Deflation Risk II

So yesterday we established that deflation means different things to different people. As such that makes it wonderful problem for politicians and journalists to fixate on – lots of words, lots of column inches, yet little actual output. In the meantime the public are distracted from those same politicians actually addressing the cause of the economic malaise they (incorrectly in my view) define as being deflation.

This morning its Alan Kohler’s turn:

Europe is clearly at the greatest risk of falling into a Japan-style quagmire of long-term deflation and depression, caused by a combination of fiscal austerity and zombie banks.

Sounds awful.

But we know what happened the last time deflation actually occurred:

In theory, deflation causes demand to shrink and the value of debt to rise, although in practice during the 19th century prices halved and output increased seven-fold.

To be clear – deflation does cause hardship for borrowers. But it is hardly alone in that category. The single largest cause of distress to borrowers is poor decision making and entrepreneurial error.

So what are politicians and policy makers worried about? Something called ‘collapsing demand’. What that means is consumers don’t why to buy the stock of goods and services at the prices that entrepreneurs thought they could get on the market. Prices have to fall for markets to clear. Falling prices can be defined as deflation – but the cause is very different. The real question here is why we observe coordinated entrepreneurial error? After all those errors should be random and uncorrelated.

The answer to my mind is excessive government intervention in the economy – either through spending or regulation. As government imposes one-size-fit-all ‘solutions’ on private decision makers so the decisions they get to make become correlated. So rather than blame ‘zombie banks’ we should be blaming zombie government spending and zombie government programs.

This entry was posted in Economics and economy. Bookmark the permalink.

63 Responses to Deflation Risk II

  1. dismissive

    But the difficulty remains. Prices can fall but most cost inputs cannot in the interventionist market we have . Since minimum wages, awards and penalties are inviolable, price deflation means business failure and unemployment.

  2. Sinclair Davidson

    Yes – there is an economic dislocation. The solution to the problem is very different to that being proposed by individuals worried about “collapsing demand”.

  3. Re your last two paragraphs, Sinclair, do you not see the utter disconnection between the second last and the last? Prices are sticky even under deflation, because suppliers don’t want to slash their profit margins or lose them altogether. This has very little to do with government.

    This is the flipside of freshwater economists’ similar problem with sticky wages. Wages are sticky because employees don’t want to accept such an overt attack on their living standards. Yet the right keeps on claiming that all ills will be cured if only the workers lowered their wages so that the market can clear.

    Blaming the market for entrepreneurial error is a cop out. Either the markets are going to clear because they are efficient, or they are filled with entrepreneurial error requiring government intervention. Which is it, Sinclair?

    As with every economic dilemma, the right’s only answer is to attack government intervention. And when things are all going well… the right attacks government intervention. It’s as if the right doesn’t care about empirical data, or the scientific method in general. Sargent and Fama have a lot to answer for.

  4. Aristogeiton

    m0nty
    #1160979, posted on January 21, 2014 at 12:46 pm

    TLDR; I hate entrepreneurs.

  5. RODNEY

    Deflation does penalise borrowers but interest rates usually compensate for this. In the Forsyth Saga one of the cousins was thought extreme because he held out for 3% on his money. Everyone else was happy with 2%. Hyperinflation would be a different matter, but has that ever occurred?
    Ever increasing Govt charges can be relied on to stop deflation.

  6. I am an entrepreneur, Aristo. You idiot.

  7. JC

    Self hatred. I can see that monster.

  8. Aristogeiton

    JC
    #1160990, posted on January 21, 2014 at 12:54 pm
    Self hatred. I can see that monster.

    Perhaps the one subject upon which monty and I agree…

  9. Aristogeiton

    Do you suffer from ‘entrepreneurial error requiring government intervention’, monty? Or just leftist error requiring vicious rebuke?

  10. Sinclair Davidson

    m0nty – markets are clearing. prices of unwanted goods are falling and entrepreneurs who have made errors 9(or whatever reason) are going out of business.

