[quote=briansd1]I’m with Arraya. His post is very reasonable.
The only thing that I would add is that deflation does not flush out debts. Short of bankruptcy, the way to eliminate debt is to pay it back. Inflation makes debt repayment much easier.
CA renter, Greece which is experiencing internal deflation has cut public employee wages about 15%. Pensions have also been cut. But asset prices denominated in a strong Euro have held more steady.
The truth is that deflation makes debts harder to pay, not easier. As far as repudiation of debt goes, it’s not possible to do so without giving up the collateral (houses).
Inflation is obviously the easier way to go. War-torn countries of Europe all inflated away to get from under their war-time debts.
In fact, even noble and royal families of Europe had their wealth wiped out because of inflation. Inflation spreads the pain more evenly because inflation requires that you continue to work, be productive, and earn cash. (Deflation protects those who already have wealth).
Also remember that an asset price collapse would affect pension funds which rely on their investment portfolios to pay out benefits. As you’ve said before, pension benefits were promised based on return on investment much more so than contribution. Defined benefits will have be reduced or canceled if there are no funds to pay them.[/quote]
We’re talking around each other’s points because we aren’t defining our terms in the same way.
Deflation can be caused by many things, one of those things being debt repudiation. When I advocate for deflation, I’m advocating for debtors to repudiate their debts — debts become “easier” to pay off because the debtors will pay nothing. Yes, that means that people will be foreclosed on, and it means that houses will become much more affordable to local workers (remember that I would also restrict ownership of land to U.S. citizens). Stocks would become more affordable to those who earn wages, as would all manner of other assets and commodities, because the value of the currency (how wages earners are paid) typically increases in a deflationary environment. It is this increase in purchasing power at the bottom of the economic pyramid* that will end up creating a floor in the market. People are buying all they way down, so it’s not like EVERYONE sits back and waits for prices to bottom. People are picking bottoms all the way down, and at some point, prices become so tempting, that a critical mass of people/investors (who no longer need to be “rich”) enter the market and support prices when they reach fundamental levels.
It also means that banks would fail, pension funds would fail, money markets would collapse, etc., and asset prices would drop rather dramatically. Jobs would be lost, wages would go down, but they are likely to go down at a slower pace than asset prices. That being said, I would contend that, while the pain is more extreme in the short term, the end of the “crisis” would come much, much sooner, and a healthier, more stable foundation would result, from which a sustainable economy could grow.
Regarding sticky wages:
THE Wall Street Journal’s Sudeep Reddy has captured a lot of attention today with an interesting story on falling wages, the impact of a deep labour market slump. He writes:
But the decline in their fortunes points to a signature outcome of the long downturn in the labor market. Even at times of high unemployment in the past, wages have been very slow to fall; economists describe them as “sticky.” To an extent rarely seen in recessions since the Great Depression, wages for a swath of the labor force this time have taken a sharp and swift fall.
The only other downturn since the Depression to see similarly large wage cuts was the 1981-82 recession. But the latest downturn is already eclipsing that one. Unemployment has stood above 9% for 20 straight months—longer than the early 1980s stretch—and is likely to remain above that level for most of 2011, putting downward pressure on wages.
My contention is that wages are less sticky this time for two reasons: global wage arbitrage (you know how I feel about that) and the DURATION of the recession/depression — which I would argue has been ongoing since 2001, but was masked by the totally unsustainable credit bubble. The duration of the recession/depression has been drawn out because of all the bailouts and interventions. We will end up falling to the same point as if we had let things fall in the first place, but it will happen over a longer period of time. This increased duration is what makes deflation particularly dangerous. If prices drop quickly, people will still be optimistic that things will get better soon, and they will continue to invest all the way down. If the recession drags on for years and years, even the most optimistic bulls begin to pull back, and you will see the economy literally stop when the last of the optimists is taken out, IMHO.
I’ve said it for years — it’s not the depth of the downturn that will cause the most pain; it’s the duration that will kill us.
Not only have they succeeded in dragging this recession/depression out for far more years than necessary, they’ve also managed to put more distance between those who caused it, and the consequences of their actions. Instead of the pain going mostly to those who caused the crisis, it will now be spread even to those who have tried to be responsible. The duration of the downturn is our greatest enemy.
*More about the economic pyramid and the circulation of money in another post…
