Why Deflation Makes for Ugly Headlines

by: Economic Disconnect

I wanted to take a minute and apologise to the readers. Last post I was a bit edgy, and I let my own frustrations bleed out into my writing. I think my post was still about where I wanted it to be, but if it was harder than usual I meant no offense to anyone. Of course there was plenty of debate and some great comments, including a personal response to my question put to Ilargi of the Automatic Earth, for which I am very grateful. Ok, back to the regularly scheduled programming.

You Know You Think About Economics Too Much When....
I have to admit that when I saw the pictures Thursday of the balloon that was drifting across Colorado (and may have had a child inside; turns out he was hiding at home) a thought jumped into my head in about 5 seconds. First, the scene:

The first thought I had was:
-"Helicopter" Ben Bernanke has swapped his whirly bird for a balloon to drop billions in dollars across America. Not only will this be more random, it is eco friendly!

Discussion is a Good Thing
Plenty of discussion from yesterday. I really do love the comments section and I get plenty of ideas from the readers on my blog and other stops on the blogroll.

First up, the author Ilargi made time to leave his answer to the question I posed last time out regarding his essay. His comment can be seen on that thread, and I will not repost it here. It was well thought out and well reasoned. My question perhaps was unfair, who can know the exact mechanism by which all the pretending will fall apart, assuming it does.

I will post a section from the latest missive at TAE, and the author I think answers my question the same way he did in the comments section:

Those who suggest that present practices of hide the baloney and have another trillion can go on for much longer seem to understand neither the costs incurred in doing so, nor the increasing instability of the underlying system.

It’ll take just a minor trigger, which could come from just about anywhere, including totally unexpected corners, to make investors lose their risk appetite faster than they can spell sell-off. That will force the hands of Washington all of them. Let them eat growth is not a slogan that wins elections when growth is nowhere to be found.

I agree, it is often small, seemingly inconsequential events that cause huge cracks to spilt. In this case it will be the "accumulation of hurt" from many small fissures that breaks the dam.

The pace of these things is what wears on me. I prefer to get things sorted out, deal with the pain, and move on. It seems policy makers are more than willing to roll around in their own slop like pigs and stay dirty. Sadly, the people will accept what they can get out of this instead of taking what they deserve (not a call for arms, but by voting for reasonable candidates). Indeed it could be a long slow burn for the middle class.

As far as gold discussion goes, I am tapped out. I have stated my case for gold over the span of 2 years and cannot add anymore to that debate. For some recent items that I agree with in principle (the iTulip article is a bit too "inflationista" for me, but well thought out) about gold and what it stands for can be seen here:
Your dollars are just Monopoly money by Bill Fleckenstein

So What's Behind Moves in Gold? by Mish Shedlock

The Game - Part I: Queen of Hearts by Eric Janszen

While not gold specific, this story explains why confidence in the financial system (via extension, confidence in money itself) is struggling due to the clear corruption and lack of trust:
The Ongoing Cover Up of the Truth Behind the Financial Crisis May Lead to Another Crash by George Washington on Zero Hedge

And now onto today's main theme....

Deflation Makes for Ugly Headlines
When people that follow economics discuss inflation and deflation they understand basic concepts of money. Ask a hard core follower of monetary issues about "real returns" over time or "inflation adjusted prices" and you will see all kinds of strange things pop up. Take this strange tidbit (via Zero hedge):

While in absolute terms the Dow may cross whatever the Fed thinks is a necessary and sufficient mark before QE begins to taper off (Dow crosses 10k just as Treasury purchases expire), the truth is that over the past 10 years (the first time the DJIA was at 10,000) the dollar has lost 25% of its value. Therefore, we present the Dow over the last decade indexed for the DXY, which has dropped from 100 to about 75. On a real basis (not nominal) the Dow at 10,000 ten years ago is equivalent to 7,537 today! In other words, not only have we had a lost decade for all those who focus on the absolute flatness of the DJIA, but it is also a decade where the US Consumer has lost 25% of purchasing power from the perspective of stocks!

Very interesting. Everyday people are not aware and do not care about such things. To them a $10 bill is worth roughly what they remember it was worth in 1999.

What is curious is that inflation results in sexy headlines like "home prices double" and "Nasdaq 5000 last stop before 10,000" or what have you. Maybe slow theft of purchasing power has been pushed like a drug over time, yes?