  11. I’m not suffering at all, Aristo. Apart from suffering fools like you and JC.

  12. Sinclair Davidson

    Gentle people – do not allow the thread to be derailed. If m0nty has sensible question answer them. I will deal with trolling.

  13. m0nty – markets are clearing. prices of unwanted goods are falling and entrepreneurs who have made errors 9(or whatever reason) are going out of business.

    And what if all this market clearing under deflation results in a recession? Is that part of your plan?

  14. .

    Please explain how low prices cause economic depressions before posing what ifs, monty.

  15. Andrew

    Re your last two paragraphs, Sinclair, do you not see the utter disconnection between the second last and the last? Prices are sticky even under deflation

    Sinclair, in which category is the claim that even deflation sees price resist falling? That sounds to me akin to the claim that even in losing the other night the Poms made more runs.

  16. Sinclair Davidson

    m0nty – I have no plan. That is part of the problem – this obsession with planning.

  17. Token

    This is the flipside of freshwater economists’ similar problem with sticky wages. Wages are sticky because employees don’t want to accept such an overt attack on their living standards. Yet the right keeps on claiming that all ills will be cured if only the workers lowered their wages so that the market can clear.

    The generous IR increase and Award “Equalisation” that the Labor Party pushed through over the past 6 years has lead to inflation in wages that is not sustainable.

    People can choose less hours, less hours per week or no employment.

    Blaming the market for entrepreneurial error is a cop out.

    Code for setting up / keeping a business in Australia when it could be based / moved offshore.

  18. Sinclair Davidson

    Andrew – don’t understand your comment.

  19. Token

    That is part of the problem – this obsession with planning.

    The left love plans, especially if people get themselves leveraged. They know where they can place the roadblocks to stop commerce and hussle for their cut.

  20. Dot, you’re just trolling now. You know perfectly well why deflation can depress demand. Sinclair even mentions it in the OP.

  21. Token

    Please explain how low prices cause economic depressions before posing what ifs, monty.

    I can’t wait to see how ever lowering IT & technology costs across many industries have caused a depression.

  22. Sinclair Davidson

    No m0nty – I placed the words ‘collapsing demand’ in scare quotes.

  23. .

    monty – you are an amatuer and I am professional. Don’t piss in my pocket.

    Tell us why demand would collapse. The empirical results were an increase in output and an increase in real wages.

    People like you really need to get your definitions clear about real versus nominal prices and also stop conflating cause and effect, like Sinclair said in part 1.

  24. m0nty – I have no plan. That is part of the problem – this obsession with planning.

    Planning to avoid recessions is the single most important economic task of government. Just ask the people. Your strategy (non-strategy?) would allow deflation to happen, and thus (probably) a Japanese-style depression to happen. This is anathema to the voting public.

    The deflation in the 19th century you mention was caused by the Second Industrial Revolution. Unless someone actually invents half of The Science Of Star Trek tomorrow, we’re not going to enjoy such advancements to make deflation palatable.

  25. gabrianga

    Go easy as I am still a virgin.

    What “fiscal austerity ” is Kohler referring to?

    The EU Governments front end loading of “renewable schemes” with grants and tax breaks?

    The blatant attempt to put the major supplier of energy ,coal, out of business?

    Perhaps the EU has seen the light (perhaps a bit late) but seemingly in the right direction

  26. No m0nty – I placed the words ‘collapsing demand’ in scare quotes.

    You stated the theory in unfavourable terms, but you still stated it.

  27. Sinclair Davidson

    Just ask the people. Your strategy (non-strategy?) would allow deflation to happen, and thus (probably) a Japanese-style depression to happen.

    Quite the contrary – the Japanese government spent a lot of time planning and a lot of money on stimulus packages over the past 20-odd years.

  28. .

    Your strategy (non-strategy?) would allow deflation to happen, and thus (probably) a Japanese-style depression to happen. This is anathema to the voting public.

    You are not theorising, monty. You are speculating.

