empirical rule known to economists as a Phillips Curve defines inverse relationship between inflation and unemployment. There is only one example of a deflationary economy after World War II: Japan in the 1990s. Surprise, it was also a period of almost constant recession.
This paper suggests that the Phillips Curve flattens in the negative inflation (deflation) zone. The problem is that, Japan is quite a unique example. Businesses there are not eager to lay off employees at a drop of a hat. It just might be that Japanese corporations kept extra workforce on their payroll because they used to do that (remember lifetime employment?). In the US example (Great Depression), the picture was very different. Unemployment jumped to 25% and stayed there for a long time.
Some people can argue that the world lived mostly in deflation since the invention of money. True. But the world also lived in an economy which wasn't growing much and most people had subsistence living standard. They couldn't cut expenses even if they wanted to. Great Depression showed us for the first time what can happen when deflation hits economy in which a significant part of spending is discretionary. Our current economy has a much higher discretionary part than in 1930s.
My take on it: be afraid of deflation, be very afraid. I applaud Fed and Treasury efforts to stop deflation. And I'm afraid that they are too late.
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Interest Rates [Credit] are the Cause and Consequence of the Explosion of Income/Wealth Disparities and, Hence, of the Inherent Instability of this Economy:
The Ominous Keynes' Liquidity Trap.
Origin of Economic Chaos.
Everyone Need an Economy, Don't You?
There Is One Solution That Works:
www.17-76.net/
A Credit Free, Free Market Economy
The New World Economic Order.
What Else?...
No One Will Chose Chaos, Will You?
The Only Goal of 1776 - Annuit Coeptis is to Implement It.
Anyone Can Join But Still Needs to Ask for It.
www.17-76.net/
The Purpose Is to Provide Both a New Deal and a New Game.
It is NOT to Fix This Economy Which is Already Beyond Repair.
The Intention Is to Create a New Economy
With the Assets of the Old One Without its Liabilities.
Why Not Insure Against the Worst Case Scenario?
Interest Rates [Credit] are the Cause and Consequence of the Explosion of Income/Wealth Disparities and, Hence, of the Inherent Instability of this Economy:
The Ominous Keynes' Liquidity Trap.
Origin of Economic Chaos.
Everyone Need an Economy, Don't You?
There Is One Solution That Works:
www.17-76.net/
A Credit Free, Free Market Economy
The New World Economic Order.
What Else?...
No One Will Chose Chaos, Will You?
The Only Goal of 1776 - Annuit Coeptis is to Implement It.
Anyone Can Join But Still Needs to Ask for It.
www.17-76.net/
The Purpose Is to Provide Both a New Deal and a New Game.
It is NOT to Fix This Economy Which is Already Beyond Repair.
The Intention Is to Create a New Economy
With the Assets of the Old One Without its Liabilities.
Why Not Insure Against the Worst Case Scenario?
Tell me exactly where you see deflation in our big ticket expenses like health insurance premiums and college tuition, as wells as in every day items such as food (shrinking portion sizes at the supermarket looks to me like inflation), auto repair, credit card fees, out of pocket medical bills such as copays, eyeglasses, and dental costs, and home contractor service call charges. I see nothing but higher costs that person A needs to get from person B to pay person C for services rendered or products delivered. Nobody can afford to undercharge here--can you say inflationary spiral?
Bottom line: Your dollar buys less every day. Last time I looked this was called inflation. The only deflation I'm seeing (besides in the size of Wall Street and CEO egos) is in real estate (LONG overdue correction IMO) and commodity and related trading markets that had been pumped to speculative and unreal heights with leverage. That hardly qualifies as economic deflation IMO.
Wake me up when the REAL costs of living go down here for 99% of us here in the US. Until then I'll continue to buy gold stocks.
Consumerism is facing a trial right now. Will they find a center to work from where natural resources are used less and recycling used more.
Even Russia is wary of Gloable Warming now and the rising water levels along the coasts.
I am happy my dollar will go further. But, you do make a good point.
You make $500 a week instead of $1,000 but then guns and butter go for half price too.
To read the posts and comments on this web site, the only economic choice we have is between communism and neo-classical economics.
Either we have no freedom at all and the government does everything or we are completely free but the government does nothing.
I'm not afraid of deflation or inflation, I'm afraid of fear, greed, ignorance and the Republican Party, the four horsemen of the economic apocalypse.
