Is Debt Deflation Just Beginning?

The debate rages on.

Is inflation or deflation the bigger threat? There are lots of people -- lots of smart people -- on both sides of the debate and they present lots of good arguments. One thing that I have not seen -- and maybe I just missed it -- was an analysis using Irving Fisher's debt-deflation framework. So I decided to put one together myself and to inject my understanding of what Ben Bernanke is try to do to stop deflation from taking hold.

The question I keep coming back to, especially as I read more about the situation Japan faced (I'm reading everything I can by Richard Koo, including his book The Holy Grail of Macroeconomics) is, "Can we generate enough counter-momentum if the debt-deflation process really takes hold?" …

And just to make sure I am not being one-sided, I am countering my fears of deflation with Monetary Regimes and Inflation by Peter Bernholz, which should arrive next week…

Without further ado, below is my research on debt-deflation.

Dave

Dave's research is a 70-page slideshow that’s easy enough to read or download from Scribd.

Here's my response:

You shouldn’t be afraid of deflation.

You should be afraid of policies attempting to fight it.

Deflation (rather price deflation) is actually the natural state of affairs. As productivity increases, more goods and services are produced relative to the population, and prices would therefore be expected to drop.

It’s the Federal Reserve, along with misguided Keynesian and Monetarist economists, who think falling prices are a bad thing. Who among us does like falling prices (except of course on things we own such as houses, but even then, who’s not sick of higher property taxes that result)?

The reality is that inflation benefits those with first access to money. Guess who that is? The answer is easy: banks, government, and the already wealthy. Inflation is actually a tax on the middle class and the poor who get access to money last. During the housing bubble, by the time the poor could get access to money easily, it was far too late to buy.

Given that inflation benefits those with first access to money, any targeted inflation at all is morally wrong.

Note that Congress has passed more than 300 affordable housing measures over the years and all of them failed. The irony now is Congress has simultaneously passed measures hoping to prop up the price of homes while still seeking additional money to create affordable housing.

Home prices need to fall (and will fall) to levels of affordability based on wages and wage growth regardless of what the Fed does. Thus, efforts to prop up prices are triply stupid: They’re costly; they won’t work (prices will fall to where they are headed anyway); and they’ll delay a recovery.

Deflation is only bad in the context of the short-term pain it will involve. Moreover, it’s important to remember that the pain of deflation is relative to the inflation party that preceded it. That party must be paid for either in terms of time or price.