From today’s WSJ – the writer below can get published by the WSJ. He is a professor at Yale. He must have advanced degrees. He has a book with a pretty title, probably published by a major university press. He makes logic mistakes SO obvious that even I [who have only written and published fiction and RPG material and whose last formal degree was in law in 1972] can catch. So either the establishment is really stupid, they really think we are stupid or both.
See how he brushes off deflation in the 20’s because while prices went down the stock market went up. The deflation therefore [he asserts] had nothing to do with the Depression [and more massive deflation] that followed. Gee that’s nice. The 20’s saw an ongoing Depression in agriculture and the rural areas that served them. In the 1920’s this was still an appreciable part of the population and economy.
And then the ASB’s came in 1929 and everything changed? Maybe. However let us look carefully. No one agrees as to what caused the Great Depression. Some people blame especially stupid monetary policies – worries about inflation leading to constricting the money supply, weaknesses in the banking systems that destroyed peoples’ savings, Britain going on gold at too high a price, the Wall Street crash cutting off loans to Germany which then stopped reparations which then led the Allies to refuse to repay the war loans to the US which…Let us stipulate that there were enough monetary mistakes to go around. Then again, if one believes in Original Sin, we live in Fallen Times, and humans will make errors. Only God is perfect. So presume our current crop of political and financial leaders can make errors. Errors from greed, from pride, from politics, from intellectual hubris,…whatever. Data is never perfect and never points clearly in any one direction.
Some people blame transient factors – the Mississippi Flood, the collapse of the Florida Land Bubble, the collapse of a stock market bubble in 1929 and again in 1932. Natural disasters happen. Financial markets have bubbles. Those things are now under control and will never happen again?…ROFL.
So let us look at deflation. Deflation has certain predictable problems. It postpones consumption and investment. It has winners as well as losers so many voters and others with power will not react well to breaking it – see Japan currently. The last time the world got into a deflationary trap [1930’s] it took WW2 to get us out. It is yet to be proven that we have an alternate economic model. Essentially the world economy has experienced major difficulties since the post-war recovery ended in the early 70’s.
Now any fool can see that there is worldwide overcapacity in manufacturing and agriculture. Services aren’t there yet but are catching up rapidly. The Washington Consensus economic model presumes that EVERY nation can follow the tracks of the East Asian Tigers. Can everyone get rich by exporting to the US? Only if fiat dollars are accepted as wealth and the US can solve our internal distributional problems so everyone can keep consuming. Fairly quickly this can be seen for the shell game it is.
I am NOT claiming that the model I gave in DNOS is the ‘right’ answer. I created a model that gets me to the space opera I wanted. It is absurdly unlikely. The high probability scenario is that the human race never gets beyond the Moon [I don’t count a Chinese or other one-shots to Mars] but reaches a level of tech we would currently call magic. The next highest probability is that we do manage to pretty much kill ourselves off. However DNOS in its mythos at least plays with the correct variables. Increased personal consumption worked after WW2 for very specific reasons. The entire First World had had a decade or more of delayed gratification – there was pent up demand for EVERYTHING. The First World other than Anglo North America had massive war damage to capital stock and personal possessions. These also created needs and wants. What we now call the 3rd world had a wartime forced savings program – US and UK bought from South America, India, Egypt, etc. and paid with dollars and sterling that could only be spent after the war. US also provided the financing for Europe and Japan to rebuild.
None of this is true any longer. Most people in the First World no longer have material needs on a 30’s, 40’s, 50’s level. Most of the 2nd, 3rd, 4th worlds lack the social infrastructure for a Marshal Plan to work. Even if it would work, we lack the mechanism to recycle the wealth generation. The WTO is ideological bullshit that ignores how societies and economies really work. What is needed is a way for the First World to make an investment that will both help the rest of the planet’s population [not every nation but in the main, as a whole] and have enough of a visible possibility of future payoff so it is an investment, not charity. Failing that, we can live with mild inflation better than mild deflation. Mild inflation is an economic lubricant. Mild deflation is arthritis. Pain hurts.
The Technology Deflator
By ROBERT J. SHILLER
After a glorious history as the driving force of economic progress, new technology is showing it can have revenge effects as well. Our biggest economic problems of today may ultimately be traced in large part to a cascade of consequences from recent advances of information technology like the World Wide Web, which became available to the public in 1994. Ultimately, technology bears responsibility for the emerging risk of a bout with deflation in a number of countries, including the U.S.
