Inflation? Ever heard of it?
It’s back. Or at least investors can smell the faint whiff of it amidst the seasonal tang of freshly cut Christmas trees.
And that’s actually a good thing.
On December 15 the Bureau of Labor Statistics announced that the Producer Price Index (PPI), which measures price increases at the wholesale level, had climbed 1.8% in November driven by rising prices for food and energy. The core PPI, which excludes those two categories on grounds that prices in those sectors are too volatile, rose 0.5%.
The next day the bureau reported that prices at the consumer level (the Consumer Price Index or CPI) had increased by 0.4% in November led by higher prices for energy and healthcare. That increase followed a 0.3% climb in the index in October. The core CPI, which excludes food and energy prices, was unchanged in November
I know that inflation hawks, on the outlook for any signs that the massive increase in government deficit spending as a result of the twin fiscal and economic crises has led to an increase in inflation, reacted negatively to this news. To them the increase in the headline PPI and CPI is a sign of that runaway inflation is just around the corner.
I’m worried about the long-term inflationary trend too. Anyone who looks at the deficits piled up in the United States (and in much of the rest of the developed world) has to worry about the possibility of runaway inflation at some point in the future.
But not yet. As Federal Reserve chairman Ben Bernanke told the U.S. Senate Banking Committee recently, the U.S. economy is operating with so much unused capacity—so many factories are running at 50% of full speed and so many workers are unemployed—that a rapid increase in inflation is unlikely any time soon.
(Of course, the definition of “anytime soon” isn’t very precise. But the term isn’t any more or less vague than the Fed’s promise to keep interest rates low for an “extended period.”)
In the short-term of “anytime soon” a bit of inflation is actually a good thing. It’s a sign that the U.S. economy is growing—prices should rise if the economy is recovering from the Great Recession—and that the United States will escape the prolonged period of deflation that has keep the Japanese economy trapped near zero growth for much of the last decade.
None of this means we—investors, Fed officials, our representatives in government—shouldn’t be worried about runaway inflation in the long run. Just that right now a little inflation is a positive signal of economic recovery.
IMO the idea that encouraging savings through deflationary policy will lead to spiraling economic collapse is logically flawed. Deflationary induced savings would act as an unemployment insurance buffer and would prop up the economy during a recession. The unemployed will spend their savings at the same time production is contracting. This would obviously be inflationary, and would induce consumption.
The market always corrects imbalances. We want the policy that creates the smallest imbalances and thus the smallest pain. Deflation right now would hurt a lot, but why not inflate our problems away right now with the stated intention of moving towards a deflationary or noflation policy? If it is known prior to enactment then speculative debt investing will dry up a bit, and maybe we’d finally force congress to put a permanent lid on debt. Deflation seems to be the only incentive for congress and individuals to not overextend and let the printing presses take the pain away. Inflationary policy surely has not worked and has created pretty large imbalances and debt insecurity.
Gentlemen, don’t misunderstand me. I’m not saying I WANT deflation. Deflation is only necessary as a counterbalance to inflation. Ideally, a monetary system should avoid both and maintain equilibrium.
Nor am I saying I want a gold standard, although it is preferable to the “printing press” standard we have now. Ask the colonial era Spanish how the gold standard worked for them. If your gold reserves increase substantially, or if your population increases or decreases substantially, you can face just as much inflation or deflation. The gold standard works best when the amount of gold reserves mirror your population’s growth/shrinkage. However, at least with a gold standard there is less opportunity for frivolous political standards to manipulate the currency value (I say less, not none).
please look at the following 2 scenarios where deflation is present.
1) deflation, 1800s, agricultural economy starting to get industrialized. gold standard, moderate debt, high savings rate, high growth.
2) deflationary spiral, 1930s, asset bubble bursted, stock market crashed, lots of people used borrowed money to invest in stocks are in debt. not on gold standard, very weak stagnant growth.
which one sounds more like what we face now? Personally speaking, I agree with Jim. I am thankful our fed is keeping interest rates near zero to prevent great depression II. inflation is the lesser of 2 evils right now 🙂
once again, I already said before. Look at the conditions that needs to be true for deflationary growth? In your fantasy world where we have no debt, and high growth, and on the gold standard. Sure, maybe deflation wont hurt.
I respect your point, and Im not a proponent of inflation lol. But look at all the assumptions you have to make in order for your model to be true lol, Your point applys to conditions that are completely unrealstic to what we face right now. We are not on the gold standard, our government has already ran up the debt for decades, globalization and trade at a complete different level. With weak growth like this, deflation can only lead to a spiral.
My point was that you can have strong economic growth in a deflationary environment. You misread the chart you linked to (look at the table format). The price level started at 51 in 1800 and ended at 25 in 1899 = 50% decline in prices.
You don’t realize it but you’re making my point with your 20th century GDP statistics. Yes GDP went up strongly but it was on the back of debt. We now have something like $50 trillion in total debt (federal, state, local, consumer, corporation). That’s what drove the GDP growth so high.
