American Madness

Intelligent Criticism in the Service of a Better Nation




There’s nothing wrong with deflation
unless you’re owed money, right?

Posted by Josh Friedlander | 7 Comments

I’ve been scratching my head for weeks now every time I read that deflation is bad. It’s like every business writer at every paper got a memo or something. Are they under the impression that inflation is inevitable or that each year products should go up in value? It’s absurd. The only relevant distinction I see is that U.S. debts are denominated in U.S. dollars, so that it really sucks when people can’t pay you back because the salaries they earn the goods they sell are priced lower, rather than higher, than in the past. It means that the debts effectively increase in value if value is measured as the amount of work (economic output) necessary to discharge the debt. So, deflation would lead to many more loan defaults, one would think, or (more likely) to the renegotiation downward of existing loans, so that a rough equality would be achieved in terms of the amount of work relative to the size of a loan. It makes you wish there were some more objective measure of value (like, I dunno, gold) to which we could benchmark debts.

In some sense, deflation would appear to help the little guy and hurt the big guy. The big guy owns stocks and has lent a lot of money at current prices and wants a certain number of dollars back at a certain value. But if prices of goods and services decline, doesn’t the big guy when he gets fewer dollars back (due to defaults and renegotiated levels of debt) have roughly the same amount of value to spend? So, what’s the difference? Can someone explain this to me in English?

Posted on December 25, 2008 in American Madness

Comments

7 Responses to “There’s nothing wrong with deflation
unless you’re owed money, right?”

  1. Josh Friedlander
    December 25th, 2008 @

    Jay Hancock’s blog gives a decent explanation. The reason is psychological:
    http://weblogs.baltimoresun.com/business/hancock/blog/2008/10/whats_so_bad_about_deflation.html

    Deflation is a persistent and broad decrease in prices. Deflation arrives when there is too much productive capacity/supply and too little demand. (The real estate market, with 11 months’ supply of empty homes trying to get sold, is the primo example.) When supply is too great relative to demand, companies cut prices. Lower prices mean lower profits, and lower profits cause debt defaults and layoffs, which reduces demand even more. Perhaps the most damaging deflationary outcome is when consumers stop spending because they see prices falling and figure the car they want will be cheaper in six months. So they wait. Then they may wait another six months, especially if they just got laid off. This puts new pressure on companies.

  2. Joel Friedlander
    December 28th, 2008 @

    If the cost of everything goes down, then the costs of production also goes down. If this is so then the companies have a better profit margin if productivity remains the same. They can cut costs by reducing salaries, which won’t hurt the workers because the cost of living has also gone down. Right now, there are many companies that are reacting to the crisis by reducing work hours and pay instead of firing people. That is the better way, since it keeps people on the job for a time when the crisis is over. The violent fear of deflation is just one more exaggeration by the government and the media. This entire crisis is based upon fear and irrational behavior.The need for controls on investment are patent, but will anything really be done?

  3. wiki
    December 29th, 2008 @

    http://en.wikipedia.org/wiki/Deflation_(economics)#Deflationary_spiral

  4. Cameron
    January 20th, 2009 @

    The deflation spiral argument is spurious. Think of computers they are always getting cheaper, faster and more storage – people still buy a new one because they want it. I don’t see too many people hanging on to their 486 so they wait for the cheaper computer in the future….

  5. Josh Friedlander
    January 21st, 2009 @

    Except for me, Cameron. I still have a TV from 1984.

  6. Nimrod
    May 13th, 2010 @

    The ‘computer’ argument is equally spurious. What if all you’ve got is the 486 year after year? Still, a mildly deflationary environment would require some productivity gains and product improvements year after year to justify the higher real prices. Now that would be a good incentive. It also encourages you to buy only what you need to buy, and hire whom you need to hire, reducing a lot of wasteful production/consumption and leveraged speculation from the world.

    Obviously you don’t want too much deflation, just like you don’t want too much inflation. Anything around zero would be just fine. The trouble is people had gotten hooked on inflation for far too long and hyper-inflation expectation had actually gotten embedded into the prices of financial assets. These, more than anything, were the stuff that the US actually produced and consumed those past few years! Too bad they aren’t in the PPI or CPI calculations. So now a return to normalcy by itself would induce hyper-deflation, and no, you can’t have that, as it would amount to a reduction in living standards. I mean, if you never could have afforded a house, but you have one, you’d want to keep it.

  7. Ed Watt
    November 12th, 2010 @

    I agree with your position in why inflation is bad. I would also like to state the obvious that gas and diesel fuel out country and our economy as a result. Every time the economy starts to improve the price of fuel goes up and slows the economy again. How long are folks going to ignore this 1,ooo Lb gorilla in the front room?

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