Friday, September 30, 2011

Inflation or deflation? Depends what you measure

I've written many articles here about the parlous state of the US and world economy, most recently last weekend. I don't see much about which to be positive right now, and I think that state of affairs is set fair to continue, not for months, but for years.

However, I may have been too focused on money supply and the threat of inflation. From the point of view of Austrian economics, of course, this is almost inevitable; but from another perspective, examining different economic indicators, the opposite problem - deflation - may be a greater threat. I'm indebted to Mike Shedlock ("Mish") for examining this issue and providing some interesting reading.

In August Mish wrote a blog post called 'Yes Virginia, U.S. Back in Deflation; Inflation Scare Ends; Hyperinflationists Wrong Twice Over'. It's fairly technical, so if you're not an economist or a follower of economic theory, you might find it a bit daunting: however, it repays careful perusal. It's not comforting reading, but it analyzes fifteen trends in our economy right now and shows how, together, they may be pointing to an overall deflationary trend. I'm not going to post an excerpt here, because you really need to read the whole thing to get the big picture.

In September, Mish followed up with another look at where we're at. He put forward a list of twelve specific policy recommendations for Washington that would address our problems, and hopefully avoid the worst of both inflation and deflation. Some of his suggestions make me wince, but I can support many of them.

  1. Banks and bondholders should take a hit. Banks are not going to lend anyway so bailing them out at the expense of taxpayers is both morally and economically stupid. End the bailouts, all of them, and prosecute fraud, the higher up the better.
  2. Implement serious bank reform now, not 9 years from now. Banks should be banks, not hedge funds. This proposal will necessitate breaking up banks. So be it.
  3. Scrap Davis-Bacon and all prevailing wage laws. Such laws drive up costs and have wreaked havoc on many cities and municipalities, now bankrupt or on the verge of bankruptcy.
  4. Pass national right-to-work laws. Once again, we need to reduce costs on businesses and local governments to spur more hiring and reduce costs.
  5. End collective bargaining rights of all public unions. The goal of unions is to provide the least service for the most money. The goal of government should be to provide the most services for the least money.
  6. Scrap ethanol policy and end all tariffs.
  7. Legalize hemp and tax it. Prison costs will go down, tax revenue will grow, and biofuel and fiber research will expand as hemp produces very soft fibers.
  8. Corporate income tax rates should be lower in the US than abroad. Current policy encourages capital flight and jobs flight via lower tax rates on profits overseas than in the united states. This penalizes businesses that work only in the US, especially small businesses that do not have an army of lawyers and lobbyists.
  9. Stop the wars and set a plan to bring home all US troops from Iraq, Afghanistan, and 140 or so other countries.The US can no longer afford to be the world's policeman.
  10. Implement Paul Ryan's Medicare voucher proposal. It is the only way so far that anyone has proposed that puts much needed consumer "skin-in-the-game" that will reduce medical costs.
  11. Legalize drug imports from Canada.
  12. End the Fed and fractional reserve lending. Both have led to boom-bust cycles of ever-increasing amplitude.

There's more at the link. I've added links to explanatory articles for terms with which some readers may not be familiar.

Evidence that Mish may be on to something when it comes to deflation comes from an article today at CNBC.

Home prices are unlikely to recover before 2020 and mortgage defaults will persist for years, says a survey of bank risk managers out Friday.

. . .

The findings, which authors called “a decidedly pessimistic outlook”, are a sharp reversal from cautious optimism the survey respondents expressed late last year and in early 2011.

In addition, 73 percent of surveyed bankers say they expect mortgage defaults to remain elevated for at least another five years. And 46 percent believe mortgage delinquencies will increase over the next six months.

. . .

A large number of respondents says they also expect to see an uptick in delinquencies on auto loans, credit cards and student loans.

Small businesses are expected to continue face a challenging credit environment. More than one-third of respondents forecast an increase in delinquencies on small business loans.

Bankers also appear to be pessimistic about recovery in consumer spending, with 64 percent of respondents expecting credit card usage to remain below pre-recession levels for at least five more years.

Again, more at the link.

Certainly, if these forecasts are correct, then the stifling of consumer demand will force producers to lower prices on at least some goods, otherwise they won't be able to sell them at all. That translates directly to deflationary pressures on at least some sectors of the economy. I'm not seeing that affecting things like gasoline, food, etc. right now - but housing? Oh, yeah . . . many US housing markets resemble economic slaughterhouses right now. Far too many people bought into the hype that their property(ies) would always increase in value, so they invested everything in their homes, and sometimes in investment properties too. Now they're underwater, and their savings - which were never in cash, only on paper, expressed as the increased value of their real estate - are non-existent.

An awful lot of Baby Boomers expected the increased value of their homes to provide several hundred thousand dollars of retirement capital when they sold them and moved into something smaller. As a result, they didn't bother saving money for retirement in other ways. Now that their homes are worth far less (sometimes they owe more on them than they're worth), their retirement funding no longer exists. They can't possibly survive at their present standard of living on Social Security, and their kids are in sufficient financial hot water in today's economy that many of them won't be able to support their parents. The upshot is that consumer demand from the older generation, which has been counted upon by business and commerce for years (since they tended to have more disposable income than younger people with families), has dwindled drastically. It's not going to come back anytime soon.

I'm still not convinced that deflation is a certainty. Indeed, many economists (particularly of the Austrian school) think that the opposite is more likely to happen. However, thanks to Mish's analysis, I've now got deflation on my radar screen. I'll be watching this area with great interest.


1 comment:

SiGraybeard said...

Maybe I'm too much of an Austrian-leaning guy, but I can't see deflation as a big threat. It's true that deflationary collapse is a more common problem historically than hyperinflation, but we're doing everything to set inflation up.

Beyond that, do you honestly think even one of Mish's suggestions would pass? Scrap the Davis-Bacon act, pass national right to work, end collective bargaining for public unions.. with this administration?? SEIU, AFL and the other big unions spent darned near a billion dollars to get Obama elected; does anyone honestly think they'd just say, "oh...OK" and walk away? Anyone who proposes such things will be waking up with a horses' head in their bed, at best - if they ever wake up again.

Any baby boomers who didn't trade up in houses with that plan, who paid off their mortgage early to have more economic freedom, and saved 20% per year in their 401k (sheepishly raises hand) are going to get wiped out by the Either 401k accounts will be seized in some way when they absolutely need that money, or inflation will make it worthless.