* * *
The sequence of events is clear: Technology and the Internet drove the spectacular stock market boom between 1995 and 2000, because investors overreacted to it, believing in a "new era." The boom extended to most advanced countries of the world -- the Internet was excitement without borders. It was this accelerated technology and its attendant ability to infiltrate all corners of the globe that brought our current woes. Alan Greenspan and the president did not bring us these problems, and they cannot be expected to provide perfect solutions either.
A stock market boom has its own internal dynamics, and ultimate collapse, a collapse that brings business confidence down with it. The overcapacity generated by the 1995 to 2000 boom, and the disruption of business plans caused by the subsequent crash, have by now reduced capital goods orders and shipments, slowing the economy. With the higher productivity brought on by the new technology, firms, desperate to restore profit margins, are taking the opportunity to economize on workers. As a further repercussion, workers, growing fearful of the job situation, are not consuming as much as they otherwise would. The ultimate result: Our uneven response to new technology has brought on a long weak period for employment and the economy.
An economic decline, if it persists, tends to have as a consequence lower inflation rates. At this time, lower inflation rates mean deflation, since there is not much further down for inflation to go without falling below zero.
Because of greater vigilance against inflation since 1979, when Paul Volcker took over as Fed chairman, there has been a long-term downtrend in the inflation rate. Inflation measured by the CPI was 13.3% in 1979, and has been on the decline, more or less, ever since: In the last 12 months inflation was only 2.2%. With the trend toward lower inflation, there is less latitude for short- or medium-run fluctuations in inflation without bringing on deflation. We are not used to hearing about deflation, outside Japan, but we had better get used to it, so long as trend inflation stays low: There will be episodes of deflation.
A period of deflation is not the end of the world. The longest deflation since the Bureau of Labor Statistics started keeping records in 1913 was in fact in the "Roaring Twenties." In the 41 months from November 1925 to April 1929, a period over which the stock market doubled, U.S. consumer prices fell 1.8% a year. This rate of consumer price deflation exceeds the rate of deflation in Japan since 1998, which has been only 0.7% a year. But the deflation of the 1920s did not damage confidence or derail the economy.
The risk of deflation now differs from the 1920s, because it comes with a weak economy in which confidence, though recently buoyed by the end of the war, remains vulnerable. It is most unlikely that any future deflation will be as long or severe as it was in the Depression, from November 1929 to March 1933, with prices falling at a rate of 9.1% a year. On the other hand, people in advanced countries today, sensitized to the parallels with the long-term sluggishness and deflation since 1998 in Japan, might see even a mild deflation as a blow to their confidence as severe as the stock market drop since 2000 was.
The Fed, it has often been noted, does not have much latitude for conventional expansionary monetary policy. It cut the federal funds rate from 6.5% in January 2001 to 1.25% today, a total decline of 5.25%, and that did not cure the economy. Since interest rates cannot go below zero, the latitude for further cuts is markedly reduced. Bringing the federal funds rate down below 1% itself will have a negative psychological impact, raising further public comparisons with Japan.
The Fed can conduct heterodox monetary policy, expanding the money supply by buying such things as long-term bonds. And ultimately, such a policy will stop the deflation. But there is a question whether the Fed or any other central bank can smoothly execute such a policy. There is no science about how to conduct such a policy to control the inflation rate accurately, given potential lagged feedbacks and hard-to-gauge expectation effects.
There is a risk that Mr. Greenspan will make the same mistake that Masaru Hayami, the governor of the Bank of Japan until March, made: going too slow. Mr. Greenspan understands where Mr. Hayami went wrong, but in the difficult environment, he might make the same mistake for fear of expanding too fast and causing a bout with higher-than-desirable inflation. Given the lack of knowledge about heterodox monetary policy, there is a variety of possibilities, including a deflation of short duration, a deflation of several years, or a sudden increase in inflation.
The Fed ought to start experimenting with such heterodox policies now. Given the vulnerability of economic confidence, it is probably wiser to risk erring on the aggressive side, pushing policies toward inflation. But even if the Fed does this as well as can be expected, a problem of deflation might be transformed into a problem of stagflation for a while -- not a nice option either. The economic problems, rooted in the human response to the nascent information technology of our age, will not be so easily vanquished.
We merely have to consider that such economic dislocations are the price of progress. We will get over this rough period, and, so long as our economic policies protect us from the greatest risks of such a transition, new prosperity is still to be expected from our new technology in the longer run.
Mr. Shiller, a professor of economics at Yale, is the author of "The New Financial Order: Risk in the 21st Century," (Princeton, 2003).
Updated June 12, 2003
posted by scott 7:41 AM