Our Deflationary Mindset Is the Most Concerning

Phil Gramm famously stated in July that "this is a mental recession." He followed up with further quotable remarks and some explanation of his statements (you can read a Washington Times writeup here). Despite anything else he said, his comment implying an imagined-recession, as Americans were paying $4 for gas and fearing pink slips, was what grabbed media attention. Though Mr. Gramm was quickly proven wrong by economic data that confirmed the existence of a very real recession, I understood his point: The current dire warnings perpetrated by our president and media that are predicting economic catastrophe are NOT promoting a quick recovery. A consumer is not encouraged to stimulate the economy via purchases, investment, or job creation if he is being force-fed predictions of the end of the world.

Alongside the general discussion about shrinking GDP and worsening employment numbers, many observers have been debating whether the current stimulative policies will result in massive inflation or crippling deflation. Proponents of the first idea claim that the rampant creation of money (TARP, Bailouts, Stimulus Bill, etc.) will result in Zimbabwe-like hyperinflation. Though the government is creating a couple trillion dollars, I personally believe that the huge stock, commodity, housing and derivative market losses will offset this fresh money. I nevertheless strongly disagree with the recent stimulus bill (at least in its most current forms), but for other reasons. I disagree because it is full of pet projects and pork, it will surely increase America's borrowing costs over time, and it will be my taxes that eventually pay off these debts. I'd like to keep much of the money that I plan to make.

Therefore, I think that deflation is the more likely monetary problem, though the condition that I'm calling "a deflationary mindset" is the primary concern.

Capital and capital markets remain relatively frozen. Credit card and loan companies have raised lending standards, lowered lines of credit, and have generally slowed their rates of lending. Leveraged buyouts are non-existent. Many companies still holding mortgage-related assets have decided to let portfolios run-off (whereas their business model pre-meltdown was the continued accumulation of such assets).

Even more bleak and reflective of my "deflationary mindset" principle is the change in consumer purchasing habits. The savings rate has approached 3% of income over the past few (recessionary) quarters, while it averaged below 1% from 2005 through the first quarter of 2008 [graph below]. Most retailers and restaurants (excluding a few value-oriented entities) are suffering huge month-over-month and year-over-year declines in overall and same-store sales.

click to enlarge

Frugality is in vogue.

The attitude of both boomers and younger adults has changed from overconsumption to penny-pinching - thus, my "deflationary mindset." Advertisements are now being written to appeal to cost-conscious consumers - the words "in this economy" are uttered annoyingly frequently. Recent CES and various auto shows have been scaled back in comparison to the excess of better years. Corporations are canceling purchases of jets and corporate retreats as the media started to crucify any corporation that is still actually stimulating the economy. Though this frugality is good on an individual level, and was obviously absent from American culture over the past few years, this attitude will prolong the recession as consumers are reluctant to buy their next iPod (AAPL), car (TM), (GM), (F), (NSANY) or computer.

For the vast majority of Americans that will retain employment during this recession, low prices on consumer discretionary purchases will make consuming fun. I don't expect a long Japan-like deflationary period (mainly due to the huge government money injections), so purchase your LCD TV reasonably if you want to snag the best price.

I may one day eat my words, but I am currently not afraid of the Big Bad Recession. Obama can attempt to scare the public into supporting a bloated stimulus bill, but the economic truths are likely not as bleak as he'd have you think. Right now, spending normally (though within your means) is the most patriotic thing you can do for your country.

Comments

[MaineLobster:]

Can someone please write an article about the cost of consumer goods which have not come down since their peak in 2007. Or is this how you define "deflation".

Crude oil is $41 a barrell, gasoline still costs $2 a gallon, liquid laundry detergent is $20 a gallon, Gillette razor replacement cartiges cost $21 for a pack of 10. I could go on...

Commodities have come down but we will never see that at the retail level. Even though there is a reduction of consumption, the manufacturers and retailers are soaking up the extra profits.

We should see this reflected in corporate earnings next quarter as expectations will be met and in most cases exceeded because of lower labor, raw material, and transportation costs.

The market is poised for growth.

Enjoy!
The Lobster.

Feb 11 07:12 AM

[cristian:]

Concerning for whom? The malfeasants that provoked this crisis? My advice to them is, live within tour means, like everybody else. Eventually even our corrupt government (both sides of the isle), will have no choice but read you the riot act.

