On Exporting Deflation

Return­ing to our char­ac­ters of a few weeks ago, we remem­ber that Bob and his coun­try had increased the sup­ply of waf­fles thus mak­ing the export of Bob’s organic grass-fed but­ter cheaper. This hap­pens because other coun­tries like Nigel’s can now get more waf­fles on the pas­try cur­rency mar­ket and can buy more of Bob’s but­ter. There is a slight (or not so slight in our exam­ple of dou­bling the waf­fle sup­ply just so Bob could sell more but­ter) infla­tion­ary pres­sure in The Land of Guns and Large Bor­der Fences. Another effect of this deci­sion is a slight defla­tion­ary pres­sure in Nigel’s Land of Peo­ple With Below Aver­age Den­tal Hygiene (LOPWBADH).. The rea­son this is so is because of the con­nect­ed­ness of the two coun­tries via the pas­try exchange mar­ket. The Nigel’s clot­ted cream now costs more to export it to Bob’s coun­try. On the sur­face this looks infla­tion­ary because the prices went up. But when think­ing about infla­tion or defla­tion, it’s impor­tant to con­sider both prices and demand. Because Nigel will now sell less clot­ted cream, he may have to lay off Colin, his dairy man­ager. Colin may then have to get a lower pay­ing job which means he has fewer crum­pets to spend. This lack of demand on a broader scale leads to defla­tion­ary pressures.

This lack in aggre­gate demand is a side of the inflation-deflation dis­cuss that you’ll rarely see in finan­cial press because it’s the part of the equa­tion cen­tral banks have almost no con­trol over. We’re cur­rently see­ing this in Euroland where the economies of the mon­e­tary union have been under sig­nif­i­cant down­ward pres­sure for months as unem­ploy­ment remains stub­bornly high in many coun­tries. When you don’t have a job, you don’t buy either clot­ted cream or expen­sive imported grass fed but­ter. The con­tin­ued defla­tion­ary pres­sure can quickly spi­ral down­wards. Once upon a time, defla­tion was a nor­mal part of the eco­nomic cycle and when every major cur­rency in the world was tied to a hard asset, typ­i­cally gold, there was a gen­eral defla­tion­ary pres­sure because you can’t increase the money sup­ply with­out increas­ing the pro­duc­tion of the hard asset. These days, with no coun­try tied to a hard asset, defla­tion is sup­pos­edly a thing of the past (though the time may be return­ing as the Chi­nese gov­ern­ment has been buy­ing gold in large quan­ti­ties, another fact you won’t see men­tioned in the finan­cial press). And in fact, defla­tion is a ter­ri­fy­ing prospect for gov­ern­ments and cit­i­zens that are heav­ily indebted. Dur­ing defla­tion, the cost of debt rises as the cur­rency appreciates.

Imag­ine a sce­nario where 50% of your income goes to ser­vic­ing your credit card debt. What hap­pens if you sud­denly make less money or if the inter­est rates rise? Big trou­ble, that’s what hap­pens. Now your debt to income ratio goes up and you either have to do with­out things or begin to think about default­ing on the debt. Our reliance on debt as a soci­ety both con­sumer and gov­ern­ment means defla­tion is extra­or­di­nar­ily dan­ger­ous. For exam­ple, it takes half the tax rev­enue of the coun­try of Japan to ser­vice their pub­lic debt. What hap­pens if inter­est rates rise in Japan? Sud­denly, they strug­gle to pay their oblig­a­tions. That’s why they (and many other coun­tries) can’t afford to let inter­est rates rise. Their answer is to adopt a pol­icy of zero inter­est rates by manip­u­lat­ing the mar­ket with made up money.

Europe is cur­rently on the precipice of defla­tion. To fight it, the Euro­pean Cen­tral Bank has announced a $1.3 tril­lion (give or take a euro or two) stim­u­lus pro­gram aimed at increas­ing the infla­tion rate and sta­bi­liz­ing the fall in prices. Leav­ing aside whether this will even work, what effect does this have on other coun­tries? This inten­tional devalu­ing of the Euro will lead to stronger cur­ren­cies in the trad­ing part­ners of Europe. Those stronger cur­ren­cies now have to con­tend with the defla­tion­ary aspects which is exactly what is hoped for by the Euro­zone. This beg­gar thy neigh­bour approach even­tu­ally causes other coun­tries to retal­i­ate lead­ing to a cur­rency war which many peo­ple think we are cur­rently in. This is the mean­ing of export­ing deflation.

