Whip Deflation Now

The central truth of the U.S. economy this Christmas season can be summed up in one word.

Deflation.

Few Americans understand deflation because few have been alive to see it. The last such spiral came from 1929-33. This was what the Great Depression was all about.

Prices do decline during deflation, but wages fall faster. There was a lot of talk when I was a kid about wages being “sticky downward” but the last few years have put the lie to that. Real wages haven't gone up for a decade, and in many areas they're now headed down in absolute terms.

It's prices that are sticky downwards. While the Great Depression was a global phenomenon, with negative growth everywhere, this current deflation is limited to the “developed” world. Growth remains in places like Brazil, India and China, as well as the rest of Southeast Asian, and even Africa doesn't have it too bad in comparison with the past. This demand is keeping commodity prices from falling as they did 80 years ago, masking the reality of deflation from policymakers, and from voters.

Fast action by Hank Paulson prevented a worldwide catastrophe in late 2008. but actually set us up for today's bigger problems. He basically created money and threw it at his banker friends with the aim of making them whole and keeping the financial system running. But rather than take losses equal to their capital intake, as they should have done, instead of writing off mortgages that couldn't be paid, the banks pocketed the money and started paying one another bonuses again.

So let's simplify things. What happened in 2008, what's happening today, is called a bankruptcy. What is supposed to happen in a bankruptcy is that creditors write-off bad loans. What happens to bad loans that get written off? That money basically disappears from the system. That's why injecting new capital – creating new money – is so important. Its aim is to forestall deflation by increasing the supply of money.

The problem today is that creditors don't want to take their medicine. European bankers don't want to take their medicine and write off enough loans to allow payment and renew growth. European central bankers don't want to create enough Euros to make this possible. Europe is waiting for a “Lehman moment” to do what Paulson did, create new money to wipe out old debts.

There's a second step in this policy scenario that hasn't taken place. New investment sufficient to get the private economy rolling again. Yes we had the stimulus, but Paulson lied about the depth of the problem, as we now know, and the stimulus was insufficient. We're only now starting to get back on track, just as Europe faces its crisis.

The danger, which goes by the name Japan, the “lost decade” everyone is talking about, is simply a deflationary spiral that has yet to be addressed. Look at the value of the Yen compared to, say, the dollar. It's about 75. Last time I was in Japan, in 2009, it was 110, and I thought it was insane then. Back when I first visited Japan, in 1989, shortly after that nation's bubble burst, it was about 130.

It needs to be at around 150, and for that to happen the Bank of Japan needs to create, out of whole cloth, trillions and trillions of yen, and find some way to distribute those yen to stimulate investment. The currency makes them rich, but an insane fear of inflation, leading to its opposite, is keeping that from happening.

All those calling for “austerity” are calling for a Japanese solution to our problems. England is currently trying austerity as a cure for its economy and guess what – their debt problem is worse than ever. That's because, as fast as they cut services, they destroy growth and the real economy. What they should be doing is creating new pounds that can go into investments that make money.

And that's what we should be doing too. The good news is that, thanks to our central bank, whose chair did his dissertation on Depression Economics, we sort of are. We're growing, a little bit, because there are enough dollars coursing through the economy to allow for some profitable investments. But we can do more. Not by borrowing dollars, but by creating them.

By creating inflation.

Conservatives today say, as they did in 1933, that inflation is evil, that it must be avoided at all costs. They say this because they represent creditors, people who lent money, too much money, on projects that didn't get a return. They want their money back, and inflation will make that money worth less.

To that I have to say, tough titties. You'll make up for it in better stock prices, in bigger sales, in growth down the road. That's the way out. For Japan, for Europe, and for America as well.

Now you Ron Paulites are probably saying, hmmm, that man is arguing that we bugger the dollar. Won't gold rise in value? Yes, it should. But it's already rising in a deflationary economy. Gold isn't money. Gold is a commodity with a few industrial uses, but that's all it is. Nothing is money, except money.

And for growth we need more money. Once we get growth the burden of our debts will decrease, there will be investment alternatives to gold, and any rise in gold's price will be moderated. Buy gold if you want.

I prefer money.

More money, please.