Deflation is the Name of the Game

You are worried about your job. There are rumours of layoffs; your in-laws’ pensions might be at risk because the company they worked for for years is teetering on the edge of bankruptcy. Meanwhile, as the malls empty, sale prices abound. Sitting there on the table in front of you is a pile of credit card bills, mostly priced at something over 18% interest …

Is it any wonder you’d be taking any spare cash, and any “stimulus cheques” (like the carbon tax offset in BC, or the ones sent out earlier this year in the US), and paying down that debt? That you’d be cutting back on your own spending (“it’ll be cheaper still in a bit”) and, after years of not worrying too much, socking upward of 15% monthly into your own personal rainy day fund?

Now, tell me: if Jack Layton’s beloved “ordinary Canadians” are smart enough to figure all this out, why can’t professional economists and politicians?

This morning I arose to find the Prime Minister’s musings on opening our wallets to spread cash around. As with most “professional” economic thinkers, the answer to deflation is deemed to be ever more liquidity and cash injected into the system, to get people to spend. Slightly more sensible — but note the word slightly — was the view of the economists working for those paragons of greed, the banks. The sensible part is building infrastructure for the future; the really silly part is using borrowed money to do it, rather than doing what Joe and Jane Canadian are doing: cutting out unnecessary expenditures, making choices between this and that, getting in the black and conserving cash.

Ah but, Monty Python style, the Sensible Party has morphed into the Silly Party overnight — with the Really Silly, Outrageously Silly and Perpetually Offended and Deeply Silly Parties sniping from the corners. I don’t know what the headline writers will do with Prime Minister the Rt. Hon. Tarquin Fintimlimbimlimbimwhimbimlin Bus Stop Ftang Ftang Olay Biscuit Barrel, but that’s where we’re headed. Probably call him Oil of Olay for having slid one by us all in the last election or something.

One would think that eighteen years of experience in Japan since 1990 might have provided a note of caution before Canadian policy makers had rushed to the “throw money at the problem and worry tomorrow about how to pay for it all” school of economics — the real Keynes would rise up in righteous anger at this misuse of his ideas if so many experts weren’t piled higher and deeper upon his grave — but after all, if you’re liberal in your thinking, history is bunk and means nothing. (Besides, didn’t Japan recently call on the rest of the world to copy their 0% interest rate and 180% of GDP debt ratio policy on the grounds that “it hasn’t worked for us, but maybe in 2008 it’ll work now for no good reason”? Don’t they call it insanity when you try the same thing again and again in an unchanged environment and expect the results to differ “this time”?) The words of others, however, loom large: “they’re doing it, so we should, too”.

Lemmings walking off a cliff into the sea couldn’t do a better job. Or are our political figures all locked in their high-school years, where peer pressure can outweigh almost any consideration of rational and moral behaviour?

What is far more likely to happen, should we walk off this cliff, is the sort of thing James Howard Kunstler has often written about in his blog, Clusterfuck Nation. People praise Franklin Delano Roosevelt for the New Deal: they forget that the Great Depression was intensified as he spent the US Treasury bare, didn’t get results, and was forced to trim back and increase the tax bite simply to stand still back in 1937. We have been suffering from an excess of money creation via credit and prices and M3 (money in circulation including credit) must reset for the economy to improve. We can try to forestall this, in which case the deflation drags on and on, the damage gets worse and worse, our public finances go back into the toilet and down the drain, Canadians become ever-more impoverished … or we can change the way we live to recognize that the era of excess finance we have lived through is gone forever.

Government, as we know it, to survive, will shrink — or we’ll just end up doing away with it. Money, as we know it, to survive, cannot be inflated to a fraction of its current value — or we’ll create some non-government money and go “off the books”. Communities will have to be more local and more self-reliant: big corporations, big unions, big governments and big continental scale anything is a function of cheap and abundant resources, and while there’s lots of resources left the cheap and easy to get ones are mostly used up. (Don’t be fooled by the recent collapse in oil prices — that was the blowing up of the bubble in commodities as yet another haven in the markets from the last destroyed bubble in real estate — look instead at the supply and demand situation.)

In a deflationary period — common in the nineteenth century, rare in the twentieth, and now present in the twenty-first — you keep real interest rates high enough to make savings and investment pay; you minimize unnecessary expenditures, you focus your resources, you encourage initiative and new sources of economic activity rather than prop up old ones and you make money into a stable store of value.

Unfortunately, for those who drew the lesson that you flood the system with ever more bail out money and “liquidity” when the problems are ones of insolvency, radical misallocation of resources and too much unproductive activity draining the real economy, ramping up the printing presses and dropping bales of cash by helicopter is just too tempting. Besides, for the power-lovers, who gets the handout, and on what terms, holds far more reward than does their own restraint.

In the words of W.B. Yeats, in his poem The Second Coming:

Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

Sauve qui peut!

“Worth the Fee to Read It” has been nominated as Best Political Blog in Canada for 2008. Please vote for it, by going to Canadian Blog Awards and selecting “Worth the Fee to Read It”. Thank you for your support!

2 responses to “Deflation is the Name of the Game

  1. You’re wrong on the New Deal.

    The New Deal brought real relief to most Americans. That said, F.D.R. did not, in fact, manage to engineer a full economic recovery during his first two terms. This failure is often cited as evidence against Keynesian economics, which says that increased public spending can get a stalled economy moving. But the definitive study of fiscal policy in the ’30s, by the M.I.T. economist E. Cary Brown, reached a very different conclusion: fiscal stimulus was unsuccessful “not because it does not work, but because it was not tried.”

    This may seem hard to believe. The New Deal famously placed millions of Americans on the public payroll via the Works Progress Administration and the Civilian Conservation Corps. To this day we drive on W.P.A.-built roads and send our children to W.P.A.-built schools. Didn’t all these public works amount to a major fiscal stimulus?

    Well, it wasn’t as major as you might think. The effects of federal public works spending were largely offset by other factors, notably a large tax increase, enacted by Herbert Hoover, whose full effects weren’t felt until his successor took office. Also, expansionary policy at the federal level was undercut by spending cuts and tax increases at the state and local level.

    And F.D.R. wasn’t just reluctant to pursue an all-out fiscal expansion — he was eager to return to conservative budget principles. That eagerness almost destroyed his legacy. After winning a smashing election victory in 1936, the Roosevelt administration cut spending and raised taxes, precipitating an economic relapse that drove the unemployment rate back into double digits and led to a major defeat in the 1938 midterm elections.

    What saved the economy, and the New Deal, was the enormous public works project known as World War II, which finally provided a fiscal stimulus adequate to the economy’s needs.

  2. Hi, ElectricMonk, and welcome.

    That World War II was the ultimate means by which the deflation of the 1930s was beaten I absolutely concur with: it changed the dynamics of spending, through rationing, and created jobs to build war materiel both for the US and for the Allies. (The same happened here in Canada.)

    We do seem to be in agreement about the policy mis-step in 1937 as well.

    Krugman is someone I read regularly and admire (to a certain extent: goodness knows he’s been right about more than his page-mate, Friedman, in the past eight years). Still, I can’t forget he has an axe to grind at the moment, too. I’m taking him with several large grains of salt when it comes to conclusions and recommendations.

    In any event, I shall do some more reading. Thanks for the stimulation of your comment!

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