7 Key Points About Deflation

[girl gone mad]

I'm not an investor in gold, which he likes, but I think his points here are valid.

http://seekingalpha.com/article/106776-7-key-points-about-deflation

1. The entire discussion of deflation is overrated and attracts far more attention than it deserves. One can discuss the advances and declines of economies and asset classes over the last two decades without once mentioning the words inflation or deflation and do just fine. More than ever before, it seems that deflation is just a word that central bankers and economists whip out as if it were some sort of a trump card that allows them to take extraordinary measures to counteract the bursting of asset bubbles.

(snip)

2. It would be the worst blunder in centuries for governments and central banks to "allow" a repeat of the debilitating Great Depression of the 1930s. Simply put, with the absence of a gold standard, you cannot have a deflationary depression unless governments and central banks allow it to happen. Some day they might, but that won't happen anytime in the next five years or so - that would be political suicide when nearly all political leaders around the world continue to believe that Keynesian remedies will still restore health and vitality to the global economy.

3. Don't confuse 1990s Japan with 1930s America - Japan-style CPI-deflation really wasn't that bad. We already have asset-deflation in much of the world and we may well see modest CPI-deflation in the year or two ahead as was seen in Japan in the 1990s. This shouldn't be thought of as being particularly significant - remember that real economic growth in Japan averaged about +1.5 percent in the 1990s and CPI-deflation never exceeded one percent per year. If, on the other hand, we were to see 1930s-style American CPI-deflation of 10 or 20 percent per year - then that would be an entirely different, much more important development.

4. The "aura" of the word deflation and the fear it instills have to do with the workings of a hard money standard from which we departed decades ago. In a hard money standard, the currency was "as good as gold" and serious problems arose within the banking system when consumers came to believe that prices would continue to fall, figuring they'd be better off delaying purchases (this was an all too common event prior to the 20th century when CPI-deflation occurred frequently). We've had nothing but inflation for more than seven decades and this fear of the currency gaining purchasing power over time is sorely misplaced in today's world of pure fiat money - money always loses value in a fiat money system.

5. There are legitimate concerns about Americans becoming much more frugal and less willing to spend as they have over the last twenty years and a prolonged period of weak consumption in the U.S. will place great strains on the economy putting downward pressure on consumer prices. Here too, CPI-deflation would be an after-effect of these potential fundamental changes in the U.S. economy, not the driver. In my view, this will eventually happen, but it is still at least five years away. Contemporary mainstream economic thought posits that all downturns can be successfully countered with easy money policies and this theory will not be completely discredited until we get rip-roaring inflation at much higher rates than what we saw over the summer.

more at link..

[ben_meyers]

1. Line up 1000 economists and you get

a line of 1000 economists.

Paul Krugman, Nobel prize winner, has a bit of a different take:

As the economist Irving Fisher observed back in 1933, when highly indebted individuals and businesses get into trouble, they usually sell assets and use the proceeds to pay down their debt.

What Fisher pointed out, however, was that such sell-offs are self-defeating when everyone does it: If everyone tries to sell assets at the same time, the resulting plunge in market prices undermines debtors' financial positions faster than debt can be paid off. So deflation in asset prices can turn into a vicious circle. And one consequence of what he called a "stampede to liquidate" is a severe economic slump.

That's what's happening now, with debt deflation made especially ugly by the fact that key financial players are highly leveraged - their assets were mainly bought with borrowed money. As Paul McCulley of Pimco, the bond investor, put it in a recent essay titled "The Paradox of Deleveraging," lately just about every financial institution has been trying to reduce its leverage - but the plunge in asset values has nonetheless left these institutions with more debt relative to their assets than before. And the numbers keep getting worse. In July 2007 Ben Bernanke suggested that subprime losses would be less than $100 billion. Last month write-downs by banks and other financial institutions passed the $500 billion mark - and the hits keep coming

The dangers of deflation are real and can be every bit a debilitating as inflation.