Deflation

[texaspackerbacker]

The latest manifestation in this mostly contrived economic "crisis" is the "threat" of deflation--the opposite of inflation, and a generally downward trend of prices across the spectrum of goods and services.

Every economics class I was ever in where this was discussed, I asked the question, "what is so bad about deflation?". I never got a satisfactory answer.

True, it is a highly unusual situation; True, deflation was a major symptom of the economic problems of the Great Depression; And true, some elements of society do not benefit from a deflationary cycle. Overall, though, it has always been my contention that deflation helps a lot more than it hurts.

The decline in oil/gasoline prices is apparently a result of this. Everything from auto prices to food to all sorts of items for Christmas shopping are dropping. This is, of course, a result of decreasing overall demand, but WHY is there a decrease in demand? My answer to that falls right back on my favorite culprit, the media--the leftist mainstream media--which has convinced the people of America that we are in a dire economic emergency. As a result, people are consuming--and buying--less on all fronts. That constitutes decreasing demand.

Corporate America is harmed by this because unlike consumers, they can't just turn off the spigot--cut costs. You can't just arbitrarily decrease employee wages. Reducing the number of employees or closing factories or stores are drastic steps with long term effects. Does that harm outweigh the widespread short term good of lower prices? It depends on your point of view--which gets us back to the class envy/class warfare discussion--and looking at the whole thing conspiratorially, THAT may be the intent of the leftist media and others who have contrived this whole economic "crisis" and pushed along by shaping the opinions of consumers.

When we had deflation in the Great Depression, it began with crop failures/the dust bowl. Thus, that deflationary spiral was caused by SUPPLY problems. It was REAL, and it harmed a lot of people. This round of deflation, however, is caused by lack of DEMAND--which is inspired by bogus propaganda, and is NOT REAL. Thus, there should be no widespread harm, and to the extent that there is harm, the perpetrators of the whole fraud are to blame.

[Freak Out]

Unless you live in Alaska. We get gouged no matter what happens.

So the evil leftist mainstream media has convinced people they should save the money they have and stop wasting it on useless items they can live without? It's wrong to not buy an Xbox?

[bobblehead]

No one is borrowing and no one is lending...figure it out from there.

[HowardRoark]

Since the disastrous 1930s, economists and central bankers seem to have lost sight of the fact that there are two kinds of deflation—one malign, the other benign. Malign deflation, the kind that accompanied the Great Depression, is a consequence of shrunken spending, corporate earnings, and payrolls. Strictly speaking, even in this case, it is not so much deflation itself that is harmful as its underlying cause, an inadequate money stock. The hoarding of money, or its actual disappearance (the quantity of money in the U.S. economy actually shrank 35 percent between 1930 and 1933), causes the demand for goods and services to dry up. In response, firms are forced to curtail production and to lay off workers. Prices fall, not because goods and services are plentiful, but because money is scarce.

Benign deflation is something else altogether. It is a result of improvements in productivity, that is, occasions when changes in technology or in management techniques allow greater real quantities of finished goods and services to be produced from a given quantity of land, labor, and capital. Because an increase in productivity is the same thing as a decline in unit costs of production, a productivity-driven decline in the prices of finished goods and services needn’t involve any decline in producers’ earnings, profits, or payrolls. Lower costs are matched by correspondingly lower consumer prices, not by lower wages or incomes. Such productivity-driven deflation is actually good news to the average breadwinner.

Benign deflation is a relatively unfamiliar concept both because modern economists devote relatively little attention to it (focusing all their discussions on inflation or on deflation of the malignant sort) and because monetary policymakers in the United States and elsewhere have prevented benign deflation from occurring throughout most of the 20th century. Thus, since World War II, the United States has witnessed frequent gains in productivity. The real (inflation-adjusted) unit cost of production of goods and services today is approximately half of what it was in 1945. Yet the general price level, instead of being half as high as it was after the war, has increased to over nine times its former level. Instead of allowing goods’ prices to fall along with their falling real costs of production, the Fed has artificially inflated those prices by pumping large amounts of money into the economy. The last time productivity improvements were allowed to be reflected, partially and temporarily, in a fallen price level was in 1955, 44 years ago. And that was not by design but by accident.

