Tuesday, October 21, 2014

The Deflationary Spiral is a Lie

Rick Newman at Yahoo *COUGH COUGH WHEEZE WHEEZE* "News" wrote a piece recently about the horrors and catastrophes of "deflation."

Yes, this economic scourge is so dangerous, so devastating that people unfortunate enough to experience it suffer:

Higher standards of living
An increase in the value of their money
Increased purchasing power
a stable currency

Sarcasm aside, you don't need to be an economist to figure out that the "deflationary spiral" is a Keynesian canard because the WHOLE POINT OF ECONOMICS AND SOCIETAL ADVANCEMENT IS TO MAKE THINGS CHEAPER!  It's the SOLE PURPOSE of economics.  Increasing standards of living through efficiency.  So already you know when somebody warns about the "horrors" of "deflation," you know they're either

1.  An ignorant journalist who doesn't know jack about economics or
2.  A politician or political operative trying to dupe you

(Mr. Newman is the first, despite his degree in economics, which was no doubt dripping with Keynesianism)

However, this simple logic to find out if believers in the Deflationary Spiral are devils or dupes, does not expressly explain or disprove their claims.  That claim being that deflation lowers demand by delaying purchases as people "know" prices are going down and simply postpone those purchases indefinitely into the future.  And while it may seem logical on the face of it, that's all it is - logical.  Not empirical.

First, in order to believe the Deflationary Spiral exists you have to believe that Americans are financially conscious and savvy enough to know about prices, inflation, etc.


The average American doesn't even know who's in congress or where Canada is, let alone what the CPI is doing!!!!  They are so stupid and so doped up on bread and circus BS that the last thing they're doing is reading Federal Reserve minutes.  They are the most economically ignorant population in the history of humanity (but they're experts in the Kardashians and ESPN post game shows).

Second, since the average American is clueless about finances and economics, they spend money like...well...Americans.  They save practically nothing,

 and (despite enormous debt forgiveness during the financial crisis) have managed to rack up cumulative household debt back above 100% GDP.

Third, Americans lack the capacity for delayed gratification.  In the now now now me me me mine mine mine society, nobody is conscious, let alone psychologically capable of budgeting, conserving or postponing purchases.

And finally, women.  (Yes, sorry, we're going there, because it's germane and true).  Depending on what statistics you want to use, women account for anywhere between 55-80% of all household purchases.  And most of them are on worthless and unneeded trinkets and crap.  I have NEVER, EVER heard a woman utter "deflationary spiral" because it has never occurred to a newly wed wife to postpone purchases of curtains for her new home, a power tripping NYC marketing executive to postpone purchases of her Pravda shoes, or a naive and clueless college student to postpone the purchase of her $200,000 "Masters in Latina Transgendered Anthropologic Poetry Unicorn Studies."

But the ultimate argument against the Deflationary Spiral is simply one of empircism.

It does not exist.

While I know economists, journalists, politicians, and everyday sheeple just like to repeat things they heard in college or the news, it doesn't make them true.  And if you look at spending versus inflation, THERE IS NO RELATIONSHIP.

This chart shows the velocity of money (the rate at which a dollar is spent and re-spent, indicating demand).  It is juxtaposed against inflation.  To the untrained eye you might be tempted to detect a pattern or relationship between the two, and according to the Deflationary Spiral believers as prices go down you should see a decrease in the velocity of money.

However, THERE IS NO RELATIONSHIP BETWEEN THE TWO.  When correlated against one another the correlation coefficient is -.04, meaning no relationship at all.

Naturally, I don't expect my little blog here, let alone this little post to correct the thousands of erroneous pages in economic textbooks.  I don't expect this FACT to change politicians' or journalists' thinking (or incentives).  And I doubt that anybody at the Federal Reserve will remove their lips from Keynes' dead ass long enough to consider this data.  But I do expect my readers and anybody who really cares about politics and economics to know the Deflationary Spiral just doesn't exist.  And that the next time you hear somebody trying to "scare-tactic" you using the "Deflationary Spiral" to know it's a calculated political move to allow for more government debt and printing of money.


Doug Cranmer said...

Hey Cap,

Thanks. How did deflation figure into the Great Depression then? I'm asking sincerely. Really enjoy your posts.

kurt9 said...

