Print, Baby, Print!
The big question for those of you with money to invest is just what type of “flation” is coming down the pipe. Will it be inflation, or OMG!! hyperinflation, or are we heading into a period of secular credit revulsion and a deflationary debt spiral that will last for decades. No one really knows. You can always reverse deflation just by printing a lot of money and giving it to people. And you can always reverse inflation, just by – well bringing on a recession and issuing a new currency.
Even Weimer Germany only had hyperinflation for about 18 months. And since Zimbabawe shelved it’s own currency, they’ve been in deflation. Ultimately, what will happen is all political. Do we have the intelligence and political will to break out of deflation? Do we have to intelligence and political will to get some inflation, but not too much? Meh, beats the hell out of me.
All I know is that I look around and I see nothing indicating any willingness to allow even trivial amounts of wage inflation, which, as I’ve said many times, is necessary to break out of the deflationary trap we find ourselves in. So, I’ve thrown in my lot with the deflationists. Pretty sure I’m right, but I certainly could be wrong, and if you think I am, by all means go out there an buy the most expensive house you can with the biggest most levered mortgage possible. Run up your credit cards, take out as many student loans as possible, buy a new car – hell, borrow money from payday lenders.
But let’s talk for a minute or two about why this matters. What’s wrong with deflation? What’s wrong with inflation? Why it is that every time I say we need to print money someone comes by and says, “inflation will kill us all, haven’t you ever heard of the Nazis!?!?!” In the most obvious sense, inflation and deflation are flip sides of the same coin. In one case – too much money chasing too few goods leads to price increases. In the other, the reverse – too little money, chasing “too many” goods leads to price decreases. But with both inflation and deflation, what really happens is that incentives relating to investment, savings, and consumption decisions get all fucked up, and it causes markets to break down. That’s the problem.
John Malkin over at the American Enterprise Institute makes the case for the Rising Threat of Deflation:
As we enter the second half of 2010–the “postcrisis” year–while markets have been obsessed with Europe’s debt crisis, they have failed to notice potentially more ominous developments. The United States and Europe are heading toward–and Japan already suffers from–deflation, a classic prolonger of crises that boosts the real burden of debt and crushes profit margins.
[T]he Bank of Japan, slow to ease after the real estate bubble burst in 1990, has pre-sided over two decades of disinflation that has become outright deflation. Japan’s nominal GDP, as of the first quarter of this year, at ¥480 trillion has dropped by an extraordinary 7 percent over the past two years because of a combination of outright deflation and low-to-negative growth. Perhaps even more dismaying, in 2010, Japan’s nominal GDP is equal to its 1993 GDP.
Financial crises are deflationary because they create a rise in the demand for cash that depresses aggregate demand at a time when substantial excess capacity exists. The excess capacity is created during the run-up to the crisis, where underpricing of risk cuts the cost of capital and leads to substantial increases in the capital stock.
In fact, banks have virtually ceased to function as financial intermediaries since 2008, preferring to use the zero cost of money provided by the Fed to finance purchases of Treasury securities instead of supplying loans to households and small businesses. After a financial crisis, banks become much more risk averse, as is manifest in their willingness to lend only to the government instead of to households and businesses. That development is deflationary because it means that a sharp boost in the monetary base engineered by the Fed does not translate into faster monetary growth at a time when the precautionary demand for money has been boosted by elevated uncertainty.
There is a bigger risk that deflation will intensify sharply because once the price level actually starts to fall, the demand for money will be further enhanced. A deflationary spiral–a self-reinforcing, accelerating drop in the price level–can result. This is because a falling price level means that cash “earns interest” since it enhances the purchasing power of otherwise sterile cash assets that pay zero interest, just as interest on a bond adds to its value in terms of its ability to be used to buy goods and services. That is why deflation drives down nominal (market) interest rates just as inflation drives them up. The “real” return on cash rises as inflation falls, thereby further boosting the excess demand for money and, in turn, exacerbating deflationary pressure. The fact that deflationary real returns on cash are not taxed further exacerbates deflationary pressure by enhancing the demand for cash.
The piece is worth reading in full. As John points out, the classic problem in deflation is that it increases the returns to cash, i.e. you can stuff cash in your mattress and have it earn “interest” – so people stop buying “stuff” and stop loaning it to financial intermediaries to lend or invest, and as wages decline and businesses fail, pre-existing debt obligations increase in real terms. So, as we cascade down the deflationary spiral, expect to see more stories like this:
NEW YORK (CNNMoney.com) — Debt collectors are getting desperate and dirty.
Harassing phone calls, abusive language and physical violence are becoming a bigger part of business as debt collectors struggle to round up money from people who don’t have it.
“The American consumer is really hurting and collectors are having to fight harder to get money,” said Robert Andrews, a senior analyst specializing in the debt industry at research firm IBISWorld.
Complaints of harassment by debt collectors surged 50% to 67,550 in 2009, according to the Federal Trade Commission. And they are on track to jump 13% this year, based on the number of FTC complaints filed in the first six months.
As I’ve pointed out, paying down debt is itself a deflationary act, and wage garnishments are the equivalent of further wage deflation. I’ll keep banging this drum until, well, until I stop, but what we need to do to break out of this is to print some money and give it to people to pay off their pre-existing debts. I mean, hell, even Libertarians who believe in things like the “sanctity of contract” agree.
Print, Baby Print!