Deflation Express?
“It is hard to see a light at the end of the tunnel for housing. Lower rates are not spurring activity because the light may be from a deflationary train.”
Thus ends an article on the Federal Reserve Board’s holdings of mortgage backed securities in today’s Financial Times.
I hate to keep harping on this topic, but I see far too many articles cluttering up good media space talking about inflation and the impact of the huge government debt now piling up.
Yes the debt is an issue to deal with in the future. No it is not a problem today.
People keep thinking of the debt in all the wrong ways. The best way to keep a perspective is to calculate the cost of carrying that debt, not just its aggregate size. It is the burden of interest payments on future budgets that matter more than the total amount of debt. That burden can be managed only if we have a healthy growing economy. In other words we need to get GDP rising from its current slowdown. And we need to avoid deflation at all costs. If GDP grows at anything like its historic rate the debt burden is automatically reduced both as a percentage of GDP, and as a percentage of the budget. It is basic math. But if we wander around trying to cut and slice the economy in order to reduce the deficit, the chances are that we will shrink the economy by reducing growth rates. So all that hard thrift and blood spilling will actually end up increasing the debt as a percentage of both the economy and the budget. Again: basic math. Thrift is self-defeating. Keynes taught us that in the Great Depression. Evidently much of our supposedly well educated analysts community never read Keynes.
And another canard to avoid: I read in some places that people calculate the debt burden and then argue that the interest payments are equal to a certain dollar amount per person. In one example I saw the figure $30,000. I am not going to dignify that calculation with a direct response, but I want to point out an even more obvious issue: those supposedly crippling debt interest payments go somewhere. Most likely into a US based pension fund or similar creditor account. It’s called double entry bookkeeping. Something the Venetians invented centuries ago. This means that the ‘crippling’ payment is someone else’s, presumably less than crippling, income. This is crucial to bear in mind. Too often we forget that the biggest investors in US bonds are US citizens. Notwithstanding the brouhaha over Chinese investments in the US the vast majority of US debt is held domestically. So one person’s crippling burden is another person’s safe retirement fund. Yes the cash is re-allocated from one set of folks to another, but basic accounting tells us that it has to go somewhere, and that somewhere is predominantly right here.
Now back to the FT article.
The big point is that for all the cash sloshing about the US economy, investment is still weak.
Why?
Classic Keynes: business expectations are very negative. This means that businesses are refusing to invest in new plant, equipment, or workers because they are afraid of the future. These negative expectations are driving – perhaps not driving is a better way of looking at it – the entire economy at present.
And, as the FT hints at, the prospect of deflation will make matters much, much, worse. Firms just won’t invest if the economy is about to fall into a deflationary spiral. On the contrary, because deflation acts to create a positive return on plain old cash – which increases in value as deflation drives prices lower through time – it makes sense to build up cash reserves rather than spend it on speculative stuff like factories etc.
The same goes for households. Cash becomes king in a much bigger way than usual. The loss normally created by holding cash rather than investing it is eliminated by deflation, and the incentive to grow is sucked out of the economy.
Under those circumstances those debt burdens come into focus very rapidly.
Forgive me for saying it, but we need a healthy dose of inflation along with that stimulus. Not exactly what the textbook tells us, but exactly what Keynes would advocate.
Why are we even arguing about this?
Oh yea … politics.
