DEFLATION AND DISCOURAGEMENT
Most economists ignore the behavioral side of finance. They tend to stick to their models, equations and textbooks. This is, in large part, what makes economics such a frustrating endeavor for so many people. They tend to ignore the simple fact that there is an unquantifiable variable in the equation – human emotion. And no matter how much we evolve and advance technologically this variable will always be the most important piece of the puzzle.
Over the last few years I have argued that much of what the government planned to do would have destructive psychological ramifications. Unfortunately, this appears to have come true as no one truly trusts the stock market these days. Small business sentiment shows a total lack of faith in the government. Consumer confidence remains abysmal. This is all very disconcerting because a deflationary environment has a way of snowballing and becoming self destructive. It can eat at a society from within as they become discouraged. The following story nicely summarizes the damaging impact of deflation:
“Once upon a time it was announced that the devil was going out of business and would sell all his equipment to those who were willing to pay the price.
On the big day of the sale, all his tools were attractively displayed. There were Envy, Jealousy, Hatred, Malice, Deceit, Sensuality, Pride, Idolatry, and other implements of evil display. Each of the tools was marked with its own price tag.
Over in the corner by itself was a harmless looking, wedge-shaped tool very much worn, but still it bore a higher price than any of the others. Someone asked the devil what it was, and he answered, “That is Discouragement.” The next question came quickly, “And why is it priced so high even though it is plain to see that it is worn more than these others?”
Because replied the devil, “It is more useful to me than all these others. I can pry open and get into a man’s heart with that when I cannot get near him with any other tool. Once I get inside, I can use him in whatever way suits me best. It is worn well because I use it on everybody I can, and few people even know it belongs to me.”
This tool was priced so high that no one could buy it, and to this day it has never been sold. It still belongs to the devil, and he still uses it on mankind.”
I believe this is exactly what happened in Japan in the 90′s. Deflation became accepted. And as it became accepted discouragement came with it. And discouragement has a nasty way of eating at people’s everyday activities. When you are discouraged by the environment you exist in you are more likely to quit, not to participate or to simply sit on your hands while you wait for things to improve. Prices fall, wages decline, profits suffer, etc.
The government is trying to talk us out of becoming discouraged. They have rescued the financial system with record bailouts, trillions in stimulus and hope-filled messages. This continues to this day. We are told that the Federal Reserve will bolster markets with quantitative easing and supportive monetary policy. We are told that the government will stimulate Main Street and small business. We are told that they will give us tax credits for buying new cars or new homes. We are told that saving the banks will save us all. But when one looks under the hood at all of these policies you realize that none of them have been beneficial to Main Street. Almost without exception they have been short-term attempts to bolster a banking system that has failed us.
Quantitative easing is just the latest gimmick to bolster bank balance sheets and generate hope of a real recovery. Real recovery will come when Main Street is cured of its debt disease. Until then, discouragement will continue to eat at the core of this system as the government continues down its misguided path. I used to think that Americans were too hopeful and prideful to be discouraged for any extended period, but this government appears to be doing a pretty good job of scaring us with their rhetoric while also implementing policy that proves them entirely ignorant in regards to all things economics. Until something actually changes in Congress it’s likely that the threat of deflation and discouragement will remain. And with it will be depressed economic growth.
isn’t it great how the USA is run by lawyers and economists – the most emotionless out of touch people on the planet.
Well done. Economics is ready to grow up as a social science, but first, Straussian Neocon elistists have to ensure total, crushing collapse, gobal violence, and discouragment so that the lesson can be learned most emphatically the hard way. One day economists will be yin-yang supply/demand siders, who can still measure and count golden eggs, but also understand the essentials of feeding and caring for geese.
strange how most of us deny we are emotionally driven.
i value intuition above logic….Vulcans are routinely wrong.
Sounds like a CS Lewis Screwtape story…
Thus the Term “Moral Hazard”.