The key point in Rick Newman's article is the effect of deflation on debt. The major institutions (government and large corporations) loaded up on debt during the 12 year bubble (1995-2008) and are screwed if we have a long period of deflation. Prudent people and business entities that wisely avoided debt will do just fine during a period of deflation. By saying that deflation is a bad thing, Rick Newman is making clear that he is a parasite and believes in bailing out other parasites at the expense of the non-parasites.

Unknown said...

I am always amused when people claim they understand economics but don't know what velocity of money is.
Mostly I just dismiss 'professional' economists. I have a friend working on a Ph.d. and he dismisses them.

DrTorch said...

I once saw Lester Thurow lecture on the evils of deflation. I believe "diabolical" was the exact word he used.

But despite my one econ course being Keynesian, I did figure out that efficiencies do cause prices to fall. And that the deflationary spiral, should one ever appear, is just an adjustment that will sort things out for the better.

Even today there's an article showing how people are finding great housing in Detroit.

Anonymous said...

You don't need a correlation coefficient to demonstrate this. Everyone knows that cel phones get cheaper and better with each generation, yet no one delays purchasing the latest model pretty much as quickly as they can under their plan. People stopped spending during the great depression because the USG so mismanaged the money supply with its new Federal Reserve powers that the distortions were epic. Distortions during the boom told midwest farmers to add more acres with debt. When the bubble burst they were wiped out. Similar in many other industries.

Nathan said...

Absolutely spot on. This is definitely one of the most aggravating lies around (though there are so many to choose from...)

The fact is that the Fed (and their ilk) have systematically stolen the productivity gains of the last 40+ years and funneled them to the crony class. It's criminal.

Keef said...

Love the post Cappy.

Also, Anonymous, you beat me to it with the iphone example. People know prices of such goods fall over time due to innovation.

I also like the example of falling food prices.

At some point you need to eat or you will die. At some point the marginal price drop is going to have infinitesimal impact on the individual in question compared to death by starvation.

H man said...

I'd put a caveat on this. There can be a thing such as hyperdeflation where money becomes an asset rather than a means of exchange just as there is such a thing as hyperinflation where money becomes liability. Both make the economy break down in their own way.

Ryan Fuller said...

Playing devil's advocate, the Fed would say that its brilliant interest rate targeting is responsible for keeping the CPI from shifting around despite the variable velocity of money, in much the same way that a person claiming to have a magic rock that prevents tiger attacks in the US can point to the low incidence of tiger attacks here.

I believe that MV=PQ is accurate. What it doesn't account for, though, is that not all money is necessarily in circulation, so fiddling around with the money supply isn't necessarily going to do anything to the PQ side of the equation.

So if, for example, we increase the money supply by a couple trillion dollars and it all goes into the excess reserves of banks, M goes way up, V goes way down, while P and Q don't see any change from this because that money literally never sees the light of day and therefore has no impact on the prices of things as long as it's not being spent.


The Fed then sees the drop in the velocity of money brought about by their monetary expansion and congratulates themselves on increasing the money supply just in the nick of time, because otherwise the economy would certainly have imploded under massive deflation. Great job, guys! What a save!

You're absolutely right about consumers not holding off on spending because they haven't got a clue about finances. Devil's advocate says that lack of savings is evidence that the Fed is doing its job by keeping inflation around. Counter-argument to that is that we can see massive, predictable price drops in specific goods and people are still buying that crap like candy. How much will the newest model of iPhone cost if you wait two years to buy it? Electronics in general depreciate at an incredible rate, but that doesn't seem to stop anybody from buying them.

It stands to reason that deflation equal to the growth in GDP (which is what you'd see with a stable money supply) wouldn't drive people into some sort of economic lockdown where nobody buys anything and the economy implodes. Consumers just don't act with the economic foresight necessary for a deflationary spiral to sustain itself.

Unknown said...

@Doug Cranmer

Part of the deflation problem in the Great Depression was the fact that you had wage and price controls. Prices were falling in everything (housing, food, etc) yet employers were not allowed to cut wages, which created unemployment. In fact, many employers paid 25% higher wages because of the New Deal. Read this WSJ article if you want to understand the Great Depression better.

"How Government Prolonged the Depression"


Our free market system has been dead for a long time.