    You also equate rising real wages, falling unemployment and an increasing population and GDP per capita with misery and depression because of the mere presence of deflation.

    Not only are you speculating – you are being superstitious.

  29. dismissive

    The lack of Federalism is another huge issue. Having spent much of last year travelling in North America, you see some huge differentials in states/provinces in the way they operate from BC where the state runs the liquor stores to Arizona where it seemed that everyone was doing there own thing.

    Every time we make National standards for awards, unions, taxes, corporations, laws, etc , we take away flexibility in the market. Federalism is a set of economic handcuffs.

  30. Percy

    What “fiscal austerity ” is Kohler referring to?

    The left have a problem understanding the term ‘austerity’. Quite often, a slightly smaller (usually still massive) deficit is labelled austerity. Usually followed by attacks on the economic right based on confusion. “Why haven’t these austerity measures worked?” I believe one of our trolls ran something similar a few days ago re the US.

    Planning to avoid recessions is the single most important economic task of government

    Ah, No.

  31. gabrianga

    All is well at Davos.

    Goldie Hawn to hold “stress classes” for those who are a bit frazzled

  32. JohnA

    Monty you misquoted:

    “Blaming the market for entrepreneurial error is a cop out. Either the markets are going to clear because they are efficient, or they are filled with entrepreneurial error requiring government intervention. Which is it, Sinclair?”

    Sinc said government intervention was the cause of entrepreneurial error, not the reverse.

    Governments distort markets by their interventions (anything beyond enforcing law and order equally upon all participants is my definition of intervention), and such distortions lead to participants receiving the wrong signals and therefore making erroneous decisions.

    If you seek further intervention to deal with errors, you are proposing an iatrogenic solution which will only worsen the problem, the end result being either fascism or socialism/communism.

  33. banz

    “Planning to avoid recessions is the single most important economic task of government. Just ask the people. Your strategy (non-strategy?) would allow deflation to happen, and thus (probably) a Japanese-style depression to happen. This is anathema to the voting public.”

    Sinclair is correct Monty, the Jap Government have been planning to exit this for 30+ years, now they are having a QE party as the last resort.

    Its not the task of government to avoid recessions, christ you can smell the very fear coming of your words, R.E.C.E.S.S.I.O.N. the horror of it all.

    Sinclair is polite, but I dont need to be, you are a fuckwit, you are gonna set things right, you have a voice and must be heard.

    I have heard you speak Monty, you are a rambling fuckwit thats needs minutes to say what should only take 20 seconds or less.

    We will get deflation in everything we own and inflation in everything we use and need, and dont bother coming back with rising property values, fueled by low interest rates, or waived stamps or first home buyers grants, in the end they will collapse as will most asset classes.

    Go tweet something, your followers await xx

  34. Squirrel

    So if Deutsche Bank has it right, peak oil is not quite upon us – good, that’s one less thing to worry about. Beyond that, I’m sure the masters of the universe will go on pushing on string for as long as it suits, and if the pretext is not the risk of deflation (howsoever defined and/or measured), there will always be a reason – think of this in contemporary economic terms:

    http://www.cartoons.ac.uk/record-image/standard/LSE2071

  35. The Pugilist

    To my mind Kohler is getting horribly confused. Merely because one particular price falls enough to affect a particular price index does not constitute ‘deflation’.

    A shift from defining deflation as a fall in the money supply (relative to demand for it) to defining it as the fall in a price index engenders massive confusion amongst modern day commentators like Kohler. The former causes prices to fall due to a chain reaction set in motion by deflationary monetary disequilibrium (excess demand for money). The latter is not particularly meaningful outside of a particular market. It is a syncronised fall in a large array of prices that is worrying…

    Errant logic such as this is the reason we get Kohler telling us a positive supply shock is bad for us and it is also the reason he cannot convincingly reconcile the fact that 19th century prices fell but output increased 7-fold and has to resort to a spurious application of Fisher’s debt deflation theory…

  36. The Pugilist

    Quite the contrary – the Japanese government spent a lot of time planning and a lot of money on stimulus packages over the past 20-odd years.

