It seems fitting that the stock markets are tanking again and the Dow Jones Industrial Average can’t remain above 10,000 for long these days.
England has been booted from the World Cup, this is sad, and I’m allowing myself to believe that a worldwide wave of mourning is suppressing investor exuberance.
Perhaps the unending vomiting of oil in the Gulf of Mexico, slumping consumer demand in the U.S., the continuing fiscal deathwatch for a number of Euro-messes, and the stalemated G20 summit in Toronto have something to do with it too.
And perhaps the very real possibility of deflation is spooking investors again – and deflation is something farmers don’t want to see. Remember, if you’re a farmer, inflation tends to be good for you, because often you’re the cause of it. When the prices of things like wheat, canola, pork and beef go up in price, food products tend to get more expensive, and the consumer sees inflation biting away at his income. The farmer often sees the prices he gets increase by far more than the rate of inflation, so it’s a relatively good situation.
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Deflation drags everything down, especially asset prices. Agricultural commodities are a form of hard asset. If the price of everything went down together, that’d be OK. The farmer would get less for his grains and livestock, but would pay less for everything he has to buy, whether that’s tractors or land or pesticides or big screen TVs. But the worm wriggling around in this deflationary apple is interest payments on debt. Those don’t go down with deflation. Debts remain at their nominal amount, and interest payments remain at their negotiated rate, but revenues to cover debts decline, creating a financial squeeze.
Anyone who often reads the blather of this blog knows that I think deflation is at least as likely to be the course of the future as inflation, but I try not to go on about it too much so that I don’t annoy folks too severely. Most economic forecasters are convinced inflationists, and I’m just a semi-convinced-deflationist scribbler, so what do I know?. But I’m bringing up the matter again today because – after months in which deflation talk has been virtually banned from the markets as recovery-talk has run amok and all the usual suspects push their expectations for inflation – deflation is being seriously considered again.
The recent interest in deflation from the markets has been partially due to growing concerns from many in the bond market about the possibility of a double-dip recession occurring, with us just having survived the first dip last year and the second one beginning soon. But the really loud public chatter began with Paul Krugman’s New York Times column yesterday in which he said he feared government spending cutbacks around the world will cause a deflationary depression to arise. He’s warned about deflation before, but his new anxiety arises from his dismay that Barack Obama’s attempt to spend the economy out of the present economic slump will be neutralized by the Europe-wide attempt to avoid a financial meltdown by slashing spending. With the world economy almost completely interlocked today, these efforts will cancel each other out, he fears.
Krugman is about the best source for getting the view of liberal economists that have some influence with the Obama administration. Krugman often criticizes Obama administration economic decisions, but does it from a rather friendly perspective, and along lines that the left-centre of the Democratic party probably shares. He’s also brilliant, and has a Nobel prize on his resume, which is more than most of us can say for ourselves. So if you want to know what the reasonable slightly-lefties are thinking, check out Krugman’s columns in the New York Times. (He is a real liberal, not in the American sense of being a socialist, but in being a believer in regulated free markets. Although righties like to hate him – a lot – he has argued against ideas like rent control and has argued in favour of trading with countries that have low wages and poor labour standard because, in his view, it’s better for them to work in a sweatshop than have no job at all. So he’s no socialist, but on the left side of the American ledger.)
He believes fully in the Keynesian notion of big government spending when the private sector is lagging. That approach, which has seemed to work for the past 70 years in his eyes, papers over cracks in the economic wallpaper until the private sector revives and can plaster-in the cracks. He despairs at efforts like those in the U.K. and Greece to slash spending in the midst of a demand slump. He thinks this has a good chance at causing the double-dip to occur and to push a temporary recession into something like the depression of the 1870s.
There are many arguments in favour of spending-control being made by economists on the other side of the ledger. But I think the most compelling ones come from beleaguered government finance ministers and prime ministers in places like Greece, Ireland and the U.K.: if we don’t stanch the flow of red ink now, the bondholders are going to push us into bankruptcy, and then we won’t be spending ANY money. And that will cause a true deflationary collapse.
Krugman argues that a worldwide spending program could avert the dangers of a deflationary depression. Finance ministers and prime ministers don’t have the luxury of being able to think big like Krugman. They have to oversee their nations’ finances and keep their individual ships afloat. It’s no wonder the Keynesianism of the Obamaites broke on the rocks of the fiscal disciplinarians at the G20: they live in different realities.
Personally, I’ve seen the economic slump since 2007 as the likely Waterloo for both those that most people call the “neo-conservatives,” who believed that unregulated markets would tend towards rationality and continual growth, and for the pseudo-Keynesians, who thought they could always trick the economy with government money and bureaucratic machinations. The former was the first shoe to fall in the crisis, and it fell hard on the craponomics that Ronald Reagan brought to the mainstream. But I’ve been waiting for the other shoe to fall – on the pseudo-Keynesians. I call them pseudo-Keynesians because they don’t truly follow the master’s teachings, but ignore his basic balance: in bad times, the government spends big and reignites demand; in good times, the government reins in spending and piles up a surplus to stop demand getting out of control and so there’s something to pay for spending in a future slump. Most leftie econotypes that I’ve known over the years have always found ways to igore the second bit of that balance. (“It’s all just numbers on a page,” a friend told me a few times in the 1990s about deficit problems, “and we can just change the numbers on the page!”)
So it doesn’t seem to me that there’s a major ideological divide between the Obamaites and the finance folks in Europe (other than the Germans, who believe in pure, Teutonic fiscal rectitude). It’s just that the Europeans spent all their money and piled up debt in the good days, and now that this crisis is crawling into a third year with no end in sight, they don’t have the ability to keep juicing the machinery. The Americans, owning the greenback printing presses that produce the world’s reserve currency, can keep extending-and-pretending with deficit spending for a time. But if the economic malaise lasts too long, even the Yanks will find it hard to keep up the “stimulus” spending.
So deflation may not come with the bang of misguided ideology, as it did in the 1930s as nations embraced trade protectionism as a supposedly sensible policy, but with a series of whimpers, as bondholders around the world begin cranking up their yield demands as they lose faith in the ability of governments to pay their debts.
Then, if that happens, it’ll be up to people like Krugman to figure out a way out of the deflationary trap without the easy answer of massive government spending.
