– James Saft is a Reuters columnist. The opinions expressed are his own –
With the U.S., Japan and Britain — nearly 40 percent of the global economy — facing the threat of deflation, it’s going to be just too easy for one, two or all three of them to get the policy response horribly wrong.
The global economy is so connected, and our experience with similar situations so limited that the scope for error is huge.
Think of it as having three pilots flying a jet plane, one each operating a wing and the third managing the tail.
Oh yeah, and they all work for different airlines.
Though there will be much talk of international coordination in the next year, and though the central banks and governments of the world will likely be rowing in the same direction, their ability to gauge the effects of monetary policy and government spending on their own economies will be pretty limited, and even more so on the whole.
Failure when fighting a global recession, a global balance sheet adjustment, a global banking recapitalization, debt deflation and very possibly actual deflation can take many forms.
“It’s very hard to calibrate and it’s awfully easy to overshoot or undershoot, both of which would be disastrous,” said Lena Komileva, London-based strategist at Tullett Prebon.
Under clubbing the response to falling prices means you could slip into a self-reinforcing deflation, making your debts, be they consumer, housing or government, heavier and setting up a cycle where businesses and consumers defer consumption and investment.
Over-reacting risks fomenting a new bout of inflation and potentially causing a new bubble. (Who knows what that would be — dirt, water, baseball cards?)
And remember too, when deflation was last an issue on this scale globally during the 1930s, the global economy was nowhere as near as integrated.
As for now, the signs are clear: deflation is a growing threat in much of the world’s economy, though still to be sure not the central forecast.
U.S. producer prices dropped by 2.8 percent in October, the largest decline on record. Core intermediate goods and core crude goods prices, which show inflation at earlier stages in the production cycle, fell by a big 1.7 and a staggering 17 percent, respectively.
Consumer prices, which are usually sticky on the way down, fell at a record rate in October, down one percent and even falling by 0.1 percent in the month when plunging food and energy prices are excluded. That will kill corporate profits and shows a business community racing with consumers to see who can capitulate fastest.
HERE, THERE AND EVERYWHERE
Inflation is falling rapidly in Britain too, with overall consumer price inflation down 0.2 percent in October, the first monthly fall since the annual January sales and the first in October since 2001, just after 9/11.
Japan meanwhile has slipped back into recession, domestic demand is weakening, wages are falling and deflation may develop some time next year, a scenario Barclays Capital rates as a 40 percent chance.
Even China, where inflation has tumbled to 4.0 percent in October from a 12-year peak of 8.7 percent in February, has moved its focus to averting deflation.
Be in no doubt, central banks have the tools to fight deflation; while interest rates can only be cut so much, officials can step up the quantitative easing now happening, they can commit to hold rates at zero for an extended period of time, they can drive down their own currency by purchasing foreign bonds or finally, simply print money and drop it from the famous helicopters.
The issue is not the tools, but the speed of the printing presses or size of the bond purchases needed to get the right result, especially when it is interacting with what will be huge tax cuts and deficit spending.
A mix of monetary and fiscal policy will work, but it’s got to be the right mix and it has to be reasonably well coordinated internationally.
None of this is without risk. Remember the last deflation scare in the U.S. in the early part of this decade, which in retrospect caused the monetary bubble which was nursemaid to the housing bubble.
Print money or borrow excessively and you could lose the confidence of the currency market and experience a run, which certainly will help to fight deflation but is no-one’s idea of good policy.
In theory the amount the state will need to borrow will be in part offset by the amount individuals save, or more to the point pay down in debt and decline to invest privately. That theory will be put to the test by the number of governments who are going to be selling a very large number of bonds, which will after all have to be paid back.
Next year is looking as if it will be as unconventional as it is scary.
– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –
Want to debate? Send you Great Debate submissions to Debate@thomsonreuters.com.
The economies in the western world are now in free fall with various governments in panic mode such as the British government which have unveiled their latest strategy to spend its way out of the recession, Its instructed the banks which have been nationalized to get lending back to 2007 levels. The US bail out is just another example that the governments have no option but to keep spending but this cannot continue the west is bankrupt and the future is grim, governments will fall the wealth will be removed from the rich and at present the powerful the outlook is for a break down in law and order.
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US dollar should be devalue to resolve the current recession and credit issue. It’s inevitable and sooner better. My two cents.
Did I pass?
