Tuesday, November 23, 2010

This is Not Good

Deflation is really not good.  Think about what would happen if suddenly, everything sold for less than it did last month. 

Krugman lays it out here in economics major detail: http://goo.gl/Wg7V.  But for the layperson, here’s the shtick.  First, if I build widgets and widget prices are going to be lower next month than this month, why would I invest money in building widgets?  I’m better off holding onto my money.  With lowered prices comes lower wage growth, especially in economies with unemployment.  Why pay more to people making widgets when there are a 100 people knocking on the door for a job?  Third, all of this is reinforcing.  Less spending begets less demand which begets lower wages which begets less spending.  Then suddenly, no one wants a widget.

I wasn’t really nervous until I saw this chart.  For those who didn’t watch Lost in Translation, Japan went through a housing boom in the 1980s to be followed by 20 years of economic funk.  Think Detroit with kimono robes and sushi. 

Two things compound the problem:

1. There’s a lot of pressure to cut government spending (ie trim the deficit).  Since we’re a borrowing country, this deficit money is a net flow into the US economy.  Cut the spending and you cut the flow.  Cut the flow and suddenly there’s $1 trillion less demand in widgets.  Dōmo arigatō.

2. Tea Partiers are throwing stones at the Federal Reserve’s action to inject $600 B into our economy.  In the Tea Party thesaurus, “central” and “reserve” are synonyms with Hitler and Maoism (or something).  See this comic:

But the Federal Reserve’s actions are to prevent the chart (above) from becoming reality.  What does a Japanese-style 20 years of non-growth look like?  Well, think close up of Bill Murray and a world where Scarlett Johansson doesn’t wear makeup.  It’s that bad.

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