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Another deflation article...

Sunday, February 08, 2009

There is some real progress being made in the mainstream media's handling of the ongoing "deflation" debate if this report by David Pierson in today's Los Angeles Times is any indication of what is to come.

Now if they could just stop using the word completely, maybe we could make even more progress.

It has taken some time, but this could be the first occasion where somebody writes a story about "deflation" and gets right to the point that falling prices are simply a result of another asset bubble having burst (or, what would be referred to in contemporary economic parlance as a severe economic contraction).

As an added bonus, Mr. Pierson deftly avoids the most annoying of all "deflation" myths. That is, that consumers will slow their purchases due to falling prices - as if somehow falling prices were the real driver, rather than the bursting of the asset bubble.

That argument was valid a hundred years ago, but not today.

That's progress.

As every right-thinking amateur economist knows, falling prices are just a symptom of the much larger problem that what passes for competence in the practice of modern day economics is to somehow create an even bigger asset bubble to replace the one that just burst.

The bigger the asset bubble, the bigger the economic slowdown when it bursts.

The bigger the economic slowdown, the more likely it is that, at some point, consumer prices might decline.

It should be clear to all but the ignoramuses of the world that, today, people are spending less (reducing the demand part of the price equation) because they are scared to death of what lies ahead, fearful of losing their jobs after already having given up hope of maintaining their home-equity enabled lifestyle, and that these decisions have nothing to do with falling prices.

Deflation: When low prices buy high anxiety
In a weak economy, prices may drop, but so do wages and job security.

Wedding photographer Pogos Kuregyan has lowered his prices.

FedEx aircraft inspector Dan Wallace is dealing with a salary cut and a retirement fund that's lost half its value.

Though prices are down for food, housing, energy and clothing, they can't buy much, because they're living on less.

After years of worrying about inflation, some economists fear the opposite could soon happen: deflation, an extended period of falling prices that indicates the economy is in a backward spiral.

Millions of Americans have less money coming in than before the recession, and their net worth has also shrunk. That means less to spend on food, clothes, gasoline, cars and shelter. And despite discounts at the store and the car dealership, a lowering of rents and a near-historic drop in the price of houses, people just aren't buying much.
The fear about this recession rests on the severity of the real estate crash and credit crunch, which translates into pain for any homeowner who sank savings into a house only to see property values plummet. Those people are facing a cash crunch of their own.

There may even be signs that -- as they did during and after the Great Depression of the 1930s -- consumers will change the way they manage money, saving more and spending considerably less. Although few would argue that this is not a more conservative and ultimately safer way for American families to live, it could push deflationary trends in the economy even further.
That's progress indeed.

This week's cartoon from The Economist:


Anonymous said...

Here's one for you Time. From Doug Noland's latest:
Despite today’s histrionic fixation on “deflation,” current dynamics have some similarities to the post-tech Bubble period. Granted, the collapse of Wall Street finance is of much greater scope and consequence than the bursting of the tech Bubble. Yet I would counter that The Burgeoning Bubble in Government Finance is poised to make the Mortgage Finance Bubble appear tiny in comparison.

Anonymous said...

Oops. I meant Tim.

Tim said...

I saw that - thanks. Here's a link for anyone else who might be interested:
The Government Finance Bubble - Doug Noland, Prudent Bear

Tim said...

Here's another along those same lines: Our economy is being held to ransom by deflation fear - Liam Halligan, Telegraph

"But UK policymakers evoke the spectre of deflation not because it's an immediate danger; it's instead been conjured up as an excuse – so ministers can yank monetary policy back from the Bank and throw fiscal caution to the wind, using fear to trump objections based on common sense and economic lessons hard-won over many decades."

I'm not the only one who thinks this way...

Expat said...

Wouldn't it be nice to hear a politician other than Ron Paul come out and say "Folks, the FIRE economy has simply been a huge bubble. All this 'deflation' you keep hearing about is not a bad thing. It's just prices returning to normality."

And, Santa, can I have a poney, and a GI Joe, and a Maserati.

Nostradamus, apparently said...

While progress is being made on the deflation front, it's always upsetting to me to see people constantly confuse net worth with cash flow.

In this article, the author makes the common mistake of conflating net worth with ability to service debt:

"Millions of Americans have less money coming in than before the recession, and their net worth has also shrunk. That means less to spend on food, clothes, gasoline, cars and shelter."

Again and again, you'll hear so-called financial experts (including Greenspan) say that the drop in real estate values has caused the cash crunch for home "owners."

The drop in house prices reduces the home BORROWER'S ability to borrow more money; it has nothing, directly, to do with his unencumbered cash flow.

Unlike some assets, an increase in the market value of your home is not necessarily a good thing since you have to insure and pay taxes based on the value of the home.

Unlike stocks or gold, for example, if you sell your house for a bundle you will have to obtain a replacement dwelling (at an equally-inflated price).

Unless you rent or downsize to intentionally pocket the gain, you get nowhere by selling your house. Most people won't rent or downsize voluntarily.

So, Greenspan and others telling Americans they are rich because their house is currently worth more than they paid for it was, as we have seen, a recipe for financial disaster.

The moronic home "owners" simply borrow more and more against the house at low rates and the greedy lenders (who discovered derivatives and MBS) are happy to loan as much as possible, all without regard to the borrower's true ability to repay the debt.

During the recent housing boom, I read many articles in financial sources arguing that America's saving rate was better than reported because of our increased home equity.

This is the same argument and shows a complete misunderstanding of savings. (These arguments reminded me of the ridiculous "new metrics" the same writers were proposing for valuing internet stocks during the tech bubble.)

My guess is that rising interest rates are inevitable for our country as global lenders become more scarce and more nervous.

Because of the incredible amount of debt at every level of our country, this will cause HUGE problems for our country as the cost of debt service skyrockets.

At the same time, the dollar may begin to lose ground against other currencies making the problem even worse. Although, with the US Dollar as the reserve currency, it's hard to say what will happen here. The dollar may well be replaced.

Simply put, we're addicted to debt as a junkie is addicted to heroin. Greenspan was our dealer. It'll take more and more smack from Bernanke, et al to keep us high.

Eventually, like all junkies, we'll crash and burn...

Tim said...

I hear 'ya - here's a TMTGM classic from late 2006 in which a Nobel Prize winning economist tried to refute the idea that we weren't saving enough: Unmeasured Savings

Nostradmus, apparently said...

Wow, you really nailed it in that post from 2006, Tim:

"Apparently even a Nobel Laureate economist thinks that people don't have to save the old fashioned way anymore, that rising asset prices will do the heavy lifting. Amazing."

I couldn't agree more. As you also pointed out, it's amazing he could write that paragraph and NEVER use the words 'real estate.'

Winning a Nobel prize today is apparently more of a political coup than an intellectual triumph.

Gore's prize is proof enough of that.

This reminds me of Greenspan winning a medal. What a joke. You wouldn't let these guys balance your check book or babysit your kids and here they are getting Nobel prizes and running the country's finances.

The insanity is truly amazing and scary.

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