Sunday, July 4, 2010

Some Deflating Thoughts

Those who oppose government intervention to prop up demand and prices
may have to come to grips with the question of deflation, and soon. Proponents of letting deflation do its work see it more as a controlled burn to help the economy while opponents think of it more as a raging wildfire.

Austerity as Insurance?, Frum’s Question and Debt Deflation « Rortybomb
What is the “free-market” answer here? In his reply to Frum’s column Roosevelt Institute’s Marshall Auerback gives the haunting answer:
Let’s be clear: The “free market solution”, to use Frum’s terminology, is basically deflation. If households attempt to net save by spending less than they are earning, and businesses attempt to net save (reinvesting less than their retained earnings), then nominal incomes and real output will be likely to fall. Money incomes and economic activity will tend to contract until private savings preferences are reduced (with essential goods and services taking up a larger share of household income as incomes fall), or until depreciation leaves businesses and households inclined to invest once again in durable assets. In the absence of any countervailing fiscal stimulus, common sense suggests that a drop in private income flows while private debt loads are high is an invitation to debt defaults and widespread insolvencies — that is, unless creditors are generously willing to renegotiate existing debt contracts en masse.

Now, I suspect that some of Frum’s fellow conservatives actually think this sort “cleansing” is good. They believe it on both moral and economic grounds. Maybe not all, but a number of the more extreme libertarians with whom I occasionally debate, actually embrace this argument. Fair enough. It’s not something I would advocate, but it has the virtue of being ideologically consistent with many of the tenets of a free market/libertarian orientation….

...I also place it with a lot of the new intellectual and activist energy on the Right forming around things like the Mises Institute, Murray Rothbard, and Ron Paul “End The Fed” (which is how I read the Tea Party movement). Ron Paul is so popular on campuses poor Josh Barro had to write a piece for the National Review explaining why “End The Fed” shouldn’t be a policy plank of a resurgent conservative movement. (He sadly doesn’t address one of the core of their problem with the Fed, the illegitimacy of a fractional reserve banking. Heh.)
Not everyone on the Right is this way. Scott Sumner says “The other 98 years I am a Chicago-trained, libertarian, inflation-hawk. Twice a century I put on my Irving Fisher super-hero suit, and emerge from my deep underground bunker.” If only he could assemble a Justice League for this Crisis. Because I’m afraid this debt-deflation mindset is where a lot of the country is, and it is exactly the cliff our country is driving towards.


Dad29 said...


So your author suggests...what?

That prices can or should be propped up? To what end?

It would be wonderful, of course, if individual EARNINGS were also propped up to match, but unlike the whippersnappers who write such drivel, I've been there.

Individual earnings do NOT keep pace with dollar-inflation. Didn't in the 1970's, nor in the 1980's. That is precisely why Greenspan (and the Feds) allowed the deterioration of credit standards for mortgages, both 1st and 2nds--to let "common man" catch up with the inflation of housing values.

Guess what? That results in defaults.

J. Strupp said...

....and entrenched deflation does not produce defaults?

"...but unlike the whippersnappers who write such drivel, I've been there."

Were you there in 1930 dadster? Irving Fisher was. And he's one of the reasons we whippersnappers believe what we do.

"That prices can or should be propped up? To what end?"

Yes, the author suggests that prices be propped up and that we inflate.

Tighter monetary policy in the future can curb inflation, should it rear it's ugly head (as Volcker acheived back in the days).

Deflating now will achieve the exact opposite of what deficit hawks are hoping to accomplish. Bottom line: You can't cut debt faster than the collapse in GDP that results from taking these measures. Not in this economic climate.

Unfortunately, I have a feeling we're going to test this theory sooner rather than later.