    On the other hand, they allowed their banking system to collapse their money supply for way too long…they should have written off bad debts and recapitalised the banking sector much earlier…

  37. PICarl

    Could it be that the cause of the low rate of inflation is that technology has made us so much more productive? For example, the price of cars in terms of weeks pay to buy one has fallen because cars are made by robots in huge factories. We might now be at the point where even socialists are having trouble squandering the world’s production.

  38. Ant

    Speaking of zombies, did you know that Hollywood has made more zombie films than westerns?

    I read that somewhere.

  39. banz

    “On the other hand, they allowed their banking system to collapse their money supply for way too long…they should have written off bad debts and recapitalised the banking sector much earlier…”

    Well, wasnt that a plan as well Pugilist…I understand what you are saying, this also indicates how ineffectual the Jap Government(S) have been.

  40. Andrew of Randwick

    Be careful with the fallacy of averages.
    For example, the CPI basket of goods is unchanging, and thus misses substitution effects. No one bought bananas at $12/kg post the QLD cyclones – they substituted.
    .
    Similarly just because the price of LCD TV’s drops 30% it is not the end of the world. Nor if the new phones go out the door with a 50% gross margin instead of 100%. Nor if people just don’t buy them or other “stuff”. The manufacturers will adapt as they always do.
    .
    I guess when food, fuel and rent begins to drop things may be tough and demand truly subdued. But given our supermarket duopoly the first won’t happen – the ultimate in sticky prices. Big oil is pretty good at protect its margins. And, Landlords (especially in Sydney) have nothing to worry about.
    House prices? I don’t think so because of the supply problem.
    So where is this threatening price deflation?

  41. Ant

    I Am Legend is my favourite. Although it’s only one of two I’ve ever watched. I think.

    Sorry, if that’s a bit of derailment.

  42. The Pugilist

    I guess when food, fuel and rent begins to drop things may be tough and demand truly subdued.

    This is a key point – when multiple prices fall fairly simultaneously, it is a symptom of a problem – that is deflationary monetary disequilibrium. One price falling enough to affect a price index (particularly because of an increase in supply) is not a problem, in and of itself…

  43. Pedro

    “A shift from defining deflation as a fall in the money supply (relative to demand for it) to defining it as the fall in a price index engenders massive confusion amongst modern day commentators like Kohler. The former causes prices to fall due to a chain reaction set in motion by deflationary monetary disequilibrium (excess demand for money). The latter is not particularly meaningful outside of a particular market. It is a syncronised fall in a large array of prices that is worrying.”

    Yes, and that type of fall is under the control of central banks.

  44. The Pugilist

    Yes, and that type of fall is under the control of central banks.

    I might nit pick and say the banking sector as a whole, but I suppose in theory, a central bank has unlimited ammunition to offset such a decline. Whether or not the central bank has the knowledge and werewithal to act is another matter.

  45. Sinc said government intervention was the cause of entrepreneurial error, not the reverse.

    If entrepreneurs are so thrown off their game by a bit of government regulation, how the hell do you expect them to handle all the complexity and chaos of doing business in the real world?

  46. JC

    If entrepreneurs are so thrown off their game by a bit of government regulation, how the hell do you expect them to handle all the complexity and chaos of doing business in the real world?

    Easy as falling off a log.

    Frank Dodd regulations.

    Tell us smart arse, how eggsactly you would navigate and act which carries an additional 300 plus new regs?

    Also
    It takes a decade to set up a mine these days just to get through the regulatory hurdles.

    You really are an idiot, desi. In fact you’re far better off at SL’s site talking about the woe mans.

  47. The Pugilist

    If entrepreneurs are so thrown off their game by a bit of government regulation, how the hell do you expect them to handle all the complexity and chaos of doing business in the real world?

    Often government regulation creates, adds to or multiplies real world complexity…

  48. JC

    Often government regulation creates, adds to or multiplies real world complexity…

    Naaaa Desi reckons it’s as easy as anything.