So how is the prob­lem actu­ally solved? A decreas­ing reliance on debt is the first start. In nor­mal times (like the 1800s) defla­tion was part of the busi­ness cycle. As defla­tion would occur, peo­ple, busi­nesses and coun­tries would delever­age, reduc­ing their debt. Even­tu­ally, the economies would cycle back to infla­tion. In today’s world, defla­tion can’t even be allowed to occur because of the debt lev­els of coun­tries. The goal is per­ma­nent growth because with­out it, we can’t pay our debts. But per­ma­nent growth funded by increas­ing debts is a fan­tasy world that doesn’t have a happy end­ing. A coun­try like Japan has no choice but to try and print money (the Bank of Japan cur­rently buys almost all of the country’s pub­lic debt) to ser­vice their debt and increase infla­tion. This is a grand exper­i­ment of our cen­tral banks unseen before in his­tory. In the short term, it means the Japan­ese yen will con­tinue to lose value to the dol­lar and the Euro­pean stock mar­kets are likely to increase just like the US stock mar­ket went up over the past sev­eral years dur­ing our own quan­ti­ta­tive eas­ing. In the long term, it’s anyone’s guess. What hap­pens if Japan defaults? What hap­pens if the ECB’s tril­lion euro pack­age doesn’t work? At some point, the lev­els of debt have to be reduced either by the dif­fi­cult process of delever­ag­ing or by default. Nei­ther will be pleas­ing and the far­ther down the road we kick the can, the harder it will get. Even­tu­ally, the road will end on a cliff and we may all just tum­ble over it.

What I’ve Been Reading

Part of my morn­ing com­mute usu­ally involves catch­ing up on Twit­ter and most recently the finan­cial infor­ma­tion com­ing out of Zero Hedge along with a cou­ple of other sources from Maudlin Eco­nom­ics. Many of these arti­cles prob­a­bly don’t war­rant a full blog post but I thought I might start aggre­gat­ing them on Sun­day morn­ings with […]

On Maintenance And Repair

When I was a kid, not so many years ago geo­log­i­cally speak­ing, I found a .22 rifle in the barn at my grand­par­ents farm. It didn’t really work and it was hard for me to ascer­tain exactly why given my rudi­men­tary gun­smith skills as a 13 year old. But I didn’t have a .22 rifle […]

On Defining Goals

I recently read an arti­cle in Gar­den & Gun (an excel­lent mag­a­zine if you love the cul­ture of the South) on three women who returned to their fam­ily farm to make a liv­ing off what they could grow and cre­ate from their own labors. One of the women was a musi­cian who had strug­gled through […]

On Understanding Currency Wars

Imag­ine if you will the fol­low­ing sce­nario: Nigel lives in the Land of Peo­ple with Below Aver­age Den­tal Hygiene (LOPWBADH). Bob lives in a neigh­bor­ing coun­try, the Land of Guns and Large Bor­der Fences (LOGALBF). Both Nigel and Bob own dairies. Nigel makes excep­tion­ally good clot­ted cream in his dairy while Bob makes organic grass […]

Easy Summer Breakfast

It’s the height of tomato sea­son around here and we’re over­whelmed with toma­toes. I may or may not have over­planted this year but I just picked a pound of yel­low pear toma­toes and there are more on the vines. With that kind of pro­duc­tion, you have to find inter­est­ing ways to eat more toma­toes. I […]

The Blood Moon and Inflation

Last night at around 3 AM I watched the blood moon eclipse from the back­yard. It was a fas­ci­nat­ing expe­ri­ence that felt pri­mal as if I were liv­ing 400 years ear­lier when an occur­rence of a total eclipse would have been some­thing peo­ple revered or even feared. Watch­ing the moon go dark would have been […]

Consistency Is Hard

One thing I’ve learned from try­ing to write every day for 40 odd days is that it’s very hard to do. Even if you aren’t par­tic­u­larly wor­ried about qual­ity (and it’s clear I’m not), doing any­thing other than eat­ing and breath­ing for 40 days in a row is dif­fi­cult. Other things get in the way […]

Falling Out of Rhythm

The days seem to be get­ting shorter and I don’t find time to write. Today there was plenty of time but I chose to spend it watch­ing the Mas­ters. I’m ok with that trade­off. I wrote my grand­mother a let­ter tonight so all in all, I fig­ure it’s a net positive.

On Garage Sales

I find the inter­sec­tion of human behav­ior and garage sales fas­ci­nat­ing. I men­tion this only because I just had one this week­end where I made a whole $46 dol­lars before sub­tract­ing expenses. I watched 5 peo­ple open the lid on a wash­ing machine as if what they saw inside told them the value of said […]