
Deflation - gz5
http://avc.com/2015/03/deflation/
======
carsongross
A slow and steady deflation is the natural state of affairs when productivity
is advancing and the social environment is relatively stable. Economists panic
about things getting cheaper because they are compromised by the current
banking system, which is based on fractionally reserved debt and requires
inflation to stave off a general run on fictional assets.

Consider: computers have been getting cheaper for a generation and its been
one of the greatest economic boons in history.

I'm aware of the standard economic criticisms of deflation, I just don't agree
with them. The massive deflation shock of the Great Depression was due to the
preceding leverage boom, and should not be used for a general analysis of
deflation without considering that boom.

Deflation is usually good. Things we want cost less of our labor. The benefits
are widely distributed with no early receiver advantages as there is with
inflation. This is a good thing.

~~~
hobbsh
The problem with deflation is that we are a nation of debtors. Deflation
causes debt to become more expensive, thus raising defaults and all of the
ripples that follow.

edit: I should clarify that I don't completely disagree, just that debt is the
real problem. No one wants to endure the short term pain so we keep "kicking
the can down the road" as they say.

~~~
graedus
Precisely. I understand it like this: if the United States has some $18tn of
debt and it has to pay this back in dollars that are more valuable than they
were when the debt was issued, that debt load quickly becomes unserviceable.
However, if they successfully inflate away some significant percentage of the
value of the USD, the nominal debt remains the same but it becomes lighter in
real terms.

Pippa Malmgren - correctly, I think - describes this inflating away the value
of the currency (and by extension, all outstanding debts) as just another form
of default, and one that has been used many times in history. It's just more
stealthy than saying "we can't pay, so we won't pay" or something similar[0].

[0]
[https://www.youtube.com/watch?v=KBU59sY2erA](https://www.youtube.com/watch?v=KBU59sY2erA)

~~~
ArkyBeagle
But government debt is _DESIGNED_ to be inflated away. The U.S ran a then-
terrifying $2B deficit during WWII. The whole point of government debt is that
GDP rises eclipse it over time.

I am rather shocked that anyone can't tell the difference between the effects
of mild inflation on debt and default.

Debt is not a blood oath - it's just a tool. We're better off if we can use
this tool and use it properly. With deflation, that's harder.

------
chubot
Can someone explain this to me? The government seems to report that inflation
is very low, bordering on deflation.

But what I see is the cost of these things skyrocketing: education, housing,
and health care. That is -- the things that real people actually need! I don't
care about the cost of cell phones and TVs and so forth. Or even gas (for me).
Those are a drop in the bucket.

Education: I graduated in 2001 from an Ivy League university. It cost $32K a
year as far as I remember. The same thing costs $50K or so now? That's a
pretty astounding increase in such a short time.

Housing: Obviously situations are different throughout the country, but in the
wealthier areas like NYC and the Bay Area housing prices seems out of control.
I feel like housing prices aren't falling in the US in general besides
economically distressed places like Detroit, but I could be wrong.

Health care: Costs also seem to be rising quickly, but admittedly that is
probably because health care is generally much better than it was 50 years ago
and people will pay anything to survive, and they are surviving in greater
rates (e.g. compare Iraq veterans to veterans of previous wars.)

Sure all of these are just anecdotes. But I think there is something to the
experience that education, housing, and health care are increasing in cost.
Probably the main reason is that they are NOT as affected by globalization.
And they are essential to life.

Lumping everything together under "inflation" or "deflation" seems misleading.
There are many different parts of the economy and they have different
properties.

~~~
nostromo
The issue is that you are not average, which is what the CPI uses. The average
American doesn't live in NY or SF and doesn't pay student loans for an elite
institution.

Here's the issue I see: the rich cities have decoupled from the rest of the
American economy. Rich cities are experiencing very high inflation, while
poorer parts of the country experience no inflation, or even deflation.

The Fed only has one lever. It cannot make money expensive in SF while making
it cheap in Detroit.

