For a while now, I have been worrying about the prospects of inflation. Well...not really the prospects, because I know it is a problem, even the government admits that we have inflation. Rather, I have worried that inflation is rapidly destroying the value of the money I have saved in the bank. Recently though, I have started hearing news about deflation, which I thought was utter nonsense. How could deflation be happening now? Gas prices were high; food prices were high; movie ticket prices were high; car repairs were expensive. If we had deflation, I thought, I would be getting richer every day. My money would be worth more as prices went down.
But then I started hearing people say deflation was a bad thing. They said that falling prices made people defer their spending and that made businesses suffer. They said that people in debt suffered with deflation because it would be harder to pay back debts. They said it was a "wolf" that was at the door ready to eat us all alive.
Then I started seeing gas prices go down; food prices started stabilizing so to speak; housing prices were still going down, and I wondered how it was possible? How could all this money that the Federal Reserve was printing actually allow any prices to fall? Then I started to worry again. What if deflation really is a problem? What if it does stifle business growth? I think I have come to a conclusion: deflation is just what we need right now.
Let me explain. In 2001, a recession caused the Federal Reserve to lower interest rates and 'pump more liquidity into the system'. This means they printed more money and expanded the money supply so that people could keep on spending money as if nothing had happened. Well, they printed so much money for so long that people began spending money like they never had before. Loans were easy to get. Cars were easy to buy. Housing prices went through the roof. People refinanced their houses and took the apparent appreciation in value of their homes and spent it on that trip to the Bahamas. In fact, we even were able to fight two wars at seemingly no cost and people were still having a great time. Life was good. Democracy was spreading. Capitalism was making us all so rich. What could have gone wrong?
Some of the first indications were people starting to default on their mortgages. You see, they had borrowed all this money and spent it on cars, houses, vacations, hot dogs, iPods, computers, flat-panel T.V.'s, and the irresistible yummies that they saw on those flat-panel T.V.'s. Suddenly, they had nothing to show for it. The cars were breaking down. The houses needed to be painted, recarpeted, and refurnished. The vacations were mostly just pictures on facebook. The hot dogs had long served their purpose. The iPods were out of warranty, and the flat-panel T.V.'s were too small to see the whole football field. They had spent all their money on things that brought absolutely no return. Worse, it had all depreciated in value and they were still making payments on the stuff. This could be called malinvestment.
It gets worse. You would think that businesses would have been smarter. They would have spent their profits on retooling, upgrading, and training. But they didn't. Rather, they payed for employee vacations and golf tournaments etc. They malinvested even worse than the consumer. Why? Because money was cheap, and they would pay it back with the profit they got when they sold their houses and businesses into a stock market that was always in the green.
Well, let's get to the point. In few words, prices got high. They got really high, and now no one could pay back all the money they owed. So people and businesses started going bankrupt. One by one they went down and all the talking heads said, "It can't get any worse" or "This is just a little dip". Now we face widespread bankruptcy.
So what do they say we have to do to solve it? Here's what we hear from all the big shots: 'Well, we need more liquidity. People don't have enough money to spend. We can't let large companies fail. Get people spending money again like they were and all will be better.' But how can the cure be exactly what caused the disease in the first place?
Here's what we need: deflation. We need a correction to what prices are supposed to be at. We need to return to sustainable prices of years ago (perhaps more). How long will it take? No longer than we let it. I remember in 2001, gas prices were even lower than they are now. Maybe we are getting there. Is anybody truly worried about the price of gas? Not really. Its a good thing insofar as we don't have to spend so much on gas and can start paying back all our debt. In fact, the more prices go down, the better off we will be in the long-run, because we will have disposable income to pay back our debts.
Some ask what will happen to the businesses though who suffer from deflation and lower profits. They may go bankrupt. Well, this is exactly what we need! I am serious! If they participated in the malinvestment during the boom, they have to accept the responsibility of the hard times that come with the bust. What remains will be stronger businesses who are better able to suit demand and smarter at investing.
What is the alternative? Well, we could do what we are doing right now. We could bail out all of America to itself. We could just get a new credit card with an unlimited line of credit and just put it all on that and start over.
We need to start over alright, but by getting out of debt, not by going into more. A wise man said, "As long as we live above our means, we are destined to live beneath our means." Are we ready for this? The politicians are scared to death. They think they are responsible, and they are, at least in part, but they are trying to cover their tracks by passing the buck to coming generations. Can we sacrifice now for our children? Can we accept personal responsibility for our foolishness and not shift that to another person who might not even be born yet? I admit, I am not sure I want to. Can't we just keep on going like we have--pushing the debt to our children, just as our parents pushed in onto us? After all, we are doing them a favor and making the world safe for democracy right? Isn't that an investment? Won't America and the world be so prosperous some day that we can pay back all our debts and live in peace and harmony?
I know I sound cynical and mocking here, but these are actually legitimate questions that reflect the views of a lot of people, even mainstream politicians and economists. How do we respond to them?
**I should note that strictly speaking, inflation is not a rise in prices just as deflation is not a fall in prices. Inflation is an increase in the money supply/goods and services in the economy ratio. That is, the total money increases relative to the goods and services available. The effect of this is an increase in prices but inflation itself is not defined as that. Deflation is the opposite.