Deflation would be really bad news

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http://www.dailymail.com/Opinion/rsamuelson/200811110114

Tuesday November 11, 2008

WASHINGTON -- Until recently, the idea that deflation - the decline of most prices - was possible, let alone a potential economic danger, seemed outlandish.

If anything, inflation was the threat. Led by rising oil and food prices, it was increasing in most countries. But in the past two months, deflation has suddenly become conceivable, and though still a long shot, it's much more menacing than most people realize.

The most urgent economic task for Barack Obama and other world leaders is to prevent the long shot from happening.

A mild deflation - like a mild inflation - would be barely noticeable, and even pleasurable. Who doesn't like lower prices?

But beyond a few percentage points, deflation can create economic havoc by forcing debtors to repay loans in more expensive money and causing consumers to postpone purchases.

In the Great Depression, deflation reigned. Consumer prices fell about a quarter from 1929 to 1933. Spending collapsed. Supply swamped demand, driving prices down.

By 1933, manufacturing output had dropped 39 percent and joblessness had reached 25 percent.

[Warpy]

1. Supply swamped demand for another reason

When the stock market crashed, most people who had invested had done so on margin and had used up all their assets in a vain attempt to hang onto their stocks. Remember, the market crashed in stages from March, 1929 until the bottom in 1933. People were fooled every time it rose, thinking the worst was over and they were safe.

With no savings and no other assets to convert into cash, they stopped spending, reducing demand for goods and services. The lowered demand fueled high unemployment. Merchants caught with inventory tried to unload it for whatever they could get, just to stay in business. They were competing with people who sold everything they had just to get food for another day. That's what drove prices down.

It all comes from the same source: holding wages down and selling people on the idea of a better life through debt.

We probably will be in for a deflationary cycle, something that's already begun with housing. We also know how to end it, by putting money into the pockets of working people who will spend it, creating demand. Whether or not this will be allowed is the only question.