Sounds like "negative feedback" to me.
But even if this does come true, in 12 to 18 months all that cash from the bailout, (or is it a rescue?) will show up and we will reinflate like you have never seen. Unless you were in Germany in the 1930's or France in the 1790s. Buy a wheelbarrow so you can carry around your money.
By then the crooks like Paulson will be safely away in a defended compound with their money, gold and mistresses while the rest of us starve and freeze. The BHO socialists will "save" us thru "change". Enriching members of the communist party, ...er I mean ACORN and the ANNIBERG group.
Good Luck, you will need it
Great article!
All the disbelief talk almost perfectly mirrors the talk from the Right when the Great Depression started - actually years into it.
What a lot of people have forgotten is that there were Hooverites who were still saying there was no Depression up until WW2. They talked about how it was just loafers and panickers and how laissez-faire and gold would fix everything.
That's what they will always say. Evidence means nothing to them. They already know who is to blame for everything before they even know the problem and there is no standard of proof that they will accept to disprove their theories. They are all true a priori.
Econ 101 - you need a history lesson, instead.
The hyperinflation in Germany occurred in 1922, not the 1930s. And it wasn't after any deflation. It was, on the contrary, a release of money supply built up during WW I combined with a centralized effort by the government to support a miner's strike to prevent payment of reparations to France. France physically occupied the Ruhr and tried to take reparations in kind, by seizing trainloads of coal. The miners responded with a strike, and the government supported the strike with printed money handed to the miners to remain off the job. This continued until the French gave up and pulled their army out of the Ruhr. Hyperinflation set in, in the meantime, as everyone switched to using foreign currencies in daily transactions. No deflation of any kind had occurred.
After that, all the governments for the remainder of the 20s and into the great depression in the early 1930s, were rigorously deflationist, with punishingly high interest rates, balanced budgets or surpluses, and a continual export surplus meant to transfer reparations payments abroad. None of which remotely worked, once the source of external financing keeping it aloft - US lending - was cut off, first by the stock market boom in New York, and then by the crash and depression. But they were still deflating violently in 1932, until forced off gold by the banking crisis touched off by the failure of the largest bank in Austria in the summer of that year.
There was no hyperinflation after that. The mark became inconvertible, and the British pound followed rapidly with a violent 35% devaluation. Deflation spread to those countries that hadn't devalued, notably France and the US, giving the final spike down in the US real economy and stock market, which only halted when Roosevelt devalued. Germany was taken over by the Nazis and ran exchange controls, doling out all foreign currency to importers with an eyedropper and a military need focus. Importers financed themselves by buying defaulted German bonds abroad at discounts and selling them to the Reichsbank for more than they paid for them --- basically debt repudiation and distress put the losses on Germany's external creditors, allowing some imports to continue.
There was no great inflation thereafter, into the war and rationing - though of course there were high black market prices once the war itself was underway.
The whole script that somehow a huge deflationary smash can be or inevitably is succeeded by an inflationary repudiation of the currency, is pure historical ignorance and fantasy. The inflation was 10 years earlier, and not linked to any deflation in any way. The reparations and war debt tangle being involved in both, is the closest one can get to linking them.
leh, thanks for pointing out that inflation and deflation are in the eye of the purchaser.
theoretically, if prices keep rising for food and medical care, people should buy them quickly so they will not have to pay increased prices later. if prices are falling in computers, clothing, homes, suvs and gas, people should retard their purchases, expecting that prices will be lower tomorrow.
unless of course, programmed american superconsumers cannot delay their gratification, in which case, they will continue to purchase everything until their credit runs out. nope, deflation does not worry me. i do not know anyone who has stopped purchasing. even the unemployed keep buying! everyone is now talking about the great bargains they are getting.
that activity should support prices pretty soon. then, the influx of injected government capital will give everyone more money to spend. we should have another bubble somewhere by the end of 2009, but where?
Inflation/Deflation do not happen in a vacuum.
Prices will go up faster or slower than wages....
It depends on which side of the equation you are on at any given time.
Equilibrium may be reached at some point in time..... then poof... time moves on. You are too simplistic on that point.
Your last comment again shows bias and ignorance!!!
Inflation/Deflation are opportunities for some, failures for others.
Fear and greed have given the world many of the advances we have
today. The Republicans are not any more ignorant than the Dumbocrats. Fortuneately, economies (U.S., specifically) are too large
for any political party too screw up for prolonged periods.