Yet ongoing, benign deflation is not just a hypothetical possibility. Many Western nations experienced something like it between 1873 and 1896, when the gold standard placed limits on Western governments’ ability to offset the effects of productivity improvements through monetary expansion. Although national price levels declined almost continuously from 1873 to 1896, causing scholars for a time to refer to the era in question as the world’s first “Great Depression,” every other economic indicator—prices, wages, profits, industrial output, trade—shows the period to have been one of unprecedented growth and prosperity. The period had its share of genuine depressions, to be sure, but those cyclical downturns were a result of faulty financial legislation. No harm seems to have come from allowing a downward trend in prices so long as that trend reflected ongoing gains in productivity.

[HowardRoark]

Obama's key nonappointment: Bernanke

The Fed chief is needed to slay the dragon of deflation. But Bernanke must be careful.

By The Monitor's Editorial Board
from the November 21, 2008 edition

Where's a good deflation-fighter when you need one? US consumer prices fell in October at the steepest rate since 1938. If that starts a self-reinforcing downward spiral in prices, Barack Obama will need Federal Reserve chief Ben Bernanke more than ever. The former Princeton scholar is an expert on deflation, a pernicious destroyer of wealth.

In a famous speech before he became the nation's central banker, Mr. Bernanke said "sustained deflation can be highly destructive'' and it "should be strongly resisted."

His wise counsel was based on his studies of the Great Depression and of post-bubble Japan in the 1990s, times when consumers and businesses were sucked into a rare mental contagion in which they delayed purchases to see if prices would fall further.

Breaking such a negative pattern, or ending a phenomenon that feeds on itself, can take years. A drop in prices may sound good – who doesn't welcome gasoline at less than $2 a gallon or affordable home prices? But when this anti-inflation becomes rampant, people who are paying off their debt in effect pay more in value over time. Spending dries up. The economy contracts.

Avoiding runaway deflation is why central banks tolerate a low level of inflation – it keeps the bigger beast at bay. For most of this year, the US and many other nations had high inflation, mainly because of rising prices for oil and food. So it was a shock that US consumer prices – excluding food and energy – actually fell in October, the first drop since 1982. A sudden fear of deflation helped knock down the stock market.

The reality is that runaway deflation doesn't yet exist. And the task of preventing it lies with Bernanke, whose term at the central bank runs until 2010. His actions may affect Americans far more than those of Mr. Obama.

What's a Fed chief to do? As the éminence grise behind the recent financial rescue plans, Bernanke is very confident the government has the tools, if not always the will, of an FDR to reverse deflation.

The Fed's first tool is to drop the interest rate used between banks to zero. The rate is now 1 percent and may be dropped in December. The Fed can then "inflate" the economy by manipulating long-term interest rates that loosen credit, effectively "printing dollars." It's a move he describes as equivalent to a "helicopter drop of money." Deflation's foe is the US Mint.

The last time the Fed tried to ward off deflation, in 2002-03 under then-Fed chief Alan Greenspan, it overshot and helped create a credit bubble that then fed a rapid rise in home prices. Mr. Greenspan compounded the problem by not reining in the practice of banks taking on risky mortgages. It was, after all, risky loans that were the root cause of the 1929 market crash.

So while Obama must rely on Bernanke to slay the deflation dragon, the new president must also make sure the Fed doesn't overinflate and create another bubble.

How to do that? The Fed must set an inflation target, say at 2 percent, and stick to it. Congress may not like it. Lawmakers sometimes like loose money to create jobs.

Bernanke will need Obama's help to set that target. In fact, the two men will need each other to keep deflation in its cave. This dragon is a creature that must be slain with care.

[LEWCWA]

My limited and I'm sure simple understanding of the problem with deflation is that people stop buying, because they feel they can get it cheaper in a few weeks. This is a tough cycle to break.....