When I visit family in Idaho, I'm sort of shocked how rich I am. But in
Seattle I'm squarely middle class. The divide seems to be growing very
quickly.

~~~
jseliger
_When I visit family in Idaho, I 'm sort of shocked how rich I am. But in
Seattle I'm squarely middle class. The divide seems to be growing very
quickly._

This is mostly an issue of cities restricting housing supply, especially
through height limits and parking minimums: [http://www.amazon.com/Rent-Too-
Damn-High-Matters-ebook/dp/B0...](http://www.amazon.com/Rent-Too-Damn-High-
Matters-ebook/dp/B0078XGJXO).

See also
[https://marginalrevolution.com/marginalrevolution/2015/03/ho...](https://marginalrevolution.com/marginalrevolution/2015/03/houston-
v-california.html):

 _Last year authorities in the Houston metropolitan area, with a population of
6.2m, issued permits to build 64,000 homes. The entire state of California,
with a population of 39m, issued just 83,000._

Want to be rich? Get out of Seattle, California, and New York.

~~~
Domenic_S
Oh look, this comment again. California doesn't need a bunch of new permits
yet because since the boom & bust there have been literally entire
neighborhoods of unfinished (builder went bankrupt or whatever) residential
construction. On top of that you can build pretty much wherever you want east
of the 5.

It's hilarious that you mention parking minimums; a friend of mine moved his
industrial business to Idaho because, hey, cheap real estate. Then found out
the building he bought wasn't going to work unless he spent some ridiculous 6
figure sum building more parking spaces, the number of which is determined by
building square footage and not the actual number of people. It's definitely
not a California-only thing.

------
themagician
The longer we stay in a zero-interest rate environment the more distorted
things become, particularly here in the Bay Area.

Every day more and more cash pours into the Bay Area because it's one of the
best risk-adjusted investments. Be it tech, real estate, or biotech,
everything is booming. Without an alternative things will continue along this
path. There's just more money here now than there otherwise would be. Some
call it a bubble, some don't—it doesn't really matter.

From a certain perceptive, it's a good thing. If things stay like this perhaps
the giant pool of money will continue to pool around things that are
relatively riskier than the traditional financial instruments.

This seems strange to us, but maybe this is actually a better allocation of
capital. Maybe we are just moving into a world where a relatively higher
portion of the world's capital flows into biotech instead of treasury bills.

------
natrius
I think this line of reasoning conflates deflation caused by a massive
deleveraging crisis and deflation caused by more of the economy jumping on the
train of dramatic price decreases that the technology industry has always
dealt with.

Our global deflation problem is caused by too much debt. Debt can't increase
faster than the economy indefinitely because it becomes impossible to pay
back. But it had been increasing in that fashion for quite some time before
the financial crisis. We're now living in a world where debt isn't growing at
those fast rates, and central banks have been trying to keep the economy going
without it.

Central banks have kept the economy going by buying low-risk assets with new
money, which makes the value of assets in general go up. They've also set
interest rates to zero, which makes it attractive to borrow money. Asset
holders feel richer and spend more money than they would otherwise. Investment
opportunities become more attractive because it's cheaper to borrow money to
take advantage of those opportunities. We get economic growth. These were
reasonable actions for our central banks to take.

But eventually, the actions of our central banks will need to be reversed. Low
interest rates and quantitative easing in perpetuity will eventually cause
inflation when the economy gets healthier, or asset prices will get too high
for people to continue to expect future gains. This is why the Fed is planning
on raising interest rates this year. The problem is that raising interest
rates will cause people to stop expecting higher asset prices as well, and
they will sell.

Deflation in the long run is something to worry about, but it's strange for me
to hear long term worries when we have more serious short term worries. How do
you stop our extraordinary monetary policies without dramatically popping the
asset bubble and causing the problems that our policies have been avoiding for
six years?

~~~
surfmike
The Fed is still not even hitting its own 2% inflation target. Long-term
inflation indicators are showing we'll have below-target inflation for a long
time. People have been saying inflation is right around the corner ever since
QE started, and it's nowhere in sight.

I would argue exactly the opposite -- deflation in the short term is something
we should absolutely worry about. We know very well how to put a lid on
inflation once it starts, but for now we have exactly the opposite problem.

~~~
natrius
Imminent inflation isn't the only problem to worry about. The main problem is
investors believing that the market has topped. If we keep rates low and the
world's central banks keep buying assets, eventually prices will reach a point
that people stop believing. The other option is that when _expected_ inflation
goes up, people will predict that interest rates will go up, and as a result,
they'll believe that the market has topped.

If asset prices drop precipitously, we might be back in 2008 (or worse).

