split thread - Potential Implications of Deflation
posted by Relayer in a different thread ...
"The deflation topic is heating up in the press. Maybe we should discuss the implications of that."
I agree that this is a worthwhile topic of discussion. Unfortunately, the only actual deflation I see happening is in real estate market prices. Maybe I'm not looking in the right places.
Re: split thread - Potential Implications of Deflation
Where would you expect to see it if you're not living in the US?
Re: split thread - Potential Implications of Deflation
Plenty of deflation occurring in labor costs to companies right now.
Re: split thread - Potential Implications of Deflation
^^^ re possible deflating labor costs, this doesn't hold true on an individual worker basis. Extremely few companies are actually proposing to cut official worker pay rates. Granted that on a total labor cost dollar basis employer expenditures are decling. But this is primarily based on laying off workers, or workers being scheduled for fewer hours per week.
Energy prices do not appear to be deflating. Nor do food prices, prices of insurance premiums, prices for utility service, property tax rates, sales tax rates, or anything else requiring an 'essential' outlay of consumer dollars.
Granted that there does appear to be some degree of price deflation for specific non-essential goods and services targeted toward the 'middle class' i.e. restaurant meals, big screen TV's etc. But where bargain basement offerings are concerned, prices for Chinese imports are creeping up ( thanks to a decline in the US dollar vs Yuan exchange rate working it way to US dep't store shelves ). And where upscale luxury offerings are concerned, Tiffany and Audi aren't offering any discounts.
Re the macro economy, it is unknown whether or not the rate at which bad ( mortgage, auto, credit card ) loans are actually being written off is greater than or less than the rate at which the US gov't is printing up new money out of nowhere. No 'official' gov't money supply statistic shows a true negative growth rate.
Re: split thread - Potential Implications of Deflation
speak of the devil, here are some 'professional' comments on the subject ...
(snip)"The Obama stimulus and bailouts haven't decreased unemployment rates or bankruptcy filings while home prices and home sales have fallen and can't get up. PIMCO's Bill Gross told Bloomberg this can all be fixed with nearly zero interest rates and additional debt to stimulate the animal spirits of investors and entrepreneurs. The federal-funds rate has been pegged at 0 to .25% since December 16, 2008, and Uncle Sam's debt is $13.3 trillion and counting. If this hasn't goosed the animal spirits, what will?
The failure of central bankers to make things all better again by creating some money and lowering some interest rates has the financial press fretting about deflation and thinking the US economy is turning Japanese. James Bullard, who heads the Federal Reserve Bank of St. Louis, came out with a paper entitled "Seven Faces of 'The Peril'." He concludes that the Federal Open Market Committee's (FOMC's) "extended period language may be increasing the probability of a Japanese-style outcome for the U.S." To avoid that outcome, Bullard argues that the Fed's most important tool is quantitative easing – printing money to buy government debt.
The Wall Street Journal's James B. Stewart claims deflation is bad because "deflation erodes profits and asset values," in his "Smartmoney" column.
People wait to buy expecting lower prices, reducing demand. Lower profits cause companies to cut expenses, including employees. It is a downward spiral that, if Japan's experience is any indication, is difficult to arrest.
Mr. Stewart is wrong on all counts. Profits are the difference between the price we sell a good for and the price it costs to produce that good. As Jörg Guido Hülsmann makes clear in his book Deflation & Liberty, "In a deflation, both sets of prices drop, and as a consequence for-profit production can go on."
And while asset values may drop, the assets don't go away. The real wealth of the nation – assets used for production – are still available to produce. However, it may be that because the debt is liquidated on those assets as prices fall, new owners will own and operate the assets, but commerce and production will certainly carry on.
Lower prices increase demand; they do not reduce or delay it. That's why more and more people own flat-screen TVs, cellular telephones, and laptop computers: the prices of these goods have fallen, and people with lower incomes can afford them. And there are more low-income people than high-income people.
Lower prices don't mean lower profits; nor do they mean that employees will be laid off. More demand for a good or service means more employees needed to produce those goods and services. "There is no reason why inflation should ever reduce rather than increase unemployment," Hülsmann writes.
People become unemployed or remain unemployed when they do not wish to work, or if they are forcibly prevented from working for the wage rate an employer is willing to pay. Inflation does not change this fact.
Hülsmann goes on to point out that only if workers underestimate the amount of money created by the central bank and therefore reduce their real wage-rate demands will unemployment be reduced. "All plans to reduce unemployment through inflation therefore boil down to fooling the workers – a childish strategy, to say the least."
Of course, Mr. Bullard over at the St. Louis Fed doesn't mention anything in his paper about individuals attaining their goals through subjective knowledge and pricing decisions. Instead he draws lots of lines on graphs and talks about Taylor-type policy rule, zero bound, the Fisher relation, "targeted" steady states, and lots of stuff that has nothing to do with economics.
So while the bond-buying Mr. Gross says zero rates will arouse the animal spirits in all of us, Mr. Bullard worries that "promising to remain at zero for a long time is a double-edged sword." Bullard writes that zero rates are "consistent with the idea that inflation and inflation expectations should rise in response to [that] promise." But in the same paragraph he continues,
But the policy is also consistent with the idea that inflation and inflation expectations will instead fall, and that the economy will settle in the neighborhood of the unintended steady state, as Japan has in recent years.