Anonymous said...

Posted article to the Facebook page Fighting Apoplithorismosphobia

she said: said...

Dear Cappy - you know I adore you. But, I guess I am one of those dupes. Plus, I'm
also a girl - so there is that.

From a consumer standpoint you are absolutely correct. Lower prices are always a good thing for the economy. Assuming people spend that money instead of squirreling it away.

From a business standpoint, lower prices are good up to a point. You know I live in Silicon Valley. Our only mission in life is to make things cheaper to kill our competition. But making things cheaper works in a controlled fashion. Each company knows pretty closely how far they can undercut their competitors.

When demand drops, it doesn't matter how good deflation is for the consumer.

I read a lot of articles that I think misrepresent deflation. People do not stop spending because they think prices will go lower and they can pick up items
more cheaply. What happens is they start hearing the rumor mill about the company not making as much money and they begin to get afraid about pink slips coming. You don't have know to know anything about economics to
understand this concept. It's pretty straight line logic. It's a feedback loop.

Thus making lower prices not as enticing because you feel like in a while - you might not have a job. Lower prices absolutely are good for the consumer, but
as in 2008/9/10 and 11 - most people could not take advantage of those savings because they were terrified they wouldn't have a job. Reinforcing the spiral.

Perhaps a person like me is fidgety about deflation. I went through the recession with property. But people like me look at interest rates in the 3.67%
range and oil now in contago and see only fear. It's never that far below the surface because it's an unforgettable experience.

The last time we had this
much oil floating around in floating storage was 2009. In 2009 we had 90 mill barrels. Right now we only have 40-50 million barrels. But then, we still have the whole winter to go.

In Silicon Valley if prices were falling 20% in 4 months, we
would scale back production. Oil producers seems to not want to do that. That is not a healthy market.

No one cares about the middle east or Russia getting butt hurt about the lower oil prices. You only have to look at Texas to know it can hurt us too. They have building high rises like it's going out of control. They have done exceedingly well through the recession. The oil thing might tip them.

Snarkolepsy who is not an economist. Clearly. But also agrees the money printing should stop. That doesn't mean there will not be a painful transition (deflation) period.

Anonymous said...

Rick Newman is a typical ass-kissing moron whose opinions on economics are so exceptionally stupid & idiotic, only intellectuals in academia, government, and the lamestream media would believe them. Aw, the contemporary pseudo writer/economist, whose twisted & perverted vision of economic reality would have gotten him laughed out of town a mere twenty years ago, but not in this day & age. It just shows you how degenerated mainstream economic thinking has become. This buffoon & his Keynesian pedigree are graduates from what I call the "kindergarten school of economics", because only someone as dumb as a retarded 6-year-old would buy into their nonsense, lies, and propaganda.

Nicely done Cappy.

sth_txs said...

I never understood how deflation could be bad, but this is the kind of stupidity taught in economics classes in many MBA programs. It is also spouted on the NBR and other business related programs and print media.

Peregrine John said...

I've been wondering about this for a long time. It's nice to find out that the giant holes in the narrative about deflationary danger aren't just my ignorance but, in fact, holes. I really don't mind if Snarkolepsy's right and a deflationary period is on the painful side. Resetting a badly set fracture is always unfun. Just so long as it's not extended but dumbassed legislation like 80 years ago.

Also, nice to see Snarkolepsy here.

I keep forgetting to mention, Cap, but your Cap'n America outfit cracks me up, especially the child-size shield. Freakin' awesome. But you're Cap'n Capitalism: there should be some change for that. Instead of a star in the middle, a $ perhaps? Eh, too cheesy, and it'd make clueless people think you're Captain Ke$ha. A nickel? There's gotta be something. You could sell them for costumes and fund the next road trip.

Anonymous said...


I delay purchasing a cell phone because I cannot accept cell phone fees.

I am delaying my purchase decision to get a cell phone until the day when technology is advanced enough to make a cell phone without service fees.

I am tired of monthly cell phone fees or pay as you go fees.

Cell phones are the electronic equivalent of SUV gas guzzlers.

Plus, no pesky and bothersome relatives are calling me about things they want from me and I don't get annoying telemarketers.

Come to think of it, the best cell phone is the no phone.

That is, nobody calls me, I call nobody and it costs nothing.