------
runako
>What if we have seen peak energy prices on our lifetime? What if we won’t see
long term rates in the US of 10% again in our lifetime?

It's predictable that financial operators will, at some point during a cycle,
begin to wonder if current conditions will persist forever. What's fascinating
to me is that smart people have to relearn the lessons from not too far back,
as if it's all new material. "The new normal" ended a long time ago for many
asset classes.

As a credit to Wilson, he's not cheerleading for the ideas in his post.
Nonetheless, the questions he raises mirror the idea that the dollar was dead
(Protect your wealth with Bitcoin!) or the earlier idea that real estate
prices will only go up. Or that the New Economy wasn't bound by the old rules.
The peak oil idea was popular in 2006, and celebrities wanted to get paid in
Euros during the crisis.

The global economy is dynamic. Times change. Stuff repeats. This time is not
different.

~~~
gfodor
Stuff doesn't repeat, it rhymes. We may see the economic cycle upturn again,
but interest rates might not go along for the ride this time. For example, in
the 70's, stagflation was pretty different that time. Also the balance sheet
recession in Japan was also pretty different.

We're riding some major trends in increased productivity that may go
exponential, so if that's the case then yes, this time it is very different
and the downward pressure on rates from this might put us into a secular
deflationary period of a pretty long time. Nobody is saying we'll _never_ see
a period of rapid inflation or high interest rates, but merely saying that we
may be in a secular period that lasts long enough for that not to matter for
anyone alive today.

------
softdev12
With inflation running so low in the U.S. for so many years, it's easy to try
to extrapolate this trend as the new norm. And, yes, there are technology
pressures that push costs down (i.e machines replacing workers, Moore's law,
etc.)

However, there are two big factors that argue against long term deflation:

1) Employee wages: Built into the compensation system is a review process that
rewards workers for their work. To date, this process includes a wage increase
in the form of a "raise". In an era of full employment, periodic raises push
costs up, which leads to increases in prices, which leads to inflation. To
change this, the compensation system would need to be changed or employment
severely reduced.

2) Central Banks: Most central bankers will use all their tools (in the form
of monetary fiscal policy) to prevent long-term deflation. So, there will
likely be a major counter-acting force from large governments over time.

~~~
mrec
> To date, this process includes a wage increase in the form of a "raise". In
> an era of full employment, periodic raises push costs up

Not inherently, I don't think. If every employee started on $10 and got a $1
raise every year until they retired, and there was a 1:1 ratio of joiners to
retirers, there's no overall inflation. Individuals' wages might rise over
time, but the average wage doesn't have to.

> Most central bankers will use all their tools (in the form of monetary
> fiscal policy) to prevent long-term deflation.

Empirically, central bankers respond to a bursting asset bubble by blowing a
bigger asset bubble. Dotcom bubble crashes, blow a housing bubble. Housing
bubble crashes, blow an everything bubble.

------
roymurdock
Saving is the way to bet on deflation. If you really want to bet on deflation
simply sell all non-necessary assets now, hold your wealth in cash or 10 year
T-bills (not short-term interest bearing debt which are highly-correlated to
the rate of deflation), and watch your cash/bonds appreciate relative to the
goods you've sold.

------
ojbyrne
I feel like this is a blind spot of VCs - thinking that every oscillation in
something - like the current price in oil - is the "new normal" \- when it is
just as likely to go back to where things were before in 3-5 years.

Occupational hazard, I think.

~~~
JustSomeNobody
I think it's just to get their name on a few soundbites rather than actually
believing what they say. It's harmless to call something the "new normal".
Even if it proves to be temporary it's relatively easy to spin it so that you
were correct anyway.

------
api
I can't imagine energy staying this low for very long. 80+% is fossil:
increasing consumption, finite supply. Short term booms and busts are
possible, but I fail to understand how the laws of physics permit a secular
bear market in energy until we have something really replacing fossil fuels.

Conventional wisdom seems frequently wrong in economics. If deflation is now
the expectation, inflation might be around the corner.

~~~
jessaustin
_...fossil... finite supply._

This is only true in a trivial sense. As it should be clear by now (although
to be fair it also should have been clear 30 years ago), more effective
extraction methods are developed at a steady pace.

