Messages to my mother Ia

I had a couple of followups to my message to my mom about deflation, since it seems to be on a lot of people’s mind. I sent these on to her also, so I’ll include them as an addendum to the previous post.

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http://www.kansascity.com/2010/07/26/2109337/optimistic-consumers-can-save.html

Has some numbers. Same upshot as me – only by boosting consumer confidence. This can really only be done by getting the people with jobs to spend money now. Which means they need to have jobs and feel comfortable that they will have one in the future.

Also, here is a great Forbes article about deflation that just came out:

http://blogs.forbes.com/investor/2010/07/27/deflation-dissected/

He backs me up about the deflationary aspects of reducing government spending. The worst thing the government could do during deflation is to stop spending.

Lacy Hunt, in another article, talked about what we might do. He said we need a technological breakthrough. We broke the Deflation after the Civil War by a tremendous number of such (railroads, McCormick reapers, etc., telegraph). New technology might work if it can create jobs.

But normal companies just do not create enough jobs in deflationary periods.

Oh and he mentions something I am also coming around to. Just as the Republicans and Conservative Democrats are pushing cutting spending, which would be suicide during deflationary times, liberal Democrats want to allow the Bush tax cuts to go away. During normal times, I would be for this. Just as I would be for more responsible spending. You worry about debt during good times. Which is what we did in the 90s. The best economic times of the last 30 years. We actually had no deficit spending and reduced our government’s debt.

But during a deflation, any sort of tax raise of almost any kind will make things worse (see what I mean about solving deflation. Too much debt may be a problem but raising taxes or reducing spending will actually have no positive effect in deflationary times and would most likely be harmful.) So keeping the Bush tax cuts around for a while longer would be fine, as long as we do not also try to reduce spending.

The only thing worthwhile the government can do during deflation is to spend money creating jobs, not to simply stimulate the economy indirectly (as the guy said in the first article – the multiplier effect of a normal economy does not hold during deflation). They need to do anything to boost consumer confidence in order to break the deflationary cycle. Having a job is task number 1.

The party that solely focusses on jobs programs will be on the right track. But it will require some real education of the population. And it may require about faces of politicians (such as spending for NASA, etc.) which is never very likely.

I am not really very hopeful that we will actually do the right thing until after it is too late to prevent.These changes may not happen at all until our policies provoke real deflation. That is, America is much better dealing with emergencies after they have happened. There is still too much political capital on both sides to ignore the deflation warnings and keep pushing their current views, views from either party that will only make things worse.

That is why Krugman, and others, pushed so much last year for the stimulus program to not only be bigger but to really only focus on jobs, not lowering taxes. He may turn out to be very prescient but no one in politics really listened to him. The Dems used the money for Keynesian type stimulus and the Republicans got their tax cuts, and the final package was too small to stop what might be coming.

I’ve been hoping so much for the last year that Krugman was wrong, that he was a doomsayer and it would be okay. I have become more and more convinced that the political policies of both parties will drive us directly into the arms of deflation.

The key is doing anything and everything to create jobs directly, not relying on the invisible hand to do it. That will only happen when we return to economically normal times.

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I also found a couple of recent articles – all from this week – that discuss deflation, stimulus and/or unemployment. Seems that it is on everyone’s minds.

Paul Krugman Permanently High Unemployment

Brad deLong David Altig Says That Our Cyclical Unemployment Has Started to Turn Structural

Mark Thoma The Cost of Convenient Optimism

NYT In Study, 2 Economists Say Intervention Helped Avert a 2nd Depression (without the stimulus, we would already be in a deflationary spiral)

Messages to my mother I

My mother is a disruptive innovator, like me. She has a wide range of connections across many communities, is not afraid of new things – she has had a Mac for over 20 years, makes her opinion known – thus the disruptive, and loves letting other people know about new information she gets.

So she sends me links to interesting stuff she reads all the time. Oh and we tend to vote for different political parties, so our world views are different but, as any creative person knows, you learn the most from people who see the world differently.

Anyway, I end up writing these long emails back to her. They often have a reasonable amount of research in them. So I thought I’d kill a couple of birds with one stone and repurpose them for my blog, removing all the personal stuff like endearments. I’ll do some editing and mash together several emails if there is a thread.

Here we go.

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She sent me this article from the Houston Chronicle. I replied:

He is talking about deflation.

A subject very dear to my heart (so sorry of I get a little didactic) and one that I’ve written about this many times over the last decade: https://amanwithaphd.wordpress.com/2008/11/21/scary-graph/

https://amanwithaphd.wordpress.com/2003/06/24/wed-25-jun-2003-033038-gmt/ (from Robert Reich)

https://amanwithaphd.wordpress.com/2002/08/21/thu-22-aug-2002-004006-gmt/ (from 2002)

Deflation sounds great (prices dropping) but is horrible. People do not have jobs so there is reduced spending. There is little economic action because no one is spending. Since money is worth more in the future than now, no one (either consumers or companies) spends anything.