So would you rather have 400% GDP growth with no virtually no debt (from 1820-1900) or 1000% GDP growth (1900-2009) with debt 4X the size of GDP, that’s unserviceable without resorting to hyperinflation or a default? The century you prefer results in a debt that is going to bankrupt the country. I’ll take slightly slower growth that is sustainable.
ohh and this is just as irrelevant as the 1800-1900 argument. but since we are at it 🙂
real per capita GDP in 1800 was roughly $1200, and in 1900 is roughly $4100, ill be generous and say, that it went up 4 times in the 19 century. your so called deflationary century where the US’s growth is supposedly so strong :p
in the next 100 years where your so called inflationary century. In 2000, real per capital gdp was about 40,000, which went up 10 fold from 1900.
By your logic, inflation > deflation.
But the fact of the matter is, there are so many other factors involved. This whole 1800-1900 thing is a very bad argument to try to show that deflation > inflation.
source:
http://www.nationmaster.com/
I bed to differ, outside of the spikes from the war, most of the 100 years is spent in the 20s. its relatively flat compared to the 20th century.
Fascinating discussion. I must say I’m certainly no expert, but am intrigued by a deflationary economy. I do think that people are bombarded with the notion that deflation is bad and therefore don’t even question inflationary policy.
Thanks for the chart Terry, but I would like to disagree with your assertion CPI was flat. If you look at it closely it spikes 2 times around 1815 and the Civil War, but for two 40 year periods it tracks downward from 40 to 25.
Ultimately, neither inflation or deflation is bad if kept to 1-2% annually, but I guess I lean toward deflation since I’m a saver at heart.
have a good night!
I’m not implying anything about any miracle or magical solution lol I have repeatedly said that high inflation is not a good thing either, however right now avoiding Great Depression II is more important than worrying about inflation for now.
If you are rooting for Great Depression II to occur then you probably does not have a realistic idea about just how bad it would hurt everyone.
Your argument of 1800-1900 is wrong
Please see the data below. CPI was flat from 1800-1900 not deflationary.
http://economics-charts.com/cpi/cpi-1800-2005.html
]
Ok, last one from me and then I’ll have to call it a day…
Deflation is actually a good thing, because in a deflation prices drop and money becomes more valuable, so deflation encourages people to save money. Deflation rewards the prudent saver and punishes the profligate borrower. The way a society, like an individual, becomes wealthy is by producing more than it consumes. In other words, by saving, not borrowing. And during a deflation, when money becomes more valuable, everybody wants money. They want to save. Whereas during an inflation, you want to get rid of the money. You want to consume. You want to spend. But you don’t become wealthy by spending and consuming; you become wealthy by producing and saving.
Inflation encourages people to borrow, because they expect to pay the debt off with cheaper dollars. It encourages people to mortgage their future.
The basic economic fallacy in your argument is that a high level of consumption is good. Well, consumption is neither good or bad. The problem is the emphasis on consumption financed by debt — which leads to the national bankruptcy we’re facing. It’s much healthier to have an emphasis on production, financed by savings.
Terry you seem to imply that in the future the economic problems we’re facing are going to be resolved by some kind of economic miracle. I totally disagree. All that’s happening is we’re kicking the can down the road. The further the can is kicked the worse the resolution is going to be. You’re right that deflation can be avoided by the Fed printing trillions upon trillions of dollars. However, that’s just going to result in an inflationary depression like Zimbabwe. In reality, it doesn’t really matter what I think because we all know what the Fed is going to do: print, print and print some more.
Gusspresso your deflationary spiral claim is simply an erroneous theory. I’m still waiting for an answer to how the US economy grew so incredibly fast from 1800 – 1900 despite a deflationary environment. Let me ask you this: if your refrigerator busted tonight but you knew that prices would be 5% lower a year from now would you wait to buy it? Of course not, you’d still buy the things you need but wouldn’t feel pressed by inflation to spend your money and take on debt to spend even more.
Enjoyed the discussion guys. Have a good night!
^^exactly :), Jim has said the same thing.
With respect, you guys are living in some fantasy world with a set of fantasy fundamentals thats from another dimension if you believe deflation is good for us right now.
Deflation makes the buying power of your savings worth more tomorrow than it is today. That’s dangerous because it gives incentives for people to stop buying and only put what they have in savings since they’ll get more from it next year (including large purchases like mortgages). That’s a hard scenario to have economic growth in.
Seen another way, if goods cost less and less (deflation) then companies are forced to reduce costs or squeeze margins in order to stay in business. They might even have to lower production and layoff workers which ends up reducing demand even more.
The problem is that it becomes a downward spiral. When people start to expect deflation, it becomes a self fulfilling prophecy where demand dries up and people wait for better deals and unemployment goes up as companies can’t make profits under these situations and reduce headcount. Unemployment up, spending down, revenue down, reduce expenses, unemployment up… (repeat^∞)