[EDIT: since this has been confused multiple times, let me clarify that
"trivial" and "absolute" are not antonyms.]

~~~
jacquesm
No, it is _very_ true in an absolute sense as well. It's just that border
keeps on shifting but underneath that there is a very real finite amount that
exists, and not all of that will ever be extracted.

~~~
jessaustin
I was thinking of exactly that absolute sense. I consider that sense trivial,
in that it won't ever affect our economic situation. (I assume we'll have some
other way of making plastics centuries from now when extraction tech finally
stops improving.)

~~~
jacquesm
> I consider that sense trivial, in that it won't ever affect our economic
> situation.

It is already affecting our economic situation in a very real sense and it has
done so catastrophically on several occasions in the past.

Imagine a world where oil costs $500 / barrel and you're looking at a totally
different world than the one we live in today. That would completely alter the
balance of power.

~~~
jessaustin
Well, let's not bicker. If you're contemplating sustained (not temporary
spikes!) $500/b then you don't agree with TFA's claim that "energy prices are
going relentlessly down", although you state above that the feasible
extraction "border keeps on shifting". Presumably you envision some factor
that will stop innovation in extraction, which would be interesting to learn.

~~~
jacquesm
We are awash in energy, that's not the problem. The problem is in capturing
that energy and that energy comes in many forms and only oil currently allows
you to project power on a global scale.

"It's raining soup, and all we have is forks"

And energy prices for say electricity could be going down while energy prices
for petroleum could be going through the roof. Utility pricing for energy is
historically coupled to the oil price but that won't be sustainable as an ever
larger chunk of the energy consumed electrically is generated by renewables or
nuclear.

The big wildcards are:

\- ITER

\- further dramatic reduction in solar panel pricing

\- mass transportation using electricity

\- battery technology

\- the first successful long range electrical airplane

------
terrilldent
Core CPI is around 1.7% in the US right now. Energy is affecting the non-core
value (currently at 0% or slightly negative). The non-core value is typically
very volatile.

The Fed has a target of 2% inflation. Krugman makes good arguments that the
target should be 4%.

Meanwhile the Fed is talking about raising interest rates later this year
(which is deflationary).

There are two clearly different views forming and it will be interesting to
see how it plays out.

Canada has a target 'between 1 and 3%' and our core is currently sitting at
2.1%. We just had a interest rate decrease.

Some recent comments from Krugman about why we didn't see deflation during the
recent recession:

[http://krugman.blogs.nytimes.com/2015/03/31/missing-
deflatio...](http://krugman.blogs.nytimes.com/2015/03/31/missing-deflation-
and-the-argument-for-inflation/)

------
cs702
A persistently deflationary economy would be _horrible_ :

When everyone expects prices to fall in the future, everyone becomes less
willing to spend today. Sitting on cash becomes an investment with a positive
yield. The less everyone wants to spend on goods and services, _the less
businesses sell of everything_ , and the more they have to compete by lowering
prices further, making everyone less willing to spend... a vicious circle of
economic contraction.

Businesses normally find it very, very difficult to cut employee compensation
in line with declining prices, so they end up cutting costs by firing people
instead, making everyone less willing to spend, so businesses sell less of
everything, forcing them to cut costs futher... contributing to the vicious
circle of economic contraction.

A deflationary economy is a negative-sum game in which everyone loses.

~~~
gfodor
This is the standard story about deflation, but the idea that a slightly
deflationary environment will suddenly change purchase behavior has always
struck me as a bit academic. The average consumer doesn't buy stuff because
they think inflation is going to cause it to become more expensive in the
future, they buy stuff because they need it. It seems borderline absurd to
suggest that consumers are going to reconsider buying something because in a
year it will be a few % cheaper in price.

However, I do agree that a persistent deflationary economy (and the
corresponding expectations that it will continue) will have... interesting
effects on interest rates, debt, and corporate spending. But I still am not
sold on the idea that it's a de facto negative thing. I think saying
"deflation = bad" oversimplifies the lessons to be learned from the Great
Depression but unfortunately that's the lesson we're taught.

~~~
harryh
Of course it won't change consumer behavior for everyone all the time. At some
point I'm just gonna have to buy that dishwasher. But it will change consumer
behavior at the margin and what happens at the margin is what economic
thinking is all about.

Also, it's not just about consumer behavior but also investor behavior. Why
should I take the risk of investing my money in a new product or company if I
can earn a profit by hiding my money under my mattress?

