[Economist John Makin is] politically conservative, and is based at a right-wing think tank. But his warning about the looming danger of deflation reads just like something I or Jan Hatzius (Goldman’s chief economist — never mind the Blankfein stuff, the econ group is very good, and very pessimistic) might have written. Except Makin is even more gloomy, warning that we might enter deflation this year. [my emphasis]So what is John Makin saying? (Note: This links to the American Enterprise Institute, which is part of Krugman's astonished point.)
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.And that's just the first paragraph. Feel free to read the rest — it won't hurt you at all.
But for us, let's pause and get clear about "deflation," what it is and what it does:
- Naturally, "deflation" is the opposite of "inflation" — thus it's a period of falling prices.
- Prices express the relationship between "things" and "money". It's like they're on opposite ends of a child's teeter-totter. When things go up in value, money goes down, and vice versa. One of the two is always gaining in value.
In inflationary times, things gain value and money loses value (i.e., the dollar buys less). In deflationary times, money gains value and things lose value (i.e., the dollar buys more).
Keep that last in mind. If you own things in inflationary times, you're in great shape. Things (your house, for example) are gaining in value. To do well in deflationary times, you need to own money, not things. - Periods of deflation alternate with periods of inflation all the time, just as bear markets alternate with bull markets. And just as bull markets tend to be long and slow (while bears are fast and brutal), inflationary times tend to be long, often multi-generational arcs, with deflationary times the opposite.
- This means — few Americans now living were adults during our last big deflation. That would be the Great Depression of the 30s. As a result, most of us don't know enough to fear it.
- There's a long list of reasons people hate deflationary times. Here are just a few:
- Most people are loaded up with things, not cash, going into a deflation. Bad news. Only cash is king; things are cash's footstool.
Debt is especially dangerous. You borrow a dollar worth two loaves of bread, and repay a dollar worth four loaves. If prices fall 50%, your debt load doubles, just by sitting there.
You can imagine what happens to business investment in an environment where debt is dangerous. HINT: It tanks, and jobs along with it.
Dealing with the pain (or dealing with not-dealing with the pain) becomes government's chief job during a deflation. People who are loaded up with things, they need lots of help. That turns out to be most of us.
People who are rolling in cash, on the other hand, need . . . nothing; not one thing. They're fat and happy — just waiting for prices to crater so they can buy stuff up with all that super-valuable cash.
How much government spending do you think those people want? Yep . . . none. The math — and the incentives — are pretty simple. Which perhaps explains all the "no new deficit" screaming you hear, who is screaming it — and why.
Yours in less things, and a lot less screaming,
Gaius
