Saturday, July 10, 2010

Deflation is the real threat

Even a right-wing glibertarian economist at the AEI agrees. The money multiplier has taken a dramatic decrease -- indeed, has basically ceased to exist -- and the result is that, in reality, we're already in deflation.

Now, I hear you say, "but... but... prices haven't gone down!" But price stickiness is a typical trait of all deflationary regimes. The deal is that businesses will not voluntarily sell items for less than they paid to acquire / manufacture said item. If they manufactured a Woddle for $100 in pre-deflation dollars, intending to sell it for $110, they will *not* sell the Woddle for $90 in post-deflation dollars. Rather, they will accept a lower volume of business and price it at $101 or higher, and make up the difference by laying off the workers that they no longer need at the lower volume of business. Once the supply of Woddles manufactured at $100 is depleted, they can then begin manufacturing Woddles at $80 in deflated dollars and price them accordingly, but the point is that price declines lag actual deflation of the money supply -- thus "stickiness", which is more "sticky" for goods with many inputs, and less "sticky" for things like raw commodities with fewer inputs, but sticky nevertheless.

This reaction of economies to monetary deflation is a fact which greatly puzzled many economists during the Great Depression, who were baffled by both price and wage "stickiness" in the face of massive monetary deflation. They were baffled that businesses would preferentially reduce production and lay off workers rather than lower prices, when the classic economics theory of the time predicted that businesses would simply cut wages and prices to deal with monetary deflation. Both prices and wages did decrease during the Great Depression, but nowhere as much as simple monetarist observation of the money supply itself would have predicted. The difference was made up in lower economic output -- i.e., if the money supply declined by 20%, part of that would be made up via lower wages and prices, but the remainder would be made up by a decline in output due to price stickiness. This reality is why mainstream economics moved away from classical economics towards either Keynesianism or Friedmanism depending upon the political proclivities of the economist, both of whom have models which explain this actual observed reality (as vs. the imaginary reality where unicorns are real and a decline in the actual money supply results in an immediate decrease in wages and prices).

We are of course seeing that exact same scenario playing out again today, for the exact same reasons. We have models to explain this, thanks to both Keynes and Milton Friedman, yet the "conventional wisdom" still refuses to admit that deflation is a monetary rather than price phenomenon and continues to insist that we need to put the clamps onto the money supply now to prevent some mythical inflation that as has much reality as unicorns, despite the fact that both Keynes and Friedman's models were pretty darn specific that this is a time to start *printing* money, not *evaporate* it. Fascinating. In some neurotic, deranged way that usually involves people in white coats bearing restraint jackets use of the word "fascinating", that is...

-- Badtux the Economics Penguin


  1. It is all part of the plan to take the US to a more simpler time. A time when only a privileged few received a decent education, had access to decent health care, and the peons were owned by the company store. :)

  2. I don't fear deflation too much as I have no debt and some at-hand cash savings and a big IRA in US bonds. What worries me would be wage deflation in the face of inflation of food and fuel prices -- absolute necessities -- vs assets which will drop like a rock. Can't eat a house, land, factory, or a car. Or gold ;) (and thanks for setting me straight on the latter).

  3. 42, two words: Price stickiness. One word: Unemployment. So, two things become more and more likely as deflation sets in: You're more likely to become unemployed, and you're more likely to have to pay a larger percentage of your income for necessities. Deflation is bad unless you are so wealthy that you don't have to work for a living, in which case it's good because it's real interest that your money is earning (even if you're being paid 0% nominal interest). So unless you're one of the top 1%, you *should* be worried, even if you're debt-free...

    Terrant, Mexico North. That's the plan. The USA as Mexico North, with a few filthy rich owners and everybody else... peasants, peons, to be used and thrown away. And the plan is proceeding quite well, sadly...

    - Badtux the Economics Penguin

  4. Actually there is another group that does OK in deflation, and I'm in it - retired, on a fixed income, with financial assets in the form of cash equivalents, or near equivalents.

    I do have a mortgage, and the value of my house is less than what I paid 12 yrs ago, but you have to live somewhere . . .

    One crude, but illustrative definition of the money multiplier is "the amount of money the banking system generates with each dollar of reserves."

    This has been in decline sine the middle of the Reagan administration, and fell off a cliff in Sept 2008. (So clearly it's Obama's fault.)

    Current value is about 0.8.

    This is sick, sick, sick, and here is NO political will to even recognize it, let along taake corrective action. And the formula for doing so is very clear.

    Krugman keeps harping about right wing economists who spout ideas that were disproven 80 yrs go as if they have discovered startling new revelations.

    WASF, and it's gong to get a whole lot worse becaise of right wing denialism.


    WV: undipsyc - the quality of having one's psyche up one's ass, without first removing the BVDs.

  5. OK, I'm worried. I mean, yeah, no debt and savings, but losing my income would take care of that pretty quickly.

  6. Jazz, you should be worried too, because that "fixed" income can become broke real fast when the income providers decide to rewrite the rules. Like "Your pension? Sorry, we can't pay it any more because of the current economic emergency. Those bonds? Sorry, we're defaulting because current tax revenues cannot support repaying it. Your Social Security? President Obama's deficit reduction commission said Social Security payments must be cut to 20% of the old level to preserve the nation's financial integrity. And it was the benevolent, biracial liberal Obama doing this, not the malevolent Bush, so just go along with it and STFU as you starve, please."

    That's the thing about deflationary collapses -- the old rules do not apply. Unfairness prevails. All the air is sucked out of the balloon. The only thing that you can count on is the universal principle of "You're screwed." The 21st Century will be The Century of Death.


Ground rules: Comments that consist solely of insults, fact-free talking points, are off-topic, or simply spam the same argument over and over will be deleted. The penguin is the only one allowed to be an ass here. All viewpoints, however, are welcomed, even if I disagree vehemently with you.

WARNING: You are entitled to create your own arguments, but you are NOT entitled to create your own facts. If you spew scientific denialism, or insist that the sky is purple, or otherwise insist that your made-up universe of pink unicorns and cotton candy trees is "real", well -- expect the banhammer.

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