~~~
gfodor
On your former point I actually agree, but that's not the way the 'deflation =
bad' argument is usually presented. It's usually presented that "people will
defer purchases", full stop, and that would be terrible but it's hard to
believe. I agree it will happen on the margins, but that might not be a huge
deal.

Investment wise, it always comes down to risk and inflation adjusted returns.
Hiding your money under your mattress results in a risk free positive real
return in a deflationary environment, but this just the same as buying a short
term treasury bond.

It's self evident that just because you can get a risk free positive return,
it doesn't mean capital won't take on risk for a higher one. If that were the
case, nobody would invest in anything other than government bonds.

~~~
ChrisLomont
Deflation shifts the returns, making holding cash more attractive, so it
reduces investment. Reduced investment likely results in lower long term
growth as less new businesses and ideas can be funded.

~~~
gfodor
Deflation effectively increases the risk free real rate. So the same effect of
seeing the rate on the 10yr rise will be seen with disinflation. The
difference being that you get some yield for "free" by just holding the cash
and not buying bonds, but this is just incidental. The effect on risk-taking
should be the same. So the point is I don't understand why it's treated as a
deathblow for investment when we accept interest rate rises all the time
without widespread panic about investment coming to a halt.

~~~
ChrisLomont
There is a huge difference between interest rate changes, which are set in
large part by the Fed, versus deflation, which is not set by the Fed.

The return on a 10yr (govt bond I assume?) is set by the market - this is not
just picked or changed arbitrarily, although returns there are likely
influenced by Fed rates.

People control the interest yield for many products through the Fed, so we can
avoid a deflationary spiral just by having the Fed change the interbank loan
rate (among other things they can do).

Deflation (caused by many types of things from demand shocks to economic fears
to war) is often not easily dialed back, and can lead to a deflationary
spiral, which cannot be simply tuned by the Fed.

This is the reason the Fed targets slight inflation instead of zero inflation;
the controls are not magic and the inflation/deflation tends to hover around
where the Fed targets, and by staying away from zero we avoid possibly
triggering a deflationary spiral we cannot control.

In short, we have good tools for dealing with inflation. We do not have
equivalently good tools for dealing with deflation.

------
jchrisa
I enjoy this argument in favor of negative interest rates: [http://sacred-
economics.com/sacred-economics-chapter-12-nega...](http://sacred-
economics.com/sacred-economics-chapter-12-negative-interest-economics/)

~~~
skilesare
Yes. Yes. Yes! I've read the first 5 paragraphs of this and I'm pretty sure
I've found my kindred spirit. Anyone know the best way to contact this guy?

~~~
jchrisa
He's got a bunch of books, actually my favorite is "The Yoga of Eating" even
though I'm not in the market for diet advice.

------
adventured
"Energy prices are going relentlessly down."

That's very wrong.

[http://i.imgur.com/LG2LTTT.jpg](http://i.imgur.com/LG2LTTT.jpg)

Meanwhile annual energy use per household has not increased in two decades.

~~~
wutbrodo
It's worth noting that the price rise is in large part due to the switch away
from coal[1] towards more expensive nat'l gas and renewables. A big chunk of
the cost "increase" can be attributed to actually paying the cost of
externalities (i.e. the costs of coal-burning to others is not reflected in
the price).

You are right though, it does make the claim that "energy prices are going
relentlessly hard" odd without further context; presumably he was talking
about a more apples-to-apples comparison of how each type of energy is
dropping in price (oil prices dropping, renewables getting cheaper), but that
the mix is shifting towards types of energy that are more expensive (and have
less externalities) so _residential_ energy prices reflect more of the cost.

[1] [http://www.latimes.com/nation/la-na-power-
prices-20140426-st...](http://www.latimes.com/nation/la-na-power-
prices-20140426-story.html#page=1)

------
xhrpost
I think this only holds true if needs (or perhaps, desires) remain completely
static. If standard of living never increases and what we want to do with
resources never increases. If you want to compare Moore's law, technically the
5khz speed of the ENIAC would cost pennies today. So, why do we spend hundreds
of millions on super computers? Simple, we already did what 5khz did for us,
now we want to do more. If commodities are cheaper, new industries will spring
up that make use of that pricing. The builders of the ENIAC may not have
envisioned people coding in their basements to make a nice living, but that's
what they paved the way for. If there are deflationary effects in action,
though there will probably be down sides, I'm excited to see what new
industries pop up from it.

