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Deflation, Depression, Disaster

Published 12/18/08 Craig Harrington - Print Article
E-mail - editor@economyincisis.org

The model for every government is to have a stable currency that can sustain growth and encourage production. As the Treasury and Federal Reserve began pouring hundreds of billions of dollars into the financial market over the last few months, there have been many who worried these actions would result in inflation – prices rise as the purchasing power of each dollar falls.

This however has not taken place. Despite the Fed’s creation of hundreds of billions of dollars out of thin air and the Treasury’s massive foreign borrowing campaign, the prices of everything from gas and groceries to electronics and clothing has gone down. Most of us are struggling through economic hardship of our own, and the recent drop in prices has been a welcome relief; but these price corrections could have a more sinister undertone. When prices fall across the board the phenomenon is called “deflation.” If this occurs over the course of a few months we typically herald it as a relief. If it occurs over an elongated time period, it spells doom to an economy.

When prices drop across the board companies are forced to lay off workers, lay offs lead to decreases in disposable income which in turn lead to decreased consumption. In order to bring in customers companies must drop prices further, thus setting off another cycle. If this spirals out of control we could see massive joblessness, falling personal income, and prices so low companies cannot afford to produce or sell goods.

When Fed chairman Ben Bernanke was an economics professor at Princeton University he considered deflation to be one of the greatest threats to an economy and a key driver of the Great Depression. In 2002, while serving as a board governor to the Federal Reserve, Bernanke stated publicly that he would prefer driving rampant inflation then suffering the consequences of a deflated economy. The point is obviously to find a stable medium; neither maxim is preferable, but in his eyes one is certainly worse than the other.

We have some proof that prices are already dropping. Aside from what can be gathered by merely observing one’s own checkout receipts, we have seen the consumer price index (CPI) fall by a record 1.7 percent in November alone. The deflation of retail prices has been at a 10 percent annual rate for nearly three months. Retailers, and most service companies for that matter, typically drop prices in time for the holiday season but what we are witnessing is truly historic.

Another measure of the CPI – the so-called “core CPI” which does not measure volatile food and energy prices – declined by 0.1 percent in November as well. This marked the first decline in that measure since the recession year of 1982. David Wyss, a chief economist with Standard & Poors, believes that the chances of general deflation are unlikely right now. However, if the recession continues deep into 2010 (as many expect it to) we could face a very real risk.

We may also be witnessing the tip of a very real iceberg, one that could sink our economic ship for good. We may think that lower nominal prices are good, but if everyone is out of work it will no longer matter how much anything costs. If that is the case, then the second Depression will have officially taken hold, and we will all be left in its wake.

Source CNN Money:

Lower prices are probably at the bottom of the list of most Americans' current economic worries. But for a growing number of economists, it's their biggest fear.

A widespread drop in prices is known as deflation. And typically, it's not just the price of consumer goods that fall. Home prices, stock prices and even people's salaries often head lower as well.

The biggest problem with deflation is that when businesses need to continually cut prices to spur sales, they eventually respond by cutting production. That results in growing job losses, and could, in the worst case scenario, even cause a depression.

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Article Comments From Readers

guest says "organized crime" on 01/01/09
The federal reserve is unconstitutional. It is not even ran by the government. They make money out of thin air which creates more debt. The government seems to think they can do as they please without asking the people. They bailout banks and auto makers while the middle class suffer. It's the same old thing the rich get richer and common folks who make the world go 'round lose

biguru says "Unemployment" on 01/01/09
It all starts with our trade policy which outsourced our manufacturing and then services which created high Unemployment (do not believe the officially cooked numbers) that begat the mortgage crisis that begat depresion and deflation and more lay offs.

The solution is to stop imports dead in track for the next 12 months. This will cause companies to hire again because the basic necessities has to be manufactured locally and the economic engine will start again. Then you will have time to fine tune the system but not put water in the gas tank again.