In the last few months, we heard of transfer of wealth to the Mid East. If the wealth were invested in anything but dollars it dissapeared.?? There is never enough cash to liquidate the market correct? The idea that houses and real estate should automatically increase in value is not necessarly true. A house that is worth less that the mortgage against it in a current time does not mean the owner is going to liquidate it or just walk away. Every car that is sold is worth a bunch less when it goes off the lot. Just because some guy in town says the ranch is worth less does not mean the owners will sell it for that. I think the same is true for bankers in the true sense that loans were originated in the beginning. When loans were started to be made by brokers instead of bankers that all changed. But just because the broker made a loan on inflated property to a buyer that could not afford the loan why should the lender have to value it at zero? I think the market always goes up on dreams and lies and then I hear commentators crying because it is down and won’t go back up until someone lies and someone else dreams. I think that there is no money just hot checks and I am not sure when people are going to stop taking them. The world ecomony now is about like a house crap game at a local bar. The house has taken so many bad checks that they cannot afford to quit taking checks as long as they can get cash for their drinks. However an old man once told me “Son don’t give credit at that crap table, when you beat them and you know you will they won’t come back a play with you and then they won’t drink at your bar.” Some of these wisdoms need to be applied when we approach getting out of this mess.
Jesse
The money supply has been blamed as a factor in deflation as that money supply is reduced. However, other definitions of “deflation”, (wikipedia), refer to dual contributing factors: decrease in money supply, and decrease of credit. To what extent is decrease in availability of credit a contributing factor to deflation? If credit is considered beyond common types to
include leveraged amounts, as per derivatives and other instruments for leverage, (often leveraging
many times over by exotic investment vehicles), could this provide an answer as to why printing dollars has so far not stemmed deflation, and theoretically may not create inflation until the leveraged credit that is no longer available is offset by new dollars?
Mr Saft offers us a horrible - although thought provoking scenario…. But he himself offers NO SOLUTIONS…..
He must be a Republican. They are always great at scaring people to death, but they never offer any real solutions.
Respectfully,
EdgyInChina
Bradley said “monetize it”. A problem is that monetizing kills non-inflationary capital return, i.e. investors are loosing faster than non-investors :). That is not very capitalist decision, however it is most likely to happen. Than many people will completely lose their retirement accounts /which evolutionary is also correct thing/ and will be very unhappy.
Also, the CPI index is quite strange thing to use - whenever disposable income dissapears, haw can you find that by the CPI index? In our case - limited 3000 monthly income, but the expense for mortgage/rent, food and gasoline has jumped from 2000 to 3000. I don’t even count the healthcare costs, which are huge. So, from a consumer point, if no credit is available, the decrease for consumption when your unnavoidabable costs reach maximum of income is actually 100%. That means you don’t have any more money to buy things, and although the official CPI is deflationary, you available basket of goods is effectively limited to neccessities. For the consumer recently, inflation increased 10-20 %. Consumer consumption nominator in the CPI index consists only necesseties at present.
Exactly the same statistics were developed during the Great Depression, data is there, I have done models on this. Other people can do models too….
There is no room for equality in a wealth based society…
-Plato
All very intellingent comments. But all of these analyses has left out a simple, fundamental truth: the rich get richer, the poor get poorer. So long as humans roam the earth, there will be injustice among humans–its as simple as that. You can analyze this and that, but that simple fact will never change–only what you call it. What would you do if you made $10M a year? Would you give it all to charity? Build a school? Doubt it.
Central Banks or none at all:Fiat money or gold backed fixed exchange rate:Regulation or no regulation. The fact of the matter is capitalism moves through bust to boom economic cycles that no human institution has ever successfully avoided for very long. We all have our moment in the sun and so has modern capitalism. Perhaps it is time for human societies to evolve past capitalism and move on to something new. We are running out of time. Farm land is being lost to soil erosion:Fresh water supplies are dwindling:Fisheries are in collapse:The environment is becoming more toxic every day from the effects of industry and human habitation. At the same time our population continues to grow. I think the critics of Thomas Malthus should reconsider their position. Maybe then we can reconsider our positions on practices of material consumption, birth control, education, war and peace.
Since none of these money experts, Central Banks, can walk on water their best shot that everybody who is suffering can understand is to make sure their Govts. dont spend more money than they have. Lets get to the moral high ground on this and stop trying to pull a fast one on each others Govt..This is how WARS start and I don’t want my kids to get killed because of the financial cheating and greed. John
It’s a shame a global organisation such as the UN doesn’t exist in such a way as to oversee a unified effort during these (and other) troubled times. I can’t help feeling the focus on America is to a certain extent a distraction which prevents the rest of the players in the global economy to work their way through the troubles, with the emphasis on “work their way through”.
Sitting around waiting for solutions from the top seems to me to be a bit hopeful. Not that there’s anything wrong with being hopeful, but being busy and making real things which real people will buy will probably be the real solution. Giving money to corporations and/or people to pay off their debts foolishly and voluntarily entered into strikes me as being a bit stupid as it will reward and encourage the behaviour which made the mess we’re in.
Are we still working our way through the turmoil caused by World War One?
I agree that the fundamental problem is not one of confidence but is one of ability. Consumers always wish they had more to spend and would if they could. The simple matter of fact problem is that they cannot. I have yet to see recognition of this fact in the discussions that are currently focused on industry and finance.