Thanks Uncle Screwtape, I mean Sam…
I think you throw around “inflation” and “deflation” way too liberally. Let’s say the Fed bought oil futures instead of treasuries – instant inflation. Do you feel better? I doubt it.
It is important that the market channels money in the right areas to create the right kind of inflation while allowing the right kind of deflation. I believe this requires confidence in the currency, the fairness of the economy, and growth prospects. In lieu of the proper confidence money creation will increasingly flow to commodities and other hard assets, which will create the exact wrong type of inflation as homes/stocks/etc continue to deflate and the cost of living inflates.
Also, even if we can tolerate inflation in aggregate, you have to remember that we have a massive wealth disparity. $200 oil doesn’t bother me but would probably leave many households without heat, transportation, etc. This not acceptable. I don’t think this is quite so easy as “we need some inflation.” Wage inflation is what the country really needs but that probably comes with higher interest rates and stagnating financial assets as a result.
Rising oil prices is highly deflationary in its effect. It destroys discretionary sprending, puts downward pressure on the price of most of the nations housing stock.
Not if the Fed committed to increase commodity purchases to hits its inflation target. Inflation could easily be created. In theory, macroeconomists would be happy then. If the target is still hard to hit then the Fed could also buy vacant rental buildings to drive up rents. Voila – inflation.
Cost push inflation will tip whatever is left of the real economy into oblivion. The FED cannot increase wages.
Exactly my point. All this “inflation = good” analysis is so incredibly oversimplified it is useless.
Nice post. The folks in charge need to read up on Hyman Minsky’s financial instability hypothesis and Irving Fisher’s debt deflation theory of depressions. They are acting like this is the trough of a business cycle when it is the end of a long financial cycle, culminating in “Ponzi finance,” as Minsky called it. That mountain of debt has to be unwound one way or another, and some ways are more destructive to the economy and society than others. Government has to realized that it is government “of the people, for the people an by the people,” not government for the financial sector and wealthy creditors.
The present thinking is baseed on funnel up and trickle down, and it is not working. Inequality is increasing at an increasing rate, and people at large are becoming discouraged because the system in not only not working for them, but it is also working aginst them.
It is not deflation that causes discouragement, what discourages people is the underlying feeling that we are not doing the things necessary to cure the economy.
Deflation is not the disease, it is the cure. Fighting the cure can never solve the problem. Had Japan accepted this 30 years ago, they would have been rebuilding their economy for the last 20 years instead of falling farther into despair.
No market can begin to recover until it reaches the point of capitulation. Delaying the capitulation only lengthens the amount of time of the suffering.
QE only transfers the debt from the wealthy to the public. Asset deflation and the write offs that go with it is the only cure to the disease which and always has been asset price inflation.
The bubbles are the disease. Artificial price inflation based on debt, and not increases in wages. Deflation is the only cure for artificial inflation.
Deflation is the only cure for artificial inflation. JH
No, not really. If the money spent to reflate the economy had gone to the victims of the banks instead of to the banks then everyone would have been fixed including the banks.
But then we would have to admit that the banks are the villains. But aren’t they?
Lots of assumptions there, would the money have been spent to reduce household debt, or squandered on lifestyle?
At best it would have been a temporary relief, and done nothing to bring prices back in line with earnings, which is the real problem.
At best it would have been a temporary relief, and done nothing to bring prices back in line with earnings, which is the real problem. JH
Well, I should have mentioned that the bailout should be combined with leverage restrictions on the banks to eventually put them out of the counterfeiting business. Forced to loan only existing money (of which the supply would be greatly increased by a bailout with new, debt-free legal tender bailout) then bubbles would be impossible or at least much less likely.
I agree. An economic system that is perceived as unfair is also highly discouraging. I think deflation could be handled in stride if people believed that at the end of it the system would work for the average person, not just solve for some level of aggregate economic activity. We are headed in the exact opposite direction.
“The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.” Lord Acton
Well, it need not be a fight if we will put our heads together, admit the current system is flawed, protect the victims and come up with some solutions.