Nothing else will work.

guest says "Why is the US gov't allowing this?" on 01/01/09
This site is excellent, however it would be helpful to analyze the root cause of why the government would allow this to happen. My belief is it goes back to the original rise of inflation when LBJ attempted the "guns and butter" of the great society in conjunction with the Vietnam war and the subsequent end of the gold standard when France called us on printing money and wanted their gold. The American people rather than being angry at France who was being honest should have been angry at the US government. Only the discipline of Volcker and 20% interest rates restored a healthy economy.

Fast forward to the Reagan/Bush/Clinton/Bush years when we launched a military build up which ultimately bankrupted the Soviet Union, led to military hegemony where we outpsend the rest of the world combined and fight wars regularly. How could the US engage in massive arms race, cut taxes, run huge deficits and yet their is no price to pay for our "gund and butter"? No inflation shws up in CPI?

My belief is that the Maestro stumbled perhaps inadvertently on the silver bullet that allows (temporarily) the USA to have guns and butter simultaneously. One can do it as long as you are willing to allow unfettered access to the US markets by overseas countries willing to absorb the excess avalanche of paper we are printing in exchange for real goods without the corresponding rise in prices a closed system woud have under the same dynamics. They are willing to do so in order to create the wealth generating industries that generate the USA's living standard. Voila......guns, butter, low inflation are all now possible!

The problem with this is that at some juncture the imbalances rise too high and there will be a self limiting effect. Either currency collapse or if we are lucky the government will finally begin to behave responsibly instead of waiting for the rest of the world to force a slow down in our debt fueled consumption.

My belief is that the "globalization" we have experienced is made possible by short term political expediency. Why give the US citizens the hard truth that there is no real choice between massive military spending and higher taxes or lower services. Consumption and production need to be in balance whether it is consumer or F-16's. Until the USA comes to grip with this choice I don't believe there is a resolution to the problem until it is forced on us y the rest of the world.

Based on the political climate where it is blasphemy to speak of higher taxes even to pay for a war(financed by China, Russia, Japan and the OPEC countries ironically) and unheard of to ask Americans to sacrifice for a war. Where it is blasphemy to question whether we can afford the massive arms outlays and be "weak" on defense (offense would be more accurate). Without addressing these fundamental issues I don't believe there is a solution until it is forced by currency collapse and the resulting lowered living standards.

Based on listening to the debates where neither Obama or McCain were in favor of aggregate tax increases or decreased military spending I think collapse is likely conclusion.

Imagine the ire of even the most dogmatic defenders of free trade, tax cuts and foreign wars if they received the bill in real time for our adventures? Immediate cessation of the wars, military build ups and impeachment of Bush would have bene the result!

IMHO

guest says "deflation" on 12/18/08
this article is genius... we need more people to talk about how perilous our position really is

guest says "We created this Depression" on 12/18/08
Only a foreign trade surplus will increase our gold reserves and restore the purchasing value of our currency. Without correcting our balance of trade, the big dollars paid to import the things that we consume rather than work to manufactuere will not stop the declining buying power of the Dollar. The more money that we print, the less buying power each dollar will have. We need to re-industrialize and manufacture the things that we consume, rather than send our dollars overseas to pay people in foreign countries to manufacture the things that we consume.

If we do not look at the long term economic protection of the purchasing power of our currency, all of this big spending with printed money to reduce nemployment will probably cause inflation sufficient to result in a $100.00 price for a loaf of bread. This could also reduce this nation to third world living standard.

It is not the foreigners fault that this condition exists. We created this condition ourselves. We have destroyed most of our industries that were located in the US because they created pollution. Why should we make the things that we consume as long we can get people in other countries to work to make these things for our consumption? We can pay them with freshly printed paper currencies that they can redeem by exchanging them for title to our real estate and our remaining businesses (instead of Gold). Our Stupid Legislators, Ignorant Government Employees, Bad Corporate Managers, Greedy Unions, Wall Street Master Criminals, NAFTA, EPA, and OSHA, just to name a few, have created this situation.

guest says "Stop Importing" on 12/18/08
Stop importing stuff, specially consumer goods so that, the same stuff can be made in America that can provide jobs at the fastest rate. The Chinese will get mad, but will understand that this is an emergency and we have to do this only for the next few years.