  49. The Pugilist

    Naaaa Desi reckons it’s as easy as anything.

    With all due respect to Desi, he or she is a farken idiot…

  50. Token

    What “fiscal austerity ” is Kohler referring to?

    Its like a family who have a habit of gorging on 10 plates each night at buffets having to cut back to 7.

  51. .

    Desipis confuses acting as a market maker/player such as offering incentives to potential employees or dropping or raising prices to deal with competition or high demand – with re-engineering a whole business so it isn’t illegal and won’t be shut down.

    A “rookie error” if there ever was one.

  52. .

    Token #1161181, posted on January 21, 2014 at 3:11 pm
    What “fiscal austerity ” is Kohler referring to?

    Its like a family who have a habit of gorging on 10 plates each night at buffets having to cut back to 7.

    Whilst in his current circumstances, having the requisite werewithal to purchase only 4 per night.

  53. The Pugilist

    A “rookie error” if there ever was one.

    You’re way too kind dot…

  54. Often government regulation creates, adds to or multiplies real world complexity…

    Which would be relevant if Sinc’s argument was that sometimes “coordinated entrepreneurial error” might be caused by the government and sometimes they might be caused by non-government factors. However, Sinc’s argument was essentially that they are always caused by government hence requiring there to be no complexity or choas that the market handles poorly. He completely overlooks the ‘inbred’ nature of corporate leadership and the homogeneous corporate culture that could easily result in a large parts of an industry making the same wrong mistakes, resulting in “coordinated entrepreneurial error”.

  55. .

    However, Sinc’s argument was essentially that they are always caused by government hence requiring there to be no complexity or choas that the market handles poorly.

    No, you speculated that he assumed that. I’ve already explained to you that he did not.

    He completely overlooks the ‘inbred’ nature of corporate leadership

    You’re an envious bigot.

  56. gabrianga

    Could be Ant that there are more zombies than cowboys now running Hollywood.?

    Watching the usual mish mash of “useful idiots” presenting and receiving from their comrades in the Screen Actors Guild highlighted this.

  57. A H

    I agree, Sinclair. Lack of demand is a lie. If prices fall sufficiently then the market will clear. Deflation is a natural, healthy, problem resolving process. Intervention is unhealthy unnatural and problem creating.

    When deflation occurs as a natural process, ‘losers’ should not complain. They made the wrong decisions and misread the market.

    Of course, when you get government intervention, this distorts the market for everyone and makes malinvestment seem logical. But that’s no justification for maintaining the distortion. The intervention will come to an end at some point, the sooner the better as sooner means less readjustment from the end of the distortion.

  58. JC

    He completely overlooks the ‘inbred’ nature of corporate leadership and the homogeneous corporate culture that could easily result in a large parts of an industry making the same wrong mistakes, resulting in “coordinated entrepreneurial error”.

    Really Desi, you think industry is like the Liars Party. Interesting.

  59. JC

    I agree, Sinclair. Lack of demand is a lie. If prices fall sufficiently then the market will clear. Deflation is a natural, healthy, problem resolving process. Intervention is unhealthy unnatural and problem creating.

    For that to work, the world would have to run on far less debt and a great deal more equity. Banks would require equity levels possibly as high as 50% against leverage. That’s when deflation doesn’t necessarily turn out to be a disaster. I’m not against that sort of world, but we need to understand what we really want.

    There are demand shocks.

  60. A H

    JC, yes we do want that sort of world. Banks do need more equity. Central banking is interference. We are a long, long way away from that ideal world now.

    Demand shocks happen, the free market is best equipped to adjust.

  61. The Pugilist

    JC, yes we do want that sort of world. Banks do need more equity. Central banking is interference

    I agree, A H, but JC is right. There needs to be a discussion of what that sort of world would look like…
    Oh and we need to get rid of (or drastically scale back) deposit insurance ..

  62. A H

    That would be an interesting discussion… let me know when you are going to have it :)

Comments are closed.