------
jacquesm
Inflation adjusted oil prices:

[http://inflationdata.com/Inflation/images/charts/Oil/Inflati...](http://inflationdata.com/Inflation/images/charts/Oil/Inflation_Adj_Oil_Prices_Chart_small.jpg)

~~~
mrfusion
What should I take away from that?

~~~
jacquesm
That dollar-for-dollar oil prices have not risen nearly as much as you might
think since the 70's, especially not when compared to other items such as
real-estate or food.

------
skilesare
I just kicked off a kickstarter to try to builds some experiments to deal with
a lot of these issues. So far I'm not hopeful that there is enough interest in
looking at these things differently to get it funded, but I'm going to build
it anyway.

[https://www.kickstarter.com/projects/hypercapital/hypercapit...](https://www.kickstarter.com/projects/hypercapital/hypercapital-
experiment-testnet-apis)

More at: [http://hypercapital.info](http://hypercapital.info)

------
ArkyBeagle
It's arguably been going on ( with interruptions ) since _1992_. There are
only like two years with CPI greater than 5% in the U.S. since then.

Of course, it's unevenly distributed - medical care, education and housing
have all gone up.

I don't think we want nor should we celebrate deflation. It makes a culture
hidebound, makes (some) things harder on the poor and can destabilize
governments.

Income inequality and political polarization both have a basis in deflation,
in my view.

There are nations - like Australia - that do not have deflation. It's not
inevitable.

~~~
NeutronBoy
Australia hasn't had deflation because for the last 20 years we've basically
hitched our wagon to China in the form of mining exports. During that time
(and particularly the last 5-8 years) the rest of our heavy and manufacturing
industry has stagnated or died (our last locally made car manufactures are
finishing up production in the next few years). Now that China's boom is
slowing, and we have basically no other heavy industry left to fill the gap,
deflation is a real possibility.

~~~
ArkyBeagle
I am sure it will remain to be seen.

I am basing what I said on Sumner's writing on the subject ( how's that for an
appeal to authority? :) ) He seems to hold that Oz uses something closer to
NGDP level targeting in monetary policy.

[http://www.themoneyillusion.com/?p=12985](http://www.themoneyillusion.com/?p=12985)

I am probably missing something.

------
dimitar
One of my favorite economists has argued that whether you have 1% deflation,
0% inflation or 1% inflation isn't that different. Most prices aren't really
changing - you don't get much of the effects mentioned in the post or most of
the comments.

But getting the economy to 5% inflation? That brings a lot of dynamism back!

------
chetanahuja
Deflation is not just a problem for "debtors". It's a basic and simple problem
with the economy as a whole. The very basic problem is, if the 100 dollars I
have in my wallet right now will be worth 110 dollars next year, I would
naturally be disinclined to spend my money today?

Now, one can debate whether economic growth model as understood today (where
Growth == higher number of transactions) is the most desirable model of
economic goodness or not. But so many other metrics of a happy economy (jobs,
govt spending on public services, societal optimism etc.) are so tied up to a
growing economy in the current model, that the only practical way this could
be changed is via a huge political revolution... which has it's own problems.
Given all that, it'll be hard for a reasonable thinker to welcome a permanent
state of deflation.

And fwiw, IMHO, it's no more than a thought exercise. We're nowhere near an
actual permanent state of deflation.

------
ArkyBeagle
One of the things that I value most on the Internet is the information at this
link:

[http://wfhummel.cnchost.com/](http://wfhummel.cnchost.com/)

If it were a book, it would be a very thin book and you owe it to yourself to
read it.

------
pistle
This sounds like the converse of "housing prices are expanding at double-digit
rates! Is this the new normal?!"

Of course, that's right before a crash. Just a thought...

------
jldugger
This is more or less what Bernake was staving off in The Crisis, but he had
the political savvy to use a technical term:'deleveraging.'

~~~
chasingtheflow
This was also posted recently [http://www.brookings.edu/blogs/ben-
bernanke/posts/2015/03/30...](http://www.brookings.edu/blogs/ben-
bernanke/posts/2015/03/30-why-interest-rates-so-low)

