Tuesday, August 18, 2009

Bloomberg Opinion: Deflation Theory is Lemon We've All Been Sold

I don't often post full opinion pieces but I especially enjoyed this one on Bloomberg. In fact it sounds extremely familiar to what I wrote in May as (incredibly) economists are calling for the need for inflation; in fact 6% ... why? [May 20, 2009: Economists - US Needs More Inflation]

They argue that a looser rein on inflation would make it easier for debt-strapped consumers and governments to meet their obligations.

It might also help the economy by
encouraging Americans to spend now rather than later when prices go up.

I found that thinking both scary and dangerous, especially the second sentence. Drive up inflation so American consumers - wounded as they are, many without work and relying on government safety net - will be forced to spend, which will self reinforce into an inflationary spiral? That's mainstream economic theory? Frightful.

I’m advocating 6 percent inflation for at least a couple of years,” says Rogoff, 56, who’s now a professor at Harvard University. “It would ameliorate the debt bomb and help us work through the deleveraging process.”

Just as with the "cult of celebrity CEO as all knowing and just so rare a breed compensation must be 100s of times the average peon"; I think Americans have been brainwashed by the deflation boogie man. If you speak a dogma long enough it appears to becomes some sort of "fact" - at least in the court of public opinion. As I opined in that May piece "light" deflation or flat prices are not bad. As long as prices fell more than wages did you could actually prosper with flat wages or slowly falling wages. And let us be sure that wages have flattened in the U.S. - I saw this mind numbing statistic in another Bloomberg piece.
  • Excluding the wealthiest 10 percent, the rest of the population got an average increase of $286 over that period (1973 to 2007), or about $8.41 annually, adjusted for inflation, Tax Notes said.
That should tell you all you want to know about "trickle down economics" - but let's not get started on a tangent. If the economists (and Fed) get their way, you will be been throwing people who have enjoyed $8 real annual gains in income (post inflation) into a world of higher inflation? To get them to spend right away rather than "do the wrong thing" and save? And you ask why we have had a debt bubble? Wages not increasing but decades of Alan Greenspan + Bernanke stoking prices because its "good for us".

This is what I wrote in May

Clap your hands together for our creditors - we are going to repay them with increasingly worthless dollars. Whose the sucker now creditors? I just love this article from Bloomberg - inflation is now good for you. Remember, in the big picture there is nothing inherently wrong with deflation as long as goods prices fall quicker than wages. Inflation on the other hand is a regressive tax on the lower parts of society and benefits those with assets... the value of their wealth increases (at least in nominal terms) and many of the wealthiest live off assets not income. So you can guess which camp (inflation v deflation) they live in. And we all know who controls the purse strings in America... trust me, it's not those that will be hit with an egregious regressive tax.

So you must ask yourself in WHOSE interest is inflation "good"? Certainly not savers. Certainly not consumers. The top argument against any form of deflation is people will hoard money and not spend - waiting for lower prices. Mr. Lynn makes an excellent point - we see that every day in electronics and we don't stop spending because of that. In fact one could argue that electronics is only 2nd to healthcare to what has shown the most growth in spending the past decade. But dogma rules - it is important for central banks to print more money, to make the paper in your wallet increasingly worthless (and your real adjusted salary go nowhere for 35 years!) otherwise... well... you know... very spooky things will happen!! Don't ask what they are - just be scared! *Boo!!!*

Here is the Bloomberg opinion piece - spot on in my book on the concepts while I don't agree that "economies in Europe are really recovering much at all" (recall GDP is highly flawed):

For much of the last year, central bankers, industrial leaders and politicians have been warning us about deflation. Falling prices, they tell us, will create another 1930s-style depression. The only answer is to print money furiously.

Now it turns out the theory is a lemon. Deflation is no threat at all.

It doesn’t prevent an economy from functioning, and it doesn’t stop it from recovering either. The evidence suggests a period of sustained deflation might be what indebted economies need to get them back on the right track.

U.K. Chancellor of the Exchequer Alistair Darling said in a speech earlier this year that the Bank of England must be “prepared to act” to prevent price deflation.

“We are very keen on avoiding deflationary risk” said European Central Bank President Jean-Claude Trichet in an interview this month. Much the same message has been pumped out around the world by economic leaders.

Nor have they been slow to put their freshly minted money where their mouth is. The Bank of England has embarked on a program of “quantitative easing,” or creating new money, to stave off the threat.

The trouble is, the theory doesn’t stack up. Deflation, after all, has already arrived.

Falling Prices

In the euro region, prices fell a record 0.7 percent in July from a year earlier, after declining 0.1 percent in June, according to the European Union’s statistics office. In Germany, Europe’s largest economy, consumer prices posted their first annual drop in more than 22 years in July. Wholesale prices plunged almost 11 percent.

So the “deflating” euro area is disappearing over an economic precipice, right? Not quite. It is leading the world out of recession. Figures released last week showed Germany and France were hauling the region out of the global decline -- both expanded 0.3 percent in the three months through June after four consecutive quarters of contraction.

Not much sign of the dangers of deflation there.

In reality, anyone with a sense of economic history would have been aware that the whole deflation story was oversold. In the U.K., the House of Commons Library publishes data on prices going back to 1750. From 1814 to 1914, prices rose a bit in some years, and dropped a bit in others, so there was no real change in the price level over the century.

Greatest Power

In other words, there were plenty of deflationary years. Yet over that period, the U.K. became the greatest economic power in the world:

Its relative decline only started once inflation took hold. Deflation didn’t stop the Industrial Revolution, one of the most sustained times of economic creativity ever seen.

Likewise, a 2004 study by the Federal Reserve Bank of Minneapolis looked at the data on deflation across 17 countries over 100 years. It found that although the Great Depression of the 1930s was linked with falling prices, that wasn’t true of any other historical period. There was, it said, “virtually no evidence” that deflation caused a depression.

Why should it? We are constantly told that deflation is bad because it makes consumers hold off from buying things, thinking they will be cheaper tomorrow. But that is just silly.

Two Impulses

Everyone knows that a computer or an iPod will be both better and cheaper in six months. And people really want one right now. Torn between those two impulses, plenty of shoppers go out and buy computers and music players. It is true in the electronics industry, and, once they get used to falling prices, it will be true for other industries as well.

Deflation may be bad for particular interest groups, which happen to be very powerful. It is bad for chief executives. It is easier to keep your profits rising in a mildly inflationary environment. You can just jack up your prices a bit, and you can often cut workers’ wages by stealth by holding wages steady.

The banking industry, which has come to rely on inflation to make highly leveraged loans sustainable, also dislikes deflation.

Likewise, it is bad for governments, which use inflation to reduce the value of their debts.

On the other hand, deflation is good news for savers, who get richer just by hanging on to their cash. And it is beneficial for consumers, who get cheaper prices. It is usually good for workers as well, as they can generally hold the value of their wages, even while prices fall.

There are winners and losers, just as there are from most economic developments. The important point is that the people who lose are more powerful than the people who gain. That might explain why we hear about the dangers of deflation, and not about its advantages. It still doesn’t make them right.

There is no threat from deflation. It may even be desirable if it encourages a balance between saving and consumption, and discourages governments and banks from taking on debt.

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