Anyone heard of Deflation?

[a_unique_person]

It could be just around the corner.

http://afr.com/world/2003/05/08/FFXWMEZ7EFD.html

Deflation now Fed's main foe
May 8
Peter Hartcher in Washington

Alan Greenspan reassured anxious members of the US congress seven months ago that "we are not close to the deflationary cliff". Yesterday, he and his colleagues on the US Federal Reserve's key policy committee changed their minds.

They evidently decided that the US economy was in danger of teetering over the edge into deflation, and they said so.

This is an important moment for several reasons. It means that, in the opinion of the world's top central bank, the age of inflation is over.

"Greenspan was part of the crowd in the Ford administration in the 1970s that put out buttons saying 'whip inflation now'," recalls Brian Wesbury of the Chicago investment bank, Griffin, Kubik, Stephens & Thompson.

"He's come full circle - maybe we need buttons now that say 'whip deflation now'."

Greenspan has spoken of the dangers of deflation - a persistent fall in prices, the opposite of inflation - in months past.

But yesterday was the first time that the Fed's Open Market Committee has branded deflation Public Enemy Number One.

Yep, if there's one thing worse than inflation, it's deflation. Many who have been burned by stocks are moving into bonds and property. Usually after a business bust, the property market seems to go into a bubble. I don't know what housing prices in the US are like, but a pretty average house is now out of the reach of most people, unless you want to spend two hours each way a day commuting. Once this bubble bursts, it's deflation all the way down. Reminds me of the Great Depression fears. That is confidence is blown in business, (Enron shares, anyone), people wind up with negative equity in their home, and then prices go into a downward spiral.

Now, this is only a fear at the moment. But interest rates are already low, everyones credit cards are getting pretty maxed out, (hangs head in shame). And lowering interest rates can only go so far. In the end, it becomes like pushing on a piece of string.

Why is deflation a problem? It doesn't have to be, just as mild inflation need not be a problem.

But the Great Depression gave deflation a bad name. As prices fall, the real value of debt rises. Companies and consumers can find themselves in a debt trap, wrestling with an ever-growing debt burden.

Also consumers may stop spending because they expect prices to keep falling. Why spend $100 today on something you expect to be able to buy for $90 a little later? Consumption collapses. Recession beckons.

 

[PixyMisa]

Deflation is the reason that no-one ever buys computers (or indeed just about any hi-tech gadgetry).

No, wait...

 

[a_unique_person]

Re: Re: Anyone heard of Deflation?

Deflation is the reason that no-one ever buys computers (or indeed just about any hi-tech gadgetry).

No, wait...

Ever heard of phone companies. They are losing squillions, with Ericsson subject to rumours it may go under.

 

[PixyMisa]

[PixyMisa hides under the bed.]

I've worked in the industry for years. At one time I had squillions of my own (on paper, anyway). I see less deflation at fault there than rampant stupidity.

 

[PixyMisa]

Come to think of it, deflation has been with us since the industrial revolution and has been the primary generator of wealth for all that time. It just wasn't as rapid or as obvious then as it is today.

 

[subgenius]

Come to think of it, deflation has been with us since the industrial revolution and has been the primary generator of wealth for all that time. It just wasn't as rapid or as obvious then as it is today.

Bush-o-nomics is a house of cards. Go from a surplus to a record deficit in that short of time, and tell me something isn't going to give.
But let's increase the deficit by a political tax reduction in the meantime.
And bully people by saying "if a little (tax cut) is good, a big one's got to be great."
I will run for president on the platform that not only should we reduce taxes, the government should pay you to be a citizen.
A sucker's born every minute.
They already stole back everything the middle class accumulated in the previous eight years, in a matter of days. When the stock market falls, the money doesn't just evaporate. Where did it go?

 

[PixyMisa]

Um, it evaporates?

 

[subgenius]

Um, it evaporates?

Up.

 

[a_unique_person]

Come to think of it, deflation has been with us since the industrial revolution and has been the primary generator of wealth for all that time. It just wasn't as rapid or as obvious then as it is today.

Prices of many things are cheaper now than then (relatively speaking, but it's dollar price has still risen), but the overall trend has been inflation.

 

[PixyMisa]

Almost all manufactured goods have been getting cheaper in real terms; on the other hand, you are correct that money has generally been decreasing in value against other goods (not to mention services).

But let's ignore for the moment my sweeping and not entirely on-the-mark generalisation. I can buy a 180 gigabyte disk today for one-fifth of what I paid for a 180 megabyte disk back in 1990. (And that's without correcting for the official inflation rate.)

That's a 5000-fold deflation in cost per unit. Is this a bad thing? For whom, and why?

 

[a_unique_person]

Almost all manufactured goods have been getting cheaper in real terms; on the other hand, you are correct that money has generally been decreasing in value against other goods (not to mention services).

But let's ignore for the moment my sweeping and not entirely on-the-mark generalisation. I can buy a 180 gigabyte disk today for one-fifth of what I paid for a 180 megabyte disk back in 1990. (And that's without correcting for the official inflation rate.)

That's a 5000-fold deflation in cost per unit. Is this a bad thing? For whom, and why?

That is not quite a relevant comparision. Computers are a very new appliance, and are therefore changing at a rapid rate, plus the manufacture of many of the parts is automated, or, due to the fact that it is so new, outsourced to cheaper countries savings can be made on labour costs.

Much more useful comparisons could be made in terms of items with a longer history. Motor cars, basic food items, housing, etc.

PS My first computer used a cassette tape for storage, the thought of buying a hard disk was sheer pie in the sky stuff.

The problem with deflation, as the article states, is what happens with debt. In times of high inflation, people can go crazy with debt, as they know that in a few years, with inflation, the cost of the debt goes down. With deflation, the opposite happens. The cost of the debt goes up.

 

[PixyMisa]

That is not quite a relevant comparision. Computers are a very new appliance, and are therefore changing at a rapid rate, plus the manufacture of many of the parts is automated, or, due to the fact that it is so new, outsourced to cheaper countries savings can be made on labour costs.

Electronic computers have been around for fifty years, and this rate of deflation has been pretty normal over that time. More recently, similar deflation has spread throughout the entire electronics industry.

Much more useful comparisons could be made in terms of items with a longer history. Motor cars, basic food items, housing, etc.

Cars have certainly gotten cheaper in real terms, but not in dollar terms. Housing costs are largely ruled by land prices. Food has certainly got cheaper in real terms (though not recently), but again, not in dollar terms.

PS My first computer used a cassette tape for storage, the thought of buying a hard disk was sheer pie in the sky stuff.

Augh! Don't remind me!

The problem with deflation, as the article states, is what happens with debt. In times of high inflation, people can go crazy with debt, as they know that in a few years, with inflation, the cost of the debt goes down. With deflation, the opposite happens. The cost of the debt goes up.

The article raises two problems. Debt is one. If you have high inflation, you also have high interest rates, so people borrowing money end up paying it back in real terms. This is trickier with deflation - I can't see an easy way of enforcing negative interest rates. You'd need to periodically retire currency and issue new, revalued currency. Which would cause periodic spending panics. Badness.

But the problem with consumer spending is one that the computer industry has been dealing with - successfully - for decades. If something is of value now people will buy it even if it would be cheaper to wait.

I'm not sure that deflation really matters if (a) it's not a runaway process (and it's hard to see how it could run away) and (b) it's accompanied by a reduction in costs in real terms.

The only other generator of deflation I can see is if things were over-valued to begin with - as with real-estate pricing cycles. Buy at the height of the boom and watch your equity sink.