Meanwhile they are trying everything else, but deflation.... read, let the little man suffer, while the establishment is dipping its dirty paws in the taxpayer’s pockets. It is not workable indefinitely when "capital" is getting too good a deal, for too long. Now it is crunch time. Nothing wrong with making money, but this is what happens when one tries to suck the life out of the supporting structures.

Feb 11 07:41 AM

[kelm:]

Consumers have been living well above their means. It is a necessary step for the savings rate to go up. During the bubble people argued that the savings rate didn't matter because of the rising equity in their homes. Commodity prices, housing, and equity prices have dropped. Most non-electronic consumer prices certainly don't seem to be dropping.

You can continue to hope but I think you will be surprised at how this plays out - painfully so.

Feb 11 10:19 AM

[antiquary:]

"The current dire warnings perpetrated by our president and media that are predicting economic catastrophe are NOT promoting a quick recovery."

Absolutely right. Why the hell is Wall Street always so manic-depressive? But unlike with a manic-depressive person, what's being said about the situation can indeed change the mood. We shouldn't lie about the situation, but there are aspects of it which are scabs we shouldn't pick at, since that way they'll only take longer to heal.

Feb 11 10:29 AM

[KNAB:]

"Though the government is creating a couple trillion dollars, I personally believe that the huge stock, commodity, housing and derivative market losses will offset this fresh money. I nevertheless strongly disagree with the recent stimulus bill (at least in its most current forms), but for other reasons. I disagree because it is full of pet projects and pork,"

A few quick points from my way of thinking:

If I read you right, the toxic debts in the mortgage industry will act as a sponge for money, keeping the cash out of circulation and thus alleviating any inflation. The main problem I have with this is that the government is supporting pricing levels in the housing market that were inflated to begin with. (Well, at least this is what I heard they want to do - I am yet to see what would even accomplish this pretense of the stimulus plans.) This is what happens when there is easy money or what the Russians call "money on the wind." People lose caution. To me supporting the easy come-easy go credit (are we down to negative interest rates from the Fed yet?) in order to stimulate consumer purchasing glosses over a fundamental problem: We are seeing weaker productivity in this country. If we want to alleviate any impending inflation we need to pry the money free from those who would seek to invest it in industrial production, under more auspicious conditions. So, I apologize to anyone of the green persuasion, but we need less environmental regulations, which are a quite transparent intentional noose around the capitalist economy. And I also apologize to those who know how to spend money better than venture capitalists, entrepreneurs, and corporations, but we need to reduce the financial burdens of producers. As far as the debt of the United States, Inc.? There will be plenty of inflated dollars in the future to pay off debts. Pay them off, and then devalue the dollar. Sure the world will jump ship. But then we might finally have our own economy back again instead of trying to be the borrower of last resort.

Feb 11 01:20 PM

[henarl:]

Spending "normally" (but within your means) is an oxymoron. What was "normal" spending in the last few years was certainly not within most consumer's means. The recent spending party was financed not with earnings but with extreme borrowing - home refinancing, credit cards, car loans, big ticket financing, etc. Now the party is over and the extravagant material wealth lifestyle that America became addicted to is also over. The deflationary mindset is reality. Learn to live with it.

Feb 11 01:29 PM

[Stephen Fra...:]

I have written A papers in more-than-intermediate economics, so I guess this isn't my best work.

It's alright that you have convinced yourself of the existence of a bleaker reality thank my view of the situation, but your assumptions about my naivety are baseless and incorrect.

Feb 11 05:52 PM

[EEB:]

This reminds me of when Bush told us all to go shopping during the start of the Iraq War in order to be patriotic. Real Americans don't cower under the bed when they see friends and relatives lose jobs; they go shopping!

But, more seriously, isn't human psychology part of economics. So, if people have a deflationary mindset, then won't this affect their economic behavior. The author seems to make two inconsistent points. First, the deflationary mindset is delusional because the real economy is fundamentally sound. So, it is OK to spend because your frightened neighbors will snap out of it soon and start buying LCD TV's. (This is the Phil Gramm/George W. Bush view of thing.) Second, the author is worried that too much scary talk about the economy will affect the listener's psychology, which, in turn will influence economic behavior. But is the deflationary mindset delusional, and thus innocuous? Or, is it part of the overall economic reality, and thus a real problem? It seems like it can't be both. An A paper would have addressed this apparent inconsistency.

One more thing. Isn't the total cost for this bloated spending bill smaller than what we'll end up spending in Iraq? Which one will turn out to be the better investment?

Feb 11 09:20 PM