Wow, no wonder Keynesian central banking is so hard. You're damned if you cut rates and damned if you don't. "I moved the line on the graph. Let's see some animal spirits for crying out loud!"
In the real world, banks aren't lending because, as Murray Rothbard points out in America's Great Depression, if rates are too low, bankers have no incentive to lend, especially in a risky economic environment. Also, as Professor Jeffrey Herbener wrote in the Asian Wall Street Journal, "with distressed banks, reflation fails to induce another bank credit expansion."
Keynesians have mistaken the impotency of the Bank of Japan to restart credit expansion in the 1990s as a liquidity trap. But the problem is not that interest rates are so low everyone expects them to rise and therefore hoards cash. Banks refuse to lend because of the overhang of bad debt. Any cash infusion is held as reserve against it. Businesses refuse to borrow because of their debt burden, built up to expand capacity during the boom, and their over-capacity resulting from their malinvestments."(snip)
(snip)""Deflation is one of the great scarecrows of present day economic policy and monetary policy in particular," Hülsmann told his Economics of Deflation class at this year's Mises University. It seems a nation will destroy its finances battling the non-threat. The Organization for Economic Cooperation and Development (OECD) says the Bank of Japan "needs to keep interest rates close to zero and continue its asset-purchase program until there is a 'definitive' end to deflation," Bloomberg reports. But in the same report the OECD worried that the Bank of Japan's ability to stimulate would be curtailed by Japan's public-debt-to-GDP ratio approaching 200%.
Sounds like the folks at the OECD, like Mr. Bullard, can't make up their minds. What Austrians know for sure is that, as Professor Hülsmann makes clear, "the dangers of deflation are chimerical, but its charms are very real." Inflation, on the other hand, only helps those who are massively indebted and inefficient – governments."(snip)
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Re: split thread - Potential Implications of Deflation
Deflation in the wage market happens. It starts with restrictions on overtime. Next follows requiring "managers" to work more hours. Usually to cover the loss of overtime by hourly employees. Then, it's making "managers" out of people who are really hourly employees just to have them work more hours without overtime pay. Then there are companies who institute hiring freezes, forcing management (usually lower level management) to pick up the slack for unfilled vacancies. Next are furloughs. One of the biggest employers in the triangle, state government, had mandatory furloughs during the FY ending June 2010. Those furloughs cut 3% off of every state employee's salary. Except the legislators and the Governor. Somehow her salary was untouched.
Re: split thread - Potential Implications of Deflation
^^^ I'm going to respond that, at least technically speaking, deflation of worker wages is still not happening. Essentially, the definition of wage deflation must boil down to equal work being performed for fewer paycheck dollars. The gov't employee furloughs don't meet this criteria since it's a situation of less work for fewer paycheck dollars. However, forcing salaried management employees to work more hours and/or perform more tasks does meet this criteria ... provided that it is really happening.
Re: split thread - Potential Implications of Deflation
here is the arguably most important component to any inflation versus deflation discussion ...
(snip)Bloomberg announced the Fed is buying Treasuries on the open market today.
The process of a central bank buying the debt of the nation it represents is called "Debt Monetization."
The following is a reasonable review of what the process is and the results thereof. This time the form of the result will be "Currency Induced Cost Push Inflation."
Gold will trade at $1650 and above.
Monetizing debt
In many countries the government has assigned exclusive power to issue or print its national currency to independently operated central banks. For example, in the USA the independently owned and operated Federal Reserve banks do this.[1] Such governments thereby disavow the overly convenient ’slippery slope’ option of paying their bills by printing new currency. They must instead pay with currency already in circulation, else finance deficits by issuing new bonds, and selling them to the public or to their central bank so as to acquire the necessary money. For the bonds to end up in the central bank it must conduct an open market purchase. This action increases the monetary base through the money creation process. This process of financing government spending is called monetizing the debt.[2] Monetizing debt is thus a two step process where the government issues debt to finance its spending and the central bank purchases the debt from the public. The public is left with an increased supply of high powered money.
Effects on inflation
When government deficits are financed through this method of debt monetization the outcome is an increase in the monetary base, or the money supply. If a budget deficit persists for a substantial period of time then the monetary base will also increase, shifting the aggregate demand curve to the right leading to a rise in the price level.[3]
To summarize: a deficit can be the source of sustained inflation only if it is persistent rather than temporary and if the government finances it by creating money (through monetizing the debt), rather than leaving bonds in the hands of the public.[4]
Examples
Monetizing the debt can be used as a component of quantitative easing strategies, which involve the creation of new currency by the central bank, which may be used to purchase government debt, or can be used in other ways.
However, there can be an insidious effect. As one observer noted:
When governments reach the point where they are borrowing to pay the interest on their borrowing they are coming dangerously close to running a sovereign Ponzi scheme. Ponzi schemes have a way of ending unhappily. To get out of the Ponzi trap, governments will have to increase tax revenues, or cut spending, or monetize the debt–or most likely do some combination of all three. [5]"(snip)
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Re: split thread - Potential Implications of Deflation
Investors expect some degree of inflation in prices; they work the method to take advantage of that. Likely no one would invest in the future if deflation was the norm.