Of course right now deflation rules the landscape. This is not helpful at this juncture because deflation headlines are not exciting. In fact, they will almost always mean less money coming your way. Some points just from the past couple of days.

No cost of living increases in 2010, Social Security says
And you thought the health care debate got seniors mad, wait for this one.

Of course, any US administration (any party, anytime) would be terrified of the over-65 voter block and so on the same day the above hits the wires we also get this:

Obama calls for $250 payments to seniors
WASHINGTON (AP) - President Barack Obama called on Congress Wednesday to approve $250 payments to more than 50 million seniors to make up for no increase in Social Security next year. The Social Security Administration is scheduled to announce Thursday that there will be no cost of living increase next year. By law, increases are pegged to inflation, which has been negative this year.
It would mark the first year without an increase in Social Security payments since automatic adjustments were adopted in 1975.

Wow, not since 1975.

Of course, I thought that $250 is really not even worth the bother. By my back of the envelope account (I lied, I am using a calculator) this comes to a whopping $20.83 a month bonus per check for those that qualify. 20 Bucks! Is this where we are now?

Of course not everyone thinks a mere $20 is small potatoes. Later in the article we have this:

"The likelihood of losing an average annual COLA increase of about $200 to $300 in 2010 may sound like no big deal to some, but for millions of seniors who've already seen a third of their Social Security eaten up by health care costs, this proposed COLA relief could truly make the difference" said Barbara B. Kennelly, a former Democratic member of Congress from Connecticut who now heads the National Committee to Preserve Social Security and Medicare.

I stand corrected. I guess this kind of money is a big deal in these circles.

Mish has all the deflation headlines and they are all ugly. Consider:
Year-Over-Year CPI Negative for 7th Consecutive Month; Rents Decline First Time in 17 Years

So this is good, right? Paying less for things saves you money and lower rents may help struggling renters who have been ignored in the whole "save peoples homes" crusade. It is no less sad for an unemployed renter to be evicted from their home. They too may have to abandon pets, they too may have to take a credit hit. Of course, banks have limited exposure to renters, so the renter can go screw themselves as far as the government is concerned. Free markets are rough if you are in the wrong crowd.

So what is scary here you ask? Of course, what kinds of things are tied to the CPI? We already saw that social security would get no increase (no matter, the government will give it to them anyway). What about the minimum wage? Uh oh. You mean people WILL BE MAKING LESS during deflation. This is a problem.

Now let me be very clear here. This is in no way what the government wants. They want a great CPI print of 2% plus. They want to pay out more. They want to get money velocity going. This is in no way, shape or form a way for the government to save money, and it is not their intention.

Deflation makes for ugly headlines because the hand out programs get smaller. Of course in time your paycheck will get smaller. With less on hand, the fear is of a deflationary spiral. Here I think things get twisted by definitions.

A deflationary spiral is thought of as a process where a person thinks item X will cost less money next week, or next month so they hold off on buying. This causes a feedback loop. I would argue that a real deflationary spiral occurs at the point of recognition (POR) that yes, item X will be cheaper next month, but I will be getting less as well, so I do not buy.

To me this is a key concept. Inflationists and Deflationists are so very close in end result thinking, they only differ on mechanism. Perhaps they only differ in terminology of the overall construct of the argument.

Is there a difference between:
-Money is worth less going forward and things go up in price so you cannot afford them

-Money is worth more and things cost less but you have much less money with which to buy them

Either way, you have a problem.

In closing, deflation is a real political problem. Headlines as we have seen Thursday will garner negative feelings towards elected leaders. This is why deflation is enemy number one of the government.

Quantitative easing (QE1) on the Treasury buy side is done next week. How long until QE2 is opened up, making all the super smart bond types look like fools for defending Fed actions saying "this is a one time deal" (you know who you are). The mortgage securities purchase program will end in March, but if you really believe that then you may need to think about step one, admitting you have a problem.

I hate the phrase "This time it's different" because it is used primarily as a crutch to hang an empty argument. I would submit that this juncture in time is different than any other. What would the Great Depression onset look like with the internet available? Better? Worse? I have may own answer, but I would love to see reader answers to that one (hint, submit an answer in the comments).

In closing, thanks to all for all the interaction. We need to keep thinking and we need to keep the discussion going.