When I was in junior high, my
friend Scott had this Billy Crystal tape that we passed back and forth to each
other. I still like Billy Crystal, but let’s just say he was truly hilarious
when I was 13 back in 1987.
He had this routine about old
codgers who used to tell you how hard life was in the old days.
“We had no air…” he’d say, in an old
man voice. “No food.
We ate wool coats and we were happy.”
Then he’d project into the
future when he would be an old man, talking about what it was like in the
Sixties, about Woodstock.
“We closed down the New York
State Thruway, we were crazy… hippie… bastards.”
Battling Deflation at
Any Cost
Today’s central banking world
kind of feels like Woodstock to me. Lots of long hair, tie-dye, and perhaps a
generous helping of body odor. Certainly hallucinogenics are involved.
Think about it. In the old
days, as long as we could remember, the job of a central bank was to prevent
inflation. Also, to promote economic growth and keep people in jobs, but they
weren’t really serious about that. The only thing they were really serious
about was preventing inflation—and sometimes they did a bad job anyway.
But around 1980, central banks
got religious about inflation and started to do drastic things, like raising
interest rates. It worked so well that every couple of years they would raise
rates again. As a result, inflation went down over time, to the point where it
became a negligible factor in economic decision-making, which was the whole
point of the exercise.
Well, with price stability
achieved, there wasn’t much left to do, but central bankers get paid too much
money to sit around and stare at each other. And the one thing we learned over
the last 20 years is that central bankers are only appreciated during a crisis,
which is when they get to do
stuff, whether it works or not.
So a new crisis was invented:
deflation.
Now, you might ask why nobody
thought of deflation as a threat before. There are several reasons, but
principally, it hadn’t been around in a while until it reappeared in Japan.
The deflation in Japan was
quite nasty. Everything was going in reverse. Not only was there deflation, but
there were deflation expectations.
People expected prices to go down, so they did.
Wages went down, too, which
sucks if you have a fixed mortgage or car payment.
In deflation, debt gets larger
in real terms. But it’s great for savers. If you’ve got money in the bank
earning 0% interest, but there’s 3% deflation, you’re actually doing pretty
well.
This went on for years in
Japan, and is still going on, although they are trying hard to get out of it.
I do find this sudden obsession
with deflation peculiar. In the US, inflation has stayed positive except during
the financial crisis. In Europe, it’s hovering around zero but is not really
negative.
There is plenty of inflation elsewhere in the world. And you can go
into a spreadsheet program and see how 2% inflation compounds over time, and
look at the loss of purchasing power, and you will realize that even low
inflation can be quite sinister.
What’s Bad About
Deflation?
But here’s the funny thing
about Japan. Japan has probably had the biggest boom-bust cycle of any
developed country in the modern era. The bubble was bigger than the dot-com
bubble in the US in 2000, and the bear market continued for two whole decades. Plus,
they’ve had years of this awful deflation, where it gets harder and harder to
meet fixed debt service payments.
And yet, Japan remains one of
the richest countries in the world, with a higher standard of living than just
about anyone.
There are no shortages. They
have plenty of food and fuel.
There have been no riots, no
civil unrest.
Stocks were down 80%, but you
didn’t hear anyone complaining.
So sure—deflation is annoying.
And it’s not ideal. It’s not exactly price stability. But some things are
worse.
So if you get too much
deflation, you turn into Japan.
But if you get too much inflation, you turn into
Weimar Germany, Zimbabwe, Argentina. People die
in inflation.
I assure you that, given the
choice, you would rather live in Japan than Argentina.
Asymmetrical Response
So the reason that central
banks used to care more about inflation than deflation—and still should—is
because high inflation has far worse consequences. Their approach to price
stability should be asymmetrical.
Say there is 20% inflation. I
need to buy some fertilizer for my lawn. I go to Lowe’s and get a bag of
fertilizer, but I say to myself, “Wait, maybe I should get another one, because
I’ll need it in a few months and the price will be higher. So maybe I should
buy two.
“But wait—why don’t I buy all
20 bags of fertilizer sitting here, take them home, and when the price goes up,
I’ll sell them to my neighbors?”
So I buy 20 bags of fertilizer
and put them in my basement.
Then my neighbor goes to Lowe’s
to buy fertilizer, but it’s gone, and the guy at Lowe’s tells him the jerk up
the street bought it all. So now my neighbor is pretty angry at me.
There are a lot of angry people
in inflation, and shortages of goods. One is related to the other.
Oddly, in deflation, everyone
bands together.
Inflation Is Groovy,
Man
Today, central bankers are
trying to create inflation as fast as they can. It’s happening here in the US,
in Europe, in Canada, now in China, even Australia.
They aren’t trying to create
just a little inflation—they want above-trend inflation of 3%, 4%, maybe more.
It’s like we have complete amnesia about how horrible it was in the Seventies.
Nobody is asking the hard questions here. What if you succeed, but succeed too
well? What if you can’t reverse it?
Just because we may be
surrounded by deflationary forces doesn’t mean that QE isn’t a bad idea.
Above
all else, the central banks fear the “liquidity trap,” the point at which
monetary policy no longer has any effect. They fear this more than anything.
I think one day, 20 or 30 years
in the future, we will look back at this point in time and just shake our heads
at what crazy hippie bastards we were, collectively. We will teach in freshman
economics classes how we used to fight lower prices.
“Did you know there was a
time,” the professor says,” when central banks were actually trying to create inflation?”
“Why would they do that?”
He shakes his head grimly. “Nobody knows.”
Jared Dillian
Editor, The 10th Man
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