My take home – the government needs to spend money not for Keynsian reasons (nothing they do, whether it is stimulus or lowering taxes will work while some things can be detrimental) but to keep people employed. They are the employer of last resort. If the jobless level comes down, people will be ready to spend money. They will have more money to spend. Only if they feel confident to spend money will we be able to live through the deflationary cycle. So, do whatever is necessary to directly create jobs, to keep people employed, even if they have to create new public works programs to do it.

And continue doing that until we get out of the deflationary spiral (at which point, we should no longer need the support of the government to create jobs).

The columnist is being a little misleading, making it sound like Keynsian economics – which states that the government can stimulate the economy by lowering interest rates (monetary policy) or by stimulus (fiscal policy) – does not work at all and that we have been lied to for decades. Not true. What the economist talks about is a very specific type of economy – deflation (and realize that during deflation, supply side economics will not work either. It is the demand side that is the problem).

If we are entering a deflationary period, we are in trouble because NOTHING we know to do will change the economy except time, which is what the economist said in other articles. Not cutting taxes. Not cutting the deficit. No sending stimulus checks to people. No one really knows what to do except wait for people to start buying again. What needs to happen during deflation is that the debt needs to be reduced but it can not be because the economy is not producing enough revenue. (By the way, the same thing happens with companies. They lower the price of goods in order to raise revenues to pay off debt. But revenues do not increase so they lower things more. And so on. Why it is called deflation.)

During deflationary periods, neither monetary nor fiscal policies will be effective. In fact, nothing the government nor corporations can do will be effective at changing things unless they change people’s perceptions. The only known solution is time, time for people to start spending again.

Deflation is the thing I fear most because we have no known way to deal with it. Cutting taxes will not fix it and raising government spending will not fix it. There is no policy that either party can do at the government level to solve the problem.

And there is little corporations can do to fix it either. We know this because Japan has been dealing with deflation for almost 20 years. They have tried everything, both tax cutting and government spending. Nada.

During a deflationary period, debt, which can be great during inflation, is now bad. Anyone holding any debt at all can be in trouble. The problem is that to pay down debt requites greater revenues, which are not forthcoming, for the government or for companies.

It is not that Keynesian economics does not or has not worked in the past. It has done wonderfully during normal, inflationary, or depression eras. It will not help much during deflationary times. During deflation, money gets more valuable as time goes on (opposite of inflation). So, no one with money spends any of it because it will be worth more later. Anyone holding debt (bonds at first but eventually stocks) will be in trouble. That is one reason why Getty made out like a bandit. During the deflation of the early 30s, he had cash when no one else did.

Apple is in great shape because of their huge amount of cash. Everyone else is toast. If deflation hits, time to stuff the mattresses. Even gold will not be useful.

Deflation is the worst possible thing. And no one wants to really face it. Everyone hopes it will not materialize.Both political parties are sticking their fingers in their ears and shouting “LA.LA.LA!” So the Democrats pray that Keynsian economics will work and the Republicans still pray that reducing taxes/debt will work. They both may be whistling in the dark here. Neither policy will have any effect.

Krugman has been worried about this for quite some time. Interesting to see other economists feel similarly. The only thing that has ever gotten an economy out of deflation is time.

Why? Because it really gets down to human emotions. People really do not care as much about inflation or deflation as long as they have jobs. Deflation only gets broken when people feel comfortable enough to spend money again. And that only happens when they have jobs with an income that supports them. Get them jobs and we

So remember that while government spending can not alter the deflationary spiral, it can provide a buffer for people living in those times. This is, for me, a key reason for government spending. Not for some Keynsian or ivory tower reason. It will keep people employed while we wait this out. The government is the employer of last resort. Lowering taxes in a deflationary period will not accomplish this. Because the money returned will not be spent. It will be socked away because in deflation, money is worth more next year than today. It will not create jobs.

Many major programs of the New Deal were not really implemented simply because of the macroeconomic effects. They were to provide jobs directly. I may not like the war in Afghanistan but it is keeping a lot of people employed.  I’d prefer the government spend the money on developing green energy than war – technological breakthroughs that create new industries provide new jobs – but the thing is to keep people employed. For example, in a normal economy, it would be worth letting the private sector deal with a space program but now the NASA needs to make sure all those jobs are still around.

We can deal with deflation if people are working, just as we dealt with inflation. Without jobs, there is no good news for either political party.