|This former leading singer of "Red Shadow," the economics rock'n'roll band,
may turn out to be right that deflation won't happen, but he totally ignores
the fact that low interest rates encourages not only spending but increased
private-sector indebtedness, which not only creates increasing barriers to
expansion in the near future but is what makes deflation (when it occurs)
such a disaster.
Expectations of Economic Deflation Are Highly Inflated
The folks worried about falling prices are helping to spur growth.
By Everett Ehrlich
June 16, 2003
Every so often some economists decide that everything they ever learned was
wrong and, from that moment on, everything is going to be completely
Twenty years ago it was the idea that cutting taxes radically would pay for
itself. Predictably, the nation's largest peacetime deficits resulted. Five
years ago it was the idea that the Internet made companies valuable even if
they produced no profit and very little product. Unsurprisingly, the stock
market nose-dived soon thereafter.
Now, the idea is deflation - that prices are going to fall steadily just as
they've risen steadily for all of our lives.
Want to bet how this turns out?
Everyone agrees that sustained deflation would be a very bad thing. If
people expect prices to fall every year, then why buy anything now, why
invest in anything now and why not keep your money stuffed in a mattress as
it continually grows in value?
But the fact that deflation is bad doesn't mean it is imminent.
The proponents of impending deflation have their reasons. The first is that
Iraqi oil supplies will trigger a global glut. Another is that productivity
is so strong throughout the economy. And then there's the global
deflationary monster, China, whose 1.3 billion people work for beans and
will soon make all the world's cars, computers and cat litter.
How can global prices do anything but fall in the face of these unrelenting
Hold on. Let's say oil prices fall from their current level of about $27 to,
say, $5 a barrel. Fine - what do they do next year, fall another 20 bucks?
Lower oil prices aren't sustained deflation; they're a one-shot deal. And
dollars to doughnuts you'll take the money you saved at the gas pump and buy
something else, and the price of whatever it is will go up.
But what about productivity? Doesn't it force prices to fall? Sure,
productivity allows firms to sell for less, but if higher productivity led
to deflation, prices would have fallen for all of human history.
Productivity growth isn't a problem - it's a miracle. If it weren't for
productivity growth, we'd all have the standard of living of mule drivers
and wood cutters.
A more productive worker earns more in the marketplace and in turn spends
more. And spending more keeps prices stable, if not rising.
Which leaves the idea that China will export its own poverty to us through
lower prices for everything.
China has certainly been a prodigious exporter, but most of its success has
come at the expense of low-wage Asian and Latin American nations that make
similar products. So China's products are not lowering world prices so much
as out-competing the products of other low-wage producers. The stuff China
makes is already cheap. Moreover, at some point, China won't be a low-wage
producer. China's currency is officially pegged to the dollar, but the
pressure to allow it to appreciate is substantial. When it inevitably does,
China's products will become less cheap. It's all part of the Chinese
economy growing up.
Today, deflation is the economy's biggest worry. Even Alan Greenspan
acknowledges that it would be a bear. But the best argument against
deflation is that the U.S. economy is about to grow, and, ironically, the
deflationists have all but assured that growth.
In response to their worries, the Fed has made money cheap, because everyone
knows that's the way to fight deflation. So now financial markets, caught in
the thrall of the deflationary and "slow growth" crowd, are confident that
the Fed is going to keep money cheap to fight deflation not only this
quarter and this year but this entire decade.
Already, the rate of return on 10-year Treasury bonds is 3.11% - 3.11%,
that's all you get. Somebody must think that's an acceptable interest rate,
because somebody is lending the government their money at that rate.
But I'll tell you who thinks that's cheap - everybody who's refinancing his
or her house, often for the second time. People are running to borrow at
these rates. And the corporations refinancing their debts think it's cheap
Those very low interest rates mean that households and corporations will
have low borrowing costs for years to come, setting the stage for more rapid
- non-deflationary - growth. The deflationists who lent their money to them
at these interest rates will prove the losers when rates rise again after
the economy starts to grow, the way it always does.
The strength of the deflationists' conviction will save the economy from the
danger they foresee. It's an irony only an economist could love.
Everett Ehrlich, a former undersecretary of Commerce in the Clinton
administration, is senior vice president and director of research of the
Committee for Economic Development, a nonpartisan, business-based economic
policy think tank.
Copyright 2003 Los Angeles Times