THE REASON THAT DEFLATION IS FEARED MORE THAN A ROGUE ASTEROID HITTING THE EARTH IS THAT FAMILIES, GOVERNMENTS AND CENTRAL BANKS HAVE TOO MUCH DEBT. THE ONLY WAY THIS DEBT CAN BE REPAID IS IF INCOMES AND PRICES CONTINUE TO INCREASE.
In my lifetime, the Fed has always been concerned about inflation. Back in the sixties, President Johnson’s spending in the Viet Nam war created concern about budget deficits due to spending for both “guns and butter.” The worry was that excess spending would lead to inflation. It did.
Richard Nixon, not to be deterred by the rigidities of being on a “gold standard” devalued the price of gold to allow him to keep spending and inflation continued to ravage the country. Nixon then decided to do what all dictators would like to do and just “freeze prices.”
After government edicts completely failed, then Gerald Ford tried a full-scale public relations effort. The slogan was “Whip Inflation Now.” The idea was that if we all plant a garden and save money, inflation would go away. I bet some of those buttons are worth a lot of money today. The result was another failure.
Jimmie Carter couldn’t solve the problem with PR either. But in the last months of his presidency in 1979, he brought in the big guy Paul Volcker. No PR effort here, nothing but pure cigar-smoking hardball. Volcker raised interest rates until they were high enough to choke off all of the oxygen to the business community and a huge recession ended all hope of further runaway inflation. That was in 1981-2, and America has never seen high inflation since.
So for the past 50 years, our Fed has been concerned about keeping the threat of high inflation in abeyance. But things have changed.
Now when our Fed talks about being concerned about inflation, it is totally the opposite condition. The Fed is very concerned that we avoid deflation. They do not want to let this happen at any cost. Deflation actually sounds good on the face of it. A general decline in prices would be a great relief to many retired people on fixed income.
In a broad deflationary environment, what’s the big problem? There are at least two.
First, when people believe prices will be lower in the future, they postpone buying things. Why buy a car today, when you know it will be cheaper in the future? As more and more people make this decision, then auto production (and everything else) declines, and workers get laid off because of a lack of customers. A massive recession is the result. This is a big deal, but not the biggest deal.
Here is why our Fed, the Bank of Japan, the European Central Bank and the People’s Bank of China cannot (and will not) tolerate deflation. If incomes and prices fall for a sustained period of time, here is what happens:
As you can see, sustained deflation results in mass bankruptcy for households, businesses, governments and central banks. This is why central banks around the world say they will do “whatever it takes” to prevent deflation. So don’t be surprised at the desperate measures that have already been taken to avoid this scenario. Even more desperate measures could be around the corner.