A Short Note on Deflation

Submitted by Z. Bukhari

Just a short note on Deflation

Oooh, it's terrible. Like anything, if there's too much of it. But there's a context- obviously there's a reference- in that Deflation is occurring in the middle of either this or that. That this is what ‘it' means because it has ‘these' consequences, that this is what it does because this is how it works. And a lot of people say, Deflation! gosh,  didn't we just expand the Fed balance sheet, isn't that currency, or what about the Stimulus programs and all that cash created through the Treasury there- and then those reserves at the banks...I mean there was mention of some quite large sums? A lot of people feel that adding money to a fixed pool of resources is Inflationary. ..to which the short answer is that we have lower employment than before the money was added as well as lower payrolls on average than before, too, so no, it was not inflationary. Somewhere, the money disappeared. We know where, it's called toxic assets. The Fed is part-buying them at north of fifty cents on the dollar and helping move those that are worth anything onto private balance sheets at pennies: don't let a good crisis go to waste. Alright, I've simplified - the reason is that there's been a lot of recent market chatter about the grand cleanser of Deflation sharpening its scythe and preparing to walk amongst the doe-eyed innocents. Let's be clear, Deflation is what happens if the Demand function contracts and the requirement for money falls.

I suppose the argument goes, if you need less and/or, spend less there starts a vicious downward spiral. Except- that's an extrapolation that doesn't necessarily hold - examine the rephrase: if you need to spend less...well then, you have more to spend on discretionaries. The Demand function is after all constructed from the current aggregate spending - mortgages, utilities, foods, gas, schooling, bills, beer, women, crisps-  and it is exactly this Demand function that is being defended when we talk of the threat of Deflation. In essence, the argument goes, when things get really bad then what happens is that, as a population, we stop being able to support the spending on these items...jobs will go, investment will collapse, services will vanish... and the government won't have enough money, for one- there won't be any tax revenue, to help. Except of course, that this is the situation we have right now. Perhaps then, yes, it should be stymied, but what is meant by Fighting Deflation is exactly a continuation of the policy we have to date - and this is where the defending of the Demand function is important to understand - that essentially, the FRBNY is asking to preserve the current cost ratio of all major items in the personal budget.

In my opinion, this is the beginning of a serious mistake. I feel that the Demand function has collapsed because it could not be borne, that the cost of living was too high a proportion of disposable income. There is a necessary time lag between price inflation and wage inflation -and when the tipping point is reached - when price inflation rises that little bit too much for wages to manage - the system crashes. The provision of Personal Credit pushes us further into the red for a while, but mortgages securitization cemented the inevitability of a crash. ..and meanwhile, the efficiencies which have brought profits to credit-worthy companies will, in turn, allow them to downsize and ride out any crash. The Bail-out, the current policy, resulted in the original debt being left with the homeowner while the banks were allowed to sell their ‘toxic assets'- which Sylvain Raynes categorically stated as in the most part as being unnecessarily complex and having no real financial use- to the Federal Reserve, with the Freddies and Fannies as off-balance sheet special vehicles. Breathtakingly cannibalistic.

...and these are the people who want to fix the problem...
 
Yet, I don't see the mistake of fighting Deflation as belonging to the misanthropy of dubious financial dealings. I feel there is a second component to the general price structure which is being overlooked, the man-who-saw-tomorrow effect. In short, with access to information and the new technologies fighting their way through regulation and discovery, it is only a question of time before could well be a real, substantitive change in the actual costs of provision for physical items, food and energy. It may be ten years, worldwide maybe twenty, before the Demand function itself changes quite dramatically, as the internet changed things. Stepping in front of it now, when there is a natural juncture, could easily be the most annoyingly stupid thing that banks could ever do and also quite probably, one of their last. 

We need money, we don't necessarily need banks (if enough were willing to keep open books). Certainly, we don't need more than one.

But that is as may be... Deflation, I think we have already been going through this for some time now. If it is slated to become more serious, meaning a greater fall-off in the money travelling about the economy, then I don't believe that the administration is looking to actually change the costs-of-living to accommodate that...whereas that is exactly what should be done, not by two or three percent but by twenty or thirty percent. Effectively placing the economy on the other side of a deflationary clearing- thereby removing the ‘animal spirits' (!?). The stimulus was issued in the hundreds of billions, it could be done, I just don't think that it is planned to be. I think the idea was to provide employment in order to sustain the current personal budget.

Guessing that this is where we are headed, in a deflationary episode the levels of profits really don't matter, far more important is employment, and far more important is the distribution of basic supplies at a sensible price. These two items were critical before and it was extremely difficult to manage for them. Training for suitable skills -suffered from lack of money, time, foundation skills or even prejudice -on the part of several parties. Distribution was not terribly expensive in the US because it had cheap oil and will likely continue to have cheap access for some time. If it doesn't, then inflation on basics will rise necessarily and when the money is unavailable to buy these and they sit on the shelf, that's also counts as Deflation. If I had a point, it is that as the situation becomes more critical, the demand for less skilled labor increases but the investment is rarely forthcoming to put it to work...which is a discussion of building up the lower middle class.. a part of which is the concept of universal healthcare. So, tricky ground, but the structural changes to cope with the worst case scenario, if they are targeted for those who need work the most, can really only be conducive to medium term economic growth.  One solution to the current situation would be to put labor to work producing basic items near to where the demand exists, i.e. akin to rural industrialization, which we know works well. This can be applied to food and in fact almost everything apart from metals refining. It's even possible to make synthetic oil distributive. Heck, it even makes sense to tax imports from out of state if it serves to bolster state revenues from corporations who have international low-cost manufacturing bases. If it's possible to produce Oil, plastics, make goods, work metals and to produce food inside a small town, then profits decrease over the short term, but wealth distribution becomes more equal.  And there's no real question that this is the future- it doesn't sit well with the large corporations, the threat of terror, or with dubiously- motivated bankers...but this is a necessary part of the squaring of the circle, there isn't much point in continuing with the current economic system unless you feel that ripping off other peoples faces is the American way, gawdammit. With the ability to detect explosives as fine as it is, the threat of terror is an insufficient deterrent - which leaves the other two - and that's where the issue is one of the level of necessity for structural changes:

The bankers have just made a level of money on the scale of the entire US housing market; they've just been very well-paid. Corporations have the rights to intellectual property which is a tricky item to distribute, license and enforce. For instance, companies could develop a process and then could sell the process, rather than make the product.  The model is widespread already, in that this isn't a dramatic change. The suggestion is that corporations take an active role in farming affiliated production amongst many, many small units, could be an excellent way to restructure GE. Also, that the government stands out of the way and allows these ‘local' solutions to take shape.

Obviously, I don't expect the government/banks to do anything helpful; if these changes are to work they would have to be explored by corporate roundtables.