I obviously can only speak for myself on this point, but all I am able to do for the foreseeable future until the cost of living goes down or incomes go up substantially, is pretty much simply work to meet my cost of living needs. It happened over the last year, but the amount of money I had to make some extra purchases vanished to the point now where I dont, wont and cant make any. This holiday season I’m making the majority of my gifts and count myself lucky to have the ability to do so.
It will be interesting to see if anything all of the money and attention focused so far on finance and industries actually comes down to effect the basic economy.
“Sustained inflation entered the American economy only with the creation of the Federal Reserve in 1913.”
endthefed.us
Protest TOMORROW (11/22/08) at cities across the U.S.
join the rally to end the federal reserve system at endthefed.us. They are trying to make us all afraid of this because it it bad for them and the fractional reserve monitary polciy. If we had sound money it would be good for us. Read this article to understand both sides.
http://www.virginiainstitute.org/viewpoi nt/deflation.html
“There is all the reason in the world to avoid a demand-side deflation. There is no reason at all, however, to oppose a supply-side deflation. No reason, at least, for ordinary citizens to oppose a supply-side deflation. It may be different for politicians and government officials. They are in a different situation with respect to deflation than are ordinary citizens. Inflation allows for increases in government budgets that would never be possible under deflation. Sustained inflation entered the American economy only with the creation of the Federal Reserve in 1913. Until then, the federal government claimed less than ten percent of the output of the American economy.”
The concentration of America’s wealth in the hands of the fewest people since 1929–and we all know what happened after that. Any economist, pundit, politician, or Treasury staffer who doesn’t realize that is the root of the problem needs to be fired so they can contemplate the problem, the one they cannot seem to grasp vicariously, first hand. The Great Depression was caused by the lack of demand not for lack of supply. And yet every single step the government has taken so far is aimed at supply–including the planned automaker bailout that will help the Big Three make more cars no one wants nor can afford to buy.
The wealth is firmly clenched in the hands of those few who are gripping tighter as their fear grows and our government is going deeper into debt giving them even more in bailouts. It started with Reagan. Trickle down Reaganomics never worked, working Americans became two-income households, worked longer and drove further, and borrowed more to maintain the standard of living and create the illusion of prosperity. Over two decades in the making (real wages have been in decline in the US since 1973) this problem is too big to solve quickly. In this last decade this imbalance was masked by an asset bubble in housing created by the most ignorant and foolish Federal Reserve Chairman in US history and presided over by the president with the worst approval record in history. The transfer of wealth accelerated during the last two presidential terms until it was no longer sustainable and crashed under its own weight. But the wealth is now concentrated and locked up and our system has no mechanism to more equitably distribute it. We are in for a prolonged period of suffering and no one seems to have the guts to do what FDR did to turn it around in the 1930s. And even then progress was slow–WW II is what really turned it around. And a major war in the modern nuclear age is unthinkable.
The deflation if reached would be more a black hole in the
universe(economy).
It can be caped not by simply cheering people up, but by creating a right kind of platform where right kind of oppurtunities to invest can prevail as far as both consumer & government are concerned.
i follow your analysis, mr. saft, and you helped me to save money but i dont know the real value of THIS money. Who killed the good sense of old savers and pushed for an economy of lendandspent will have bad sleep at nite
It is deflation in a different context than in past years. Nobody would argue that the overall cost of living is high. Prolonged exposure to high living costs has a cumulative effect. Deflation is occuring not from lack of optimism or desire to buy but rather a fundamental inability to pay. Yet despite this hazardous environment you will find municipalities raising taxes.
You will also see a lot of policy initiatives hoping to restore consumer confidence. It is a great way to waste money and for bureaucrats to sit around a table nibbling shrimp - discussing how to cheer people up. People want to spend. The savings rate is zero. People are spending well beyond their means. So policy-makers should wake up and stop waisting time. Kindly fire all the psycho-analysts on staff pretending to be economists.
Monetize it!
Yep, print enough cash and pay off everyone’s debt. I mean all of it. Let every currency every where print enough to pay off all debts worldwide of all its users. (I would say citizens but currency is no longer a national thing)
What are the implications of such a bold move?
Consumer demand would boom, not having any liabilities from all the stuff we have accumulated. The housing crisis would be over since everyone owns their home and all the bondholders were paid off at par, many of us would want another one, somewhere warm for winters. State and local governments would all have clean balance sheets and significant borrowing capacity and there would be lots of cash looking for a home.
No, I don’t see a bad side to this except prices would stop falling and depending how excessive we want to get from here, inflation could run rampant. If you were completely debt free, would you go buy a new car? boat? go on vacation? (I bet the big three would love it)
Call your Congressional delegation and demand they pass the “Monetize It” plan.
Whilst we are in un-charted territory due to click of a mouse trading, trying to stop recession is like trying to stop the tide coming in, it is part of the cycle of life, there will always be good and bad times. I feel the governments should be more hands off, wait till we bottom out, THEN re-finance the system. Interest rate drops only widened the margins for the Banks and reduced the spending power of those that have savings, thus withdrawing more money from the high street.