It is the fear/greed principle that will get us going again, not promises
from politicians.
You showed some good thought process; just keep the politics out of it
and you just may be ahead of the game.
On Nov 10 11:06 AM carey_jim wrote:
> neo-classical economics says that deflation/inflation is a wash,
> that there is no net good or bad effect from either because all markets
> reach equilibrium.
>
> You make $500 a week instead of $1,000 but then guns and butter go
> for half price too.
>
> To read the posts and comments on this web site, the only economic
> choice we have is between communism and neo-classical economics.
>
>
> Either we have no freedom at all and the government does everything
> or we are completely free but the government does nothing.
>
> I'm not afraid of deflation or inflation, I'm afraid of fear, greed,
> ignorance and the Republican Party, the four horsemen of the economic
> apocalypse.
John Maynard Keynes made the same criticism of neo-classical economics you did when he said "in the long run we're all dead." (The long run is when price-wage equilibrium sets in.)
If we could keep politics out of economics we would all be Marxists watching the "withering away of the state." We can't, you and I aren't and it wont.
(Dont' forget that I'm always trying to be funny even when I'm not.)
I Like : "Deflation will kill local governments that are supported by housing values.
They will not be able to support their first responders (i.e. Police, fire and ambulance) and these services will not be responsive. Behind the scenes other services provided will go away quicker.
Things like meals for the poor, health care for the poor, or counseling among others. "
First, one inflates housing prices. Then Police, fire and ambulance services are going up... And so on.
In some California towns, police offices are paid more than the President of the USA. But it helps to feed poor?
Does it make any sense? NO! Any reason why US worker doing the same job as his Asian counterpart earns 5-50 times more? It does not make any sense.
Is not it interesting when a US plumber lives in $750,000 house?
Is there any reason why US consumer drives a Hammer with 5MPG?
GM and Ford are not in trouble because of a inflation/deflation situation. They are in trouble because the products they produce are not competitive, low-quality, and overpriced.
As for a US consumer, he/she/it is an edict. There is no way such an edict can be rehabilitated by getting a credit to buy more drugs.
Give it a chance to a free-market economy; and Mother Nature will work out problems just fine as it did for the last 3,000+ years. An economy cancer cannot be managed by a bandages and free-creedit; sometime it requires a very painful surgery.
The inflation we saw in the 70's was higher wages chasing up the price of goods causing higher wages. Some people blame the unions. But, the inflation lately from higher oil and materials doesn't have this spiral. It cuts into consumer spending in other areas, without feeding back into wages.
Fewer wages due to unemployment and demand for workers causes lower prices, since less wages are chasing (demand) these goods (supply). As of a year ago, the US consumer bought 19% of world GDP, much of the spending supply temporary from home loans and credit cards. The lower prices bring less profit, less employment, less money buying goods ... in a spiral.
Records show that in the first half of this decade Greenspan was very afraid of deflation, and this was his reason for keeping rates low. This may have been a justified fear. It's perhaps too bad that he did not have controls to limit other bubbles fueled by these low rates. If you believe the CPI (which I don't) we were on the edge of deflation.
On Nov 10 11:15 AM ferguson wrote:
> "Less paid employees means less demand for goods, creating positive
> feedback, or as its known since Great Depression, deflationary spiral."
>
>
> Sounds like "negative feedback" to me.
Amen to that, nova.
I was at my local Chevy dealer here in NY yesterday and noticed two spanking new Cadillac Escalade Hybrids on the lot. Gaudy bling-bling cars that really belong in Moscow or the mideast--wherever corrupt petrodollars exist IMO.
Nearly choked on my coffee when I saw the pricetag--$79,000!!!--... these silly tacky ridiculous beasts. And when I asked the salesman how much gas the hybrids saved, he shrugged and admitted it was probably only 1-2 mpg. Any question re why GM is on the verge of bankruptcy?
Sickness unto death indeed...
On Nov 10 11:15 AM ferguson wrote:
> "Less paid employees means less demand for goods, creating positive
> feedback, or as its known since Great Depression, deflationary spiral."
>
>
> Sounds like "negative feedback" to me.
This is positive feedback. It's enforcing negative trend, true. But negative feedback works against trend, negative or positive. For example, when falling prices increase demand, that's negative feedback. When rising prices push demand down, that's negative feedback too.