Friday, October 24, 2014

The Threat of Deflation - You're Kidding Me, Right?

Is deflation really a threat?  Get Real!

There have been a lot of articles as of late (and over the last five years) about the "threat of deflation".   Deflation is a threat?  Get real!

Please, I am looking forward to retirement and living on my savings.  Deflation would be a blessing!

Deflation is not a threat.  Why?  Because first, the vaunted "threats" from deflation are nonsense.  Second, deflation ain't gonna happen to any great extent, period.

Let's look at the first issue.  The geniuses who write these articles about deflation barf up, intact, the same party line.  "If prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases."

Really?  You think people really think that way?  In the supermarket, they are holding a loaf of bread in their hands and saying, "Gee, I think I will wait until tomorrow to buy this loaf of bread, as it will be cheaper then!"

This is a classic example of economic theorists who don't understand human nature.  If you are hungry, you buy a loaf of bread.  You are less concerned about the Future Value (FV) of bread than the fact you are hungry.

And this applies to larger purchases as well.   People buy cars, washing machines, air conditioners, refrigerators, computers, or a pair of blue jeans because their existing product has worn out.  They don't sit around like economists and make predictions about the prices of products in the future for the simple reason that most people have no clue how prices are trending.   If your car needs an engine overhaul, chances are, you are in the market for a new (or newer) car.   You don't buy a car on the premise that you'd "better buy now because they'll be more expensive tomorrow!" and you don't throw a rebuilt engine into a junker because "you might as well wait, as prices will be lower tomorrow!"

In fact, it works just the opposite.  During the last recession, when prices of cars were flat, and the prospect of higher prices seemed dim, people threw money at their older cars to fix them because they could not afford a new or newer car.   When the economy recovered, people bought new cars (and boy-howdy did they buy new cars!) because their old clunkers were really past their prime.  That is what drove sales, not some theoretical philosophy about price trending.

The idea that the average consumer can perceive price trends and then act in accordance with them is just nonsense.  People buy goods because they need them, for the most part, or they want them and believe they can afford them.   Future Values just don't register in their brains.

The second half of the equation is that deflation just isn't going to happen.   Yes, the cost of producing a lot of goods has decreased over the last few decades, thanks to China.   But the cost of energy has kept up with this pace, and as a result, prices keep going up every year.   And those folks in China, India, and other 3rd world (or 2nd or 1st?) countries who are working for low wages, are starting to demand increases and thus the cost of such goods cannot remain low indefinitely.

Yes, the growth in the population has slowed.   But it is still growing.   And that means that demand for every product, from corn to iPhones, is on the rise, which means that prices will continue to rise, albeit more slowly.   Deflation?  Maybe if a plague cuts the world population in half.  Maybe.

So what is behind this deflation gloom-and-doom?   Well, alarmist articles sell newspapers (or capture eyeballs or click-through revenue).   So if you give unconventional wisdom, people will bite on it.  It also sells newspapers if you can make alarmist claims - people bite on bad news more than good.  So if inflation goes up, you tell people how rotten it is than inflation has gone up.   If inflation is flat, you tell them how rotten it is than inflation is flat.  And if there is a possibility of deflation, well, you tell them how horrific that would be as well.

(And these articles about deflation pop up about every year or so, like clockwork, when there is a slow newsday.  If you google "deflation threat" you see articles arguing that deflation will wipe us all out - dating back every year for the last five years.)

Hmmmm... So when exactly are things going OK then?   I mean if inflation is bad, deflation is bad, and no inflation is bad, that means everything is bad all of the time, right?

Oh, right, that's the definition of reality, as viewed by the news media.   Bad news sells, they know it, and you bite on it.

Stop biting.