Deflation and How It Will Affect Us All

Everyone fears inflation. Of course, unless you were working and paying bills during the 1970′s, you have not experienced inflation. We are simply taught to fear it. Bad inflation beast!

We have been told for the past several years that inflation, taxes, healthcare and deficit spending are the Four Horsemen of the Apocalypse. We must stand guard against their perpetual onslaught. Agreed. These concerns are real. They should be acknowledged and addressed. The process is slow, cumbersome and hindered by our political wanderings between the Scylla of Socialism and the Charybdis of Capitalism. Scylla grabs six sailors from the deck and swallows them whole; Charybdis destroys whole ships that venture too near and spits out the refuse. Hopefully, November of 2012 will find us finally out of this whirlpool, into clear waters.

There is another beast. It lurks in the depths. It name need not be pronounced, for fear of bringing it forth from its lair. The Kraken lies quietly, as large as an island, seemingly asleep. Once disturbed, it becomes like the sea itself, engorging itself upon all life, sucking up even the very oxygen of the atmosphere. To put it to rest… well, no one has done that yet. Better to ignore it, tiptoeing past the graveyard of ships crushed upon its shores.

Extended metaphor? Perhaps. The beast within is deflation. Japan is being consumed by it now. For the past twenty years it has ravaged the Japanese economy, you only need to look at the USDJPY exchange rate to see that. Government spending, private wealth, public discourse from all sides, even nationalistic jingoisms, have failed to suppress the beast. An aging population incapable of even replacing itself has become one of the beasts tentacles. Low interest rates have not stimulated the economy. Excessive government spending on bridges to nowhere has failed, only piling up further debt. Health care costs, while borne by the beautiful Japanese family, still rip capital from the nation. Savings rates far surpass ours, yet the capital is underutilized, resting quietly at the Post Office account.

Once deflation emerges, chaos reigns, a slow churlish, cancer that soaks the very lifeblood from an economy. How? Interest rates remain rock bottom, discouraging lenders and applicants both from risk appetites. Consumers quickly learn to avoid spending, first on capital items, then on necessities; why buy today when the item will be ever cheaper next week, next month and next year. Cars and computers, fridges and furnaces are put off. Let’s just fix the one we have and wait. Companies reduce capital expenditures. They build up capital, even more than today’s massive $2T+. Layoffs become more prevalent. Those with jobs do more, just to keep them. An aging population saves rather than enjoys their retirement. Flexibility of spending habit becomes a crutch. Saving becomes a cancer. Debt disappears, except at the government level. The friendly folks at the Fed and the Treasury swap newly printed dollars for newly issued